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Oskar Lange'S Contributions To The Theory Of Socialism, With Applicationsto Yugoslavia And Czechoslovakia

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Oskar Lange'S Contributions To The Theory Of Socialism, With Applicationsto Yugoslavia And Czechoslovakia

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Content OSKAR LANGE'S CONTRIBUTIONS TO THE THEORY OF SOCIALISM, WITH APPLICATIONS TO YUGOSLAVIA AND CZECHOSLOVAKIA by Fereydoon Tafazzoli A Dissertation Presented to the FACULTY OF THE GRADUATE SCHOOL UNIVERSITY OF SOUTHERN CALIFORNIA In Partial Fulfillment of the Requirements for the Degree DOCTOR OF PHILOSOPHY (Economics) June 1970 70- 26,535 TAFAZZOLI, Fereydoon, 1940- OSKAR LANGE’S CONTRIBUTIONS TO THE THEORY OF SOCIALISM, WITH APPLICATIONS TO YUGOSLAVIA AND CZECHOSLOVAKIA. University of Southern California, Ph.D., 1970 Economics, theory University Microfilms, Inc., Ann Arbor, Michigan ^COPYRIGHT BY Fereydoon Tafazzoli ■ k I 1971 ! UNIVERSITY OF SOUTHERN CALIFORNIA THE GRADUATE SCHOO L UNIVERSITY PARK LOS ANGELES, CALIFO RNIA 9 0 0 0 7 This dissertation, written by Fereydoon Tafazzoli under the direction of hi s . . . . Dissertation Com mittee, and approved by all its members, has been presented to and accepted by The Gradu ate School, in partial fulfillment of require ments of the degree of D O C T O R OF P H IL O S O P H Y D a te ..J P P P ./....^ l? ... DISSERTATION COMMITTEE , - G m - ' re. C c V f e fyto*. Q Chairman TABLE OF CONTENTS Chapter Page I. INTRODUCTION..................... 1 Purpose.......................... 1 Setting of the Problem............ 1 Scope and Organization............ 4 Hypotheses....................... 5 Methodology...................... 5 Definitions...................... 6 Organization of Remainder of Dissertation................... 13 II. SURVEY OF THE MAIN CONTRIBUTIONS TO THE ECONOMIC THEORY OF SOCIALISM... 15 Introduction..................... 15 The Criticisms of Ludwig von Mises. 18 Other Critics of the Economic Rationality of Socialism....... 32 Reactions to Critics of Socialism - A Famous Debate................ 40 Socialism and Optimum Welfare Conditions..................... 60 Welfare Economics and Socialism: Policy Implications............. 71 Economic Theory of Socialism under Reconsideration................ 87 The Present State of the Diebate.... 99 Summary.......................... 103 III. LANGE'S PREWAR MODEL OF DECENTRAL IZED SOCIALISM................... 105 An Overview of Lange's Prewar Model 105 Behavioral Principles of the Lange Model of Decentralized Socialism. 113 Lange on Centralized Socialism 130 Lange's Preference for Decentral ized Socialism................. 132 ii Chapter Page The Lange Model: A Walrasian- Type Equilibrium............... 132 The Lange Model: A Graphical Illustration................... 140 The Lange Model: Welfare Implica tions.......................... 146 The Case for Socialism............ 148 Lange's View of Four Central Economic Problems: A Comparison Between Socialism and Capitalism. 155 Summary........ 163 IV. CENTRALIZED SOCIALISM AND LANGE'S POSTWAR MODEL.................... 166 Introduction..................... 166 Behavioral Principles of Central ized Socialism: The Methodology of Economic Planning............ 171 Summary.......................... 233 V. DECENTRALIZED AND CENTRALIZED SOCIALISM: AN APPRAISAL........... 238 Introduction..................... 238 Decentralized Socialism........... 239 Centralized Socialism............. 274 A Concluding Note................ 289 Summary.......................... 290 VI. THE APPLICABILITY AND RELEVANCE OF THE LANGE MODELS OF CENTRALIZED AND DECENTRALIZED SOCIALISM: THE CASE OF YUGOSLAVIA....................... 292 Introduction..................... 292 Evolution of the Yugoslav Economic System: An Analysis of Policy Interactions................... 298 An Analysis of Specific Features of the Yugoslav Economic System.. 314 Chapter Page Lange and Yugoslav Economic Practice....................... 327 General Appraisal................ 341 Summary.......................... 349 VII. THE APPLICABILITY AND RELEVANCE OF THE LANGE MODELS OF CENTRALIZED AND DECENTRALIZED SOCIALISM: THE CASE OF CZECHOSLOVAKIA............ 352 Introduction..................... 352 The Functioning of the Economy 355 Search for Decentralized Socialism. 372 Lange and Czechoslovakia's New Economic Model................. 394 General Appraisal................ 403 Summary.......................... 410 VIII. SUMMARY AND CONCLUSIONS........... 414 Summary.......................... 414 Conclusions...................... 428 BIBLIOGRAPHY 437 1 CHAPTER I INTRODUCTION Purpose The purpose of this dissertation is to critically re-examine the contributions of the late Polish economist Oskar Lange to the economic theory of socialism and to assess the relevance of the Lange model(s) to the evolution and development of the Yugoslav and Czechoslovak economic systems. Setting of the Problem Resource allocation, according to some definitions, is precisely what economics is about. Karl Marx had little to say about this key issue under socialism. After World War I, however, socialist parties acquired power in a i number of European countries, and their members were I ' i forced to examine the practical problems of socialism. j ! About the same time (in 1920), Ludwig von Mises, a critic j j of socialism, challenged the socialists in an article in j which he contended that rational calculation under social- | j ism would be "impossible." He argued that without private ! i i !ownership of the means of production there would be no j i I | j market for capital goods, no prices on them, and conse- j | J quently no way of determining rationally how they should be j used. In short, according to Mises, there is no way of ! I ! i jeconomizing the utilization of these goods and economy thus becomes impossible. | ' Actually, Vilfredo Pareto in 1897 and Enrico Barone j ! ! in 1908 had developed a mathematical solution of the pro blem of allocating capital in a socialist economy. Lionel ; Robbins and Friedrich A. von Hayek, however, in 1934 and i ! j1935 respectively, pointed out that while this solution was! !theoretically correct, it did not provide a practical Imethod of deciding how to allocate resources, especially toj ; i I I use capital equipment. A mathematical model of a complex, | modern economy would require the solution of hundreds of j thousands, or millions, of simultaneous equations, one equation for each of the unknowns, for each of the items the output of which the authorities are seeking to deter mine. By the time this extremely difficult task is accomplished, changes in the economy will have made the solution obsolete. Mises' attack on socialism, as well as the Robbins- j Hayek criticism, led to a number of counter-arguments. J Already by 1929, Fred M. Taylor had suggested that social- j ists could solve the problem by assigning provisional values through a process of "trial and error." Building on | this suggestion in the 1930's, Oskar Lange, H. D. Dickin- I j son, and Abba Lerner developed an analysis of "decentztal*- ized socialism" somethimes referred to as market socialism, | 3 liberal socialism, the "competitive solution," or the Lange- Lerner model. But for several years Lange's "economic theory of socialism" remained merely a blueprint. The Communist countries, after nationalizing a vast majority of the means of production, established a quite different economic system under which most of the market functions were replaced by central command authorizing the allocation of resources. Learning from Communist experience, the problems of the emerging economically underdeveloped countries, and some of the prominent failings of decentralized socialist economic organization, socialists focused their interest on centralized socialism as a type of economic system suitable for achieving priority goals in underdeveloped countries. Such Western neo-Marxists as Paul Sweezy, Maurice Dobb, and Paul Baran, as well as Lange (in his postwar writings), have contributed a great deal to the theory of centralized socialism. j I I In the early 1950's, Yugoslavia was the first Commu- j inist country to make a widespread use of the markets as an J I . . ! !alternative to detailed central command, thus reviving ! ; i jsome of Lange's recommendations from his prewar model. | i j Socialist economists argued that at a lower stage of de velopment there is a case for deliberate reliance upon ! i centralized socialism to achieve certain priority goals, j {but at a later stage there would be a need for a j 4 decentralized system of economic organization to attain economic efficiency. This switch became apparent in Yugoslavia in the early fifties after Tito had broken off with Stalinist Communism. In the case of Czechoslovakia, this transition came in the early 1960's. Scope and Organization The study begins with an examination, at some length, of the historical development of controversy over economic rationality under socialism with an emphasis upon prominent views found in the literature. The next issue considered is the prewar Lange model of decentralized socialism. Its constituent elements, plausibility, and prospective efficiency are examined in terms of four central economic problems: (1) resource allocation, (2) income distribution, I ' (3) economic stability, and (4) economic growth. Addi tionally, there are political, ethical, and moral dimensions of Lange's argument persuasively incorporated in the model. These non-economic issues are discussed in the course of t I describing Lange's basic economic model. Following this, j ; | the theory of centralized socialism is discussed along j j with Lange's postwar writings. Finally, the relevance of Lange's prewar and postwar models to the evolution of the Yugoslav and Czechoslovak economic systems is assessed. 5 Hypotheses This study critically examines two main hypotheses: (1) Given such goals as freedom of consumer choice, freedom of occupational choice, and consumer sovereignty, Lange's purpose in his prewar model was to demonstrate that a socialist economy characterized by public ownership of the means of production can achieve rational economic calcula tion and can reproduce the results of competitive market capitalism via a Central Planning Board performing the functions of the market; (2) It is also possible to discern relevance of Lange's postwar writings for the experience of many Communist countries, particularly Yugoslavia and Czechoslovakia. At an early stage of development, a high degree of centralization in planning and administration is necessary, especially when structural changes and a high rate of capital accumulation are perceived as essential for rapid industrialization and economic development; but at |a later stage of development, there will be a need for I | t ] I decentralization to promote economic efficiency. | j i Methodology The study presents a theoretical survey concluding j that a decentralized model of socialism could be a substi tute for competitive market capitalism in the economically- advanced nations of the world. Additionally, a theoretical analysis is presented in deducing the bases for adoptingj 6 centralized socialism as a vehicle for industrialization in economically-underdeveloped nations of the world. Finally, a historical application is given in an effort to show the harmony which exists between Lange's writings and the experiences of Yugoslavia and Czechoslovakia in their voyage into economic development. Definitions To prepare for a discussion of decentralized and centralized socialism we must define some key terms. It is difficult to separate economic systems exactly. This statement applies not only to distinctions among the main types of socialism, but also to those between competitive market capitalism and decentralized socialism and between different centralized socialist systems. Socialism I 1 Socialism, like capitalism, has undergone fundamental changes. With these changes, its definition has also been changed. "A socialist economy in the classical sense is I one that socializes production alone, as contrasted with j i communism which socializes both production and consump- j tion."1 Thus, in the classical sense, there is a distinct j difference between socialism and communism. ^Benjamin E. Lippincott (ed.), On the Economic Theory of Socialism (Minneapolis: University o£ Minnesota Press, 1938), p. 9. 7 The concept of socialism is usually defined by the two characteristics of central direction and public owner ship of the national means of production. That of course does not exclude the possibility that in any actual econo mic system the two attributes may be present in varying degrees. In more modern usage, the word socialism has been used to cover the entire spectrum from a mixed capitalist system to the highly centralized communist system. Within this more modern context, there are gradations and combinations of centralization and decentralization. The German economist W. A. Johr distinguishes four major models of socialism: (1) the entirely centrally-directed economy where the Central Planning Board (CPB) determines the consumption, saving, investment, the level of production of each corpmodity, the allocation of the labor force, and the distribution of output of consumer goods; (2) the centrally-directed economy with free consumer's choice where consumers receive money incomes and have freedom of Ichoice of commodities; (3) the centrally-directed economy iwith free consumer's choice and free occupational choice, jand labor is allocated through wage differentials rather jthan by state direction; and (4) the centrally-directed ! ieconomy with free consumer's choice, free occupational 2W. A. Johr and H. W. Singer, The Role of the Economists as Official Adviser (London: Allen and Unwin, 1955), ipp. 130-131. 8 choice, and freedom to save. The state does not directly control the volume of saving and investment, but indirectly affects the volume of saving through the rate of interest. In each of these four cases, Johr distinguishes two subdivisions: (a) sovereignty of the CPB over individual economic agents; (b) sovereignty of individual economic agents over the CPB. The major categories, (1) through (4), gradually permit more individual freedom in economic decisions. The subdivisions in each category refer to whether there exists a dictatorship of the CPB or whether there is democratic control by the consumers over the CPB. While recognizing the limitation which exists in category (1) with even subdivision (a), it is possible to say that a movement from model (1) to (4) and, within each model, from (a) to (b) involves increasing decentralization and decreasing centralization in the power to make and enforce economic decisions. i i j I Decentralized Socialism | 1 r "■"I-'-- 1 i t -r ' ' i Decentralized socialism is characterized by public i I ownership of the material means of production, but also by free choice of occupation, consumption and consumers' sovereignty. The crucial difference between decentralized ;socialism and competitive market capitalism lies in the existence of state-owned industries that are not operated for private profit. Lange's prewar model of decentralized (socialism under the Johr definitional framework, falls (under category (4) with subdivision (b), i.e., the centrally-directed economy with free consumer's choice and (free occupational choice and with sovereignty of the i ! individual economic agents over the CPB. To simplify the i discussion, under his model it is assumed that all material means of production are state-owned and that the producing units are managed by public officials who follow certain rules of behavior. Public management of all productive and distributive processes renders decentralized socialism a collectivist economy. Needless to say, any collectivist economy charac-( j terized "by the conscious setting of aims for the economy as a whole implies an authority which sees to it that 3 these aims are reached." Hence, the decentralized social ist economy needs a central authority that can set and accomplish goals, an authority that must have the power i to allocate the means of production according to some plan.! In this respect, the Lange type model of decentralized socialist economy is centralistic, though it need not be j totalitarian. Indeed, the Lange model presumes consumer's j i sovereignty in its full traditional meaning. ^George N. Halm, Economic Systems: A Comparative Analysis (New York: Holt, Rinehart and Winston, Inc., 1968), p. 179.| 10 This point is of major significance for differenti ating various forms of collectivism, as was also stressed by Johr in his definitional framework. For instance, communism and fascism will not permit consumer sovereignty to be the main criterion in production and in the alloca- tion of resources. These systems do not want unpredictable actions of consumers and workers to disturb the functioning of the plan. In his prewar model, Lange did not share this opinion. He argued that consumers' sovereignty is compat ible with the collectivist character of a decentralized socialist economy, that individual freedom can be combined with state ownership of the material means of production, and that central planning can and will follow the prefer ences of consumers. Centralized Socialism (Communism) In the centralized socialist economy, the central authority owns and controls all the means of production, ! ! autocratically determines the aims of the economy, directs j | j production in a comprehensive plan, and regulates distri- ! i bution accordingly. This scheme, while being advocated by j j centralized socialists and Lange in his postwar model, falls into category (1) with subdivision (a), i.e., the entirely-directed economy with sovereignty of the CPB over i individual economic agents, under the Johr difinitional framework. As such, the freedoms enjoyed in the 11 |decentralized socialism are abolished or postponed for the sake of comprehensive economic planning, and rapid indus trialization. This is an important point in the model of centralized socialism because centralized socialists believe that the conflict between freedom and planning must be resolved at the expense of freedom. In short, the centralized socialist economy is a planned economy at the expense of consumer sovereignty. This means that consumers ; can be forced to take what is produced and that' workers i can be made to work where the plan requires their services. i However, the centralized socialist economy can be i less extreme than this model. It may, for example, permit | free choice of consumption or the allocation of labor by wage differential. But if consumer's preferences were to |become the guide of production, the centralized socialist !system would change into decentralized socialism. i I Central Planning j In a discussion of centralized socialism we are con- |cerned with central planning. The competitive market econ- i jomy under capitalism also "plans." In essence, it alio- ! | cates its resources, via the price system in the market, in * order to achieve given ends with the least costly expendi ture of scarce resources. But this operation is automatic i and unconscious. It is not central planning for the i economy as a whole. In the broadest sense, all economies 12 are planned economies, and planning is inherent in the process of economizing. H. D. Dickinson, a decentralized socialist, adopts the following definition of planning: "Economic planning is the making of major economic decisions - what and how much to be produced and to whom it is to be allocated - by the conscious decision of a determinate authority, on the basis of a comprehensive survey of the economic system as a whole." This definition does not specify the areas which should be given to centralization and decentralization. Later, he suggests that "we may apply the term planning to schemes of economic control that deal with the broad out lines of economic activity, without regulating details, provided that, so far as they go, they treat the economic system as a whole." As an example of this type of planning, Dickinson mentions "schemes for deliberate control of the 4 price level." Following Dickinson, we stress the point that the planned economy and the collectivist economy are identical, since each implies an authority which decides what goals have to be reached and what resources are available. But j it would be appropriate, contends Halm, "to reserve the i j jterm central planning for Dickinson's first definition and t 4H. D. Dickinson, Economics of Socialism (New YorkrOxford I University Press, 1939), p. 14. 13 to refer to those broad policies of a monetary and fiscal character merely as indirect controls."'* In stressing the centralist character of planning, we may ignore the crucial difference between decentralized and centralized socialism. In his prewar model, Lange, while emphasizing freedom and decentralization, neverthe less tended to create the impression that his model would enjoy all the advantages of central planning. Centralized socialists along with Lange in his postwar model, wish to create the impression that the central plan could be com bined with a great deal of freedom for consumers, workers, and managers. We shall consider more deeply the problem of personal freedom and decentralization in the course of this study. Organization of Remainder of Dissertation Chapter II deals with a survey of the main contribu tions to the economic theory of socialism. Chapter III | analyzes the Lange prewar model of decentralized socialism.j | Chapter IV focuses on centralized socialism and Lange's j j jpostwar model. Chapter V presents an appraisal of the theoretic studies of economic and/or non-economic problems facing decentralized and centralized socialism. Chapter VI j is a case study of the relevance of Lange's recommendations j ^Halm, op.cit., p. 181. 14 (prewar and postwar) to the evolution of economic prac tice in Yugoslavia. Chapter VII is a case study of the relevance of Lange's recommendations (prewar and postwar) to the evolution of economic practice in Czechoslovakia. Chapter VIII provides a summary and conclusions. 15 | CHAPTER II ! SURVEY OF THE MAIN CONTRIBUTIONS TO THE ECONOMIC THEORY OF SOCIALISM Introduction Can a socialist society find some method of organi zing the allocation of resources which will permit the economy to function with a tolerable degree of efficiency? i This question has been debated for some sity years nowr and constitutes the heart of what is known as the "social ist controversy." Though a early as 1854 the difficulty of resolving this question was hinted at by some economists, it was never seriously descussed by classical and Marxian economists. However, in the 1920's and 1930's, when the Soviet Union was initiating a major socialist experiment, the question was revived and became a prominent topic of discussion and controversy among economists. The under lying motivating force was the challenging voice of Ludwig von Mises, who argued insistently that efficient allocation of resources was theoretically impossible under socialism. This was followed by the criticism of Friedrich von Hayek, who argues that although efficient allocation of resources jwas theoretically possible under socialism, it was prac- | tically impossible. In 1936, Oskar Lange argued that socialism is not jreally doomed to failure and that it is possible to 16 conceive of an efficient allocation of resources under public ownership of the means of production. His solution was the main step in the history of the controversy in answering Mises-type criticism. Yet, it was followed by other reactions toward making socialist allocation of resources feasible. The purpose of this chapter is to present a history of the controversy, beginning with a survey of Mises1 criticism, to compare it with subsequent criticisms, and to describe the main points made by the major participants in offering their solutions to the problem. The aim here is to explore the participants' thinking, to discuss some of the welfare implications of their solutions, to deter mine what was established and what problems remain, and finally, to examine briefly some recent contributions towards solving these problems. Early Criticism The question of efficient allocation of resources in a socialist society was relatively a neglected issue among both classical and Marxian economists before World War I. Though such economists as H. H. Gossen and E. Cannan, in works published in 1854 and 1893 respectively, hinted at the difficulty of rational economic calculation in the absence of the private ownership of the means of production, neither pursued the subject in great 17 detail.'*' In 1902, a Dutch economist, N. G. Pierson, wrote in a polemic against Karl Kautsky that even a socialist society will have its value problems and that the social ists will have to show how they are going to have a price 2 system. The economist who did more than any other to initiate discussion is Ludwig von Mises who, in an article published in 1920, brought to the forefront in the contro versy the crucial issue of economic calculation over the economic practicability of socialism. It is with the writing of Mises that any serious study of resource allo cation under socialism must necessarily begin. Oskar Lange himself expressed the same view when writing that: .. . a statue of Professor Mises ought to occupy an honorable place in the great hall of the Minis try of Socialization or of the Central Planning Board of a socialist state . . . both as an ex pression of recognition for the great service ren dered by him and as a ®Omento of the prime im portance of sound economic account.4 •^•Both of these works are cited in Friedrich A. von Hayek, "The Nature and History of the Problem," in Collectivist Economic Planning, ed. F. A. von Hayek (London: George Routledge & Sons, 1935), p. 26. 2N. G. Pierson, "The Problem of Value in the Socialist I Community," in Collectivist Economic Planning, pp. 41-85. j ^Ludwig von Mises, "Economic Calculation in the Socialist ! Commonwealth," in Collectivist Economic Planning, pp.87-130. 4Oskar Lange, "On the Economic Theory of Socialism," in On ! the Economic Theory of Socialism, ed. Benjamin E. Lippin- ! cott (Minneapolis: University of Minnesota Press, 1938), i pp. 57-58. ) 18 The Criticisms of Ludwig von Mises Mises' Theory of Value To comprehend Mises' criticism concerning the effi ciency of resource allocation in a socialist community, it is necessary to review briefly his general theories of economic value and the nature of economic calculation. Economic value, for Mises, is an intensive, subjective response within the mind of man pertaining to the useful ness or utility of economic commodities or factors. Value is a personal preference that man's mind places on parti cular units of particular things. Value is not, therefore, considered as an "intrinsic quality inherent in things," but "merely as the expression of various people's eager ness to acquire them,"5 nor is it something that arises independently within man; it is an individual preference dependent on a subjective estimation of utility. Thus, value for Mises is always relative and always dependent on the thing valued and on the valuer. Since Mises considers the nature of economic value as being entirely subjective, he holds that different estimations of value by men are to be expected. Further, since men are interested in maximizing their utility, he deduces that different estimations of value are likely to 5Ludwig von Mises, Human, Action (New Haven, Connecticut: ! Yale University Press, 1950), p. 204. lead men into exchange relationships with the goods or factors they possess. In this manner, while criticizing the classical economists on the subject of value, Mises writes that, "The basis of modern economics is the cogni tion that it is precisely the disparity in the value attached to the objects exchanged that results in their being exchanged. People buy and sell only because they g appraise the things given up less than those received." Thus, because the nature of value is subjective, Mises concludes that the exchange of units of goods or factors becomes mutually beneficial to each party and each gains value through trade. The Problem of Measuring Value While the values of units of goods or factors can be ranked on the basis of personal preference, and while subjective utility can be gained or lost through trade, Mises maintains that value itself cannot be cardinally measured. Cardinal measurement refers to a precise or objective standard of calculation and no such standard exists in Mises' subjective theory of value. Thus, the notion of a measurement of value is vain. An act of exchange is neither preceded or accompa nied by a; process which could be called a measur ing of value. An individual may attach the same value to two things; but then no exchange can result. But if there is a diversity in valuation, all that can be asserted with regard to it is the | ®Ibid., p. 205. 20 one a is valued higher, that it is preferred to one b. They are not susceptible to mental grasp by the application of cardinal numbers.7 As a result, the values that people place on goods or factors can be ranked ordinally, that is, goods or factors can be compared as having more or less value than other goods or factors. Ordinal ranking, as such, necessarily precedes any act of exchange between men. But, Mises considers objective cardinal measurement in terms of finite units or numbers to be impossible, given the subjective nature of economic value itself. The Problem of Economic Calculation Economic calculation, in Mises1 words, can be taken to mean the method "to employ the available means in such a way that no want more urgently felt should remain unsatisfied because the means suitable for its attainment were employed - wasted - for the attainment of a want less urgently felt."8 It is simply a process of using, com bining and allocating the scarce economic factors of production in such fashion that economic efficiency and maximum satisfaction are achieved from their utilization. The reason why these factors should be allocated as to obtain efficiency is two-sided. On one hand, human ends are unlimited, because they are related to man's psychology 7Ibid. 8Ibid., p. 208 21 and, on the other, the available factors are scarce and have therefore alternative uses. Accordingly, the economic problem is that of how to economize and, as such, it is the message of Lionel Robbins who defined economics as, "The science which studies human behavior as a relationship between ends and scarce means which have alternative uses." The implication of Robbins' definition is that in a society composed of different individuals with different desires and needs there are not sufficient resources to cover all the requirements of all individuals, and that it is there fore necessary to make a choice between alternative uses. Mises puts the mater in the following words: What acting man wants to know is how he must em ploy the available means for the best possible - most economic - removal of felt uneasiness . . . But the practical man, eager to improve human con ditions by removing uneasiness as far as possible must know whether, under given conditions, what he is planning is the best method, or even a method, to make people less uneasy. He must know whether what he wants to achieve will be an improvement when compared with the present state of affairs and with the advantages to be expected from the execution of other technically realizable projects which cannot be put into execution if the project he has in mind absorbs the available means. Such comparison can only be made by the use of money prices. - * - 0 9 Lionel Robbins, An Essay on the Nature and Significance of Economic Science (London: Macmillan Co., 1949), p. 1 (>. ■^Ludwig von Mises, Human Action, pp. 208-209. 22 Thus, money becomes the vehicle of economic calcula tion, and in the case of factors of production, such a tool is needed as a measurement of precise units of the advan tages to be gained or the losses to be sustained by the use of physically heterogeneous factors in the production of specified commodities. In short, Mises indicates that economic calculation requires cardinal measurement. Since subjective valuation cannot provide a universally used medium of exchange, namely, money, and since such a denominator is necessary as a pre-condition for efficient utilization of resources, he concludes that subjective valuation by itself is insufficient for rational economic calculation. Economic Calculation in a Natural Economy In examining the possibility of economic calculation in an economy which uses no money, i.e., one with a natural economy as it is sometimes called, Mises does admit that subjective valuation and ordinal ranking might suffice to lead to a rational production process. Here a farmer, for instance, might not find it too difficult to "come by a distinction between the expansion of pasture - farming and the development of activity in the hunting field.Since the processes of production in this example are relatively •^Ludwig von Mises, "Economic Calculation in the Socialist Commonwealth," in Collectivist Economic Planning, p. 96. i 23 limited, and since the factors of production have few alternative uses and are not exchanged, a direct comparison on ai v . ordinal basis of the gains and losses of specific factors employed in one direction viz-a-viz the gains and losses of specific factors employed in the other direction might be possible. The point of view that economic calculation is pos sible in a society with a moneyless economy is also shared | |by A. D. Tschayanoff whose argument is evaluated critically i |by T. J. B. Hoff in his book, Economic Calculation in the I Socialist Society. Hoff states that: j ! Tschayanoff realizes that even in a society with | a moneyless economy one must be able to make an economic comparison of the various means of pro duction used. Tschayanoff is an agriculturalist and points out that it is possible to measure the variations in a cow's milk yield by variations in I its fodder. Yet even in this particular case the | task is not so easy, for the quantity of milk yielded is not merely a question of fodder, and I once you accept the existence of other factors, ; ! you are immediately faced with the problem of how to know whether to increase the one or the other, and what to use as a means of comparison.J-2 Economic Calculation in an Exchange Economy In an exchange economy where there is a diverse num ber of factors of production with a multitude of alterna tive uses, or when the choice lies between "the utilization ^T. J. B. Hoff, Economic Calculation in the Socialist Society (London: william Hodge and Co., Ltd., 194&), p.45. 24 of a water-course for the manufacture of electricity oX the extension of a coal mine or the drawing up of plans for 13 the better employment of the energies of latent coal," the problem of rational economic calculation becomes impossible with non-comparable, heterogeneous original values. As Mises puts it: Here the roundabout processes of production are many, and each is very lengthy; here the condi tions necessary for the success of the enterprises which are to be initiated are diverse, so that one cannot apply mere vague valuations, but re quires rather more exact estimates and some judo- ment of the economic issues actually involved.19 The implication of Mises1 statement is that economic calculation in a complex industrial society seems to require an objective, homogeneous standard capable of indicating in precise terms the values of all goods and all factors in all stages of production. For Mises free- market prices provide such a standard. The Role of Objective Exchange Values Mises maintains that "in an exchange economy the objective exchange value of commodities enters as the unit 15 of economic calculation." a such, free-market prices 13Ludwig von Mises, "Economic Calculation in the Socialist Commonwealth," in Collectivist Economic Planning, p. 96. 14lbid., p. 96. 15Ibid., p. 97. 25 are the objective exchange ratios established among traded goods or factors; they are the objective consequences of subjective valuation. Free-market prices make economic calculation possible because they provide a homogeneous method of comparing the costs of different factors to each other, and to the gains of different outputs. Money prices, therefore, become the economic link between alternative means and ends, and provide - through monetary computations of the respective costs of different factors with respec tive revenues from different commodities - the most effi cient technique of production for realizing any desired end. The Role of Private Owndership of the Means of Production Objective money prices arise only where factors and goods are privately owned, that is, in the context of a free, private market. As Mises puts it: Private ownership of /tsh©. means of production is the fundamental institution of the market economy. It is the institution the presence of which charac terizes the market economy as such. Where it is absent, there is no question of a market economy.16 Goods or factors not privately owned or exchanged - while possessing subjective value - could have no objective money prices since such prices are exchange ratios, and •^Ludwig von Mises, Human Action, p. 678. 26 goods or factors not exchanged could not have exchange ratios. Private ownership is necessary, he believes, since the process of subjective valuation presupposes that men have full control of the services derived from traded 17 commodities or factors. Otherwise, any subsequent "exchange" would be artificial and any consequent "price" would be arbitrary. Hence, it is Mises' conclusion that objective money prices are impossible without private ownership and that economic calculation is impossible 18 without objective money prices. The Insufficiency of Physical Formulas as a Vehicle for Economic Calculation . Mises rejects the notion that engineering formulas which analyze the physical quantities in which resources might be combined to achieve given ends are any substitute for objective money prices. Technical formulas might be considered to be the means of rational economic calculation if factors were specific and had no alternative uses. As Mises emphasizes: . . . the mere information conveyed by technology would suffice for the performance of calculation 3-7 ibid. 3-^Ludwig von Mises, "Economic Calculation in the Socialist Commonwealth," in Collectivist Economic Planning, p. 92 27 only if all means of production - both material and human - could be perfectly substituted for one another according to definite ratios, or if they were absolutely specific.^9 But the means of production have alternative uses and may be substituted, more or less easily, in the production of consumer and capital goods. Thus the problem of rational economic calculation or efficient production is more than purely technical. The fact that man has a limited number of factors available to him and a great deal of alternative uses for these factors, he is faced with another problem, that is, the "economic" problem of attempting to decide which possible combination of factors will deliver the greatest amount of satisfaction in such fashion that no factor shall be used to satisfy a need less urgent than the one being presently satisfied. The solution of this problem, according to Mises, requires objective money prices. i The Insufficiency of the "Labor Hour" as a Vehicle for Economic Calculation Mises also rejects the idea that "labor hour" can be j , i used as an objective calculating device instead of objec tive money pricesthe first place, valuation in terms 1 Q xyLudwig von Mises, Human Action, p. 207. 2()Ludwig von Mises, Socialism; An Economic and Sociological Analysis (New Haven, Connecticut: Yale University Press, 1951), pp. 131-135. : j 28 of labor time neglects the contribution of land and capital goods. Secondly, calculation in terms of labor time ignores the fact "that between men themselves there are differences of capability and skill which result in differing qualities 21 of the goods and services produced." In this way, Mises concludes that "calculations based on labor cost rather than on monetary values would have to establish a purely arbitrary relation by which to resolve skilled into simple labor, and this would make them useless as an instrument 22 for the economic organization of resources." In short, any theory of value which ignores material contributions to production and fails to provide a common denominator to make diverse labor quality comparable cannot possibly lend itself to rational economic calculation. Mises1 Challenge for Socialism With the preceding analyses on value, prices, and economic calculation as a theoretical background, Mises' arguments concerning the economic rationality of resource allocation in a socialist community could now be developed more formally. Socialism, for Mises, entails the public ownership and control of the means of production. As he puts it, "All the means of production are the property of the community. It is the community alone that can dispose i 21Ibid. 22Ibid. I 29 23 of them and which determines their use in production." The essence of socialism, therefore, is that all land and capital goods are employed by the state. Further, Mises assumes freedom of consumer choice to the extent that consumers can purchase what they want with their income. He does not claim that socialism will necessarily force the consumer into purchasing certain commodities that no one likes to buy. In fact, he points out that the state will attempt to produce in accordance with the "variations in exchange relations in the dealings 24 between comrades;" goods in greater demand will have to be produced in greater quantities while those in less demand will have to be reduced in supply. What he does deny firmly, however, is the notion that socialism can create a rational economic calculation, that is, an efficient method of production. Mises' reasoning is deductive and is based on his theories of value and economic calculation, as reviewed above. Since, in socialism, the material means of produc tion are state-owned and controlled, they cannot become the objects of market exchanges - as there can be no free market for these factors of production. And because these 23Ludwig von Mises, "Economic Calculation in the Socialist Commonwealth," in Collectivist Economic Planning, p. 89. 2^Ibid., p. 93. goods or factors are not exchanged in free markets, it is impossible to determine their monetary value, that is, to j : assign to them exchange ratios or objective money prices. I s Therefore, no calculations of costs in monetary units are | ! possible, and without cost calculations no rational | economic calculations concerning them are possible. As a ! result, the socialist community will have to "cross the | whole ocean of possible and imaginable economic permuta- 25 i tions without the compass of economic calculation." Mises then continues: Unfortunately ... it is not possible to divorce the market and its functions in regard to the formations of prices from the working of a society which is based on private property in the means of production and in which, subject to the rules of such a society, the landlords, capitalist and entrepreneurs can dispose of their property as they think fit. For the motive force of the whole process which give:§ rise to market prices for the factors of production is the ceaseless search on the part of the capitalists and the entrepre neurs to maximize their profits by serving the consumers' wishes. Without the striving of the entrepreneurs (including the shareholders) for profit, of the landlords for rent, of the capital ists for interest and the laborers for wages, the successful functioning of the whole mechanism is not to be thought of. It is only the prospect of profit which directs production into those chan nels^ in which the demands of the consumer are best satisfied at least cost. If the prospect of profit disappears the mechanism of the market loses its mainspring, for it is only this prospect which sets in motion and maintians it in opera tion. The market is thus the focal point of the ^5Ludwig von Mises, Socialism: An Economic and sociological Analysis, p. 122. 31 capitalist order of society; it is the essence of Capitalism. Only under Capitalism, therefore, is it possible; it cannot be 'artificially' imi tated under Socialism. 6 The implication of Mises' argument as it lies in the above statement, is that the economic virtues of initiative and responsibility will decline under socialism due to lack of a success indicator, namely, profit criterion. He specifically denies the socialist argument that it will make no difference whether managers work for the state or 27 for private corporations. For Mises, the property relationship is very important. Successful business action involves the independence of risk taking and the consequent gain or loss with one's own property; it involves a number of capitalistic activities, such as speculation, trading in the commodity and stock markets, that would be absent under socialism. At this point, Mises stresses that the pretense of a competitive market will not provide efficiency. This is true, because to place bureaucrats or former businessmen in charge of socialist production will not do, as the community ownership of the means of production precludes all essential aspects of a truly competitive economy. Also. 26Ibid., pp. 137-138. ^Ludwig von Mises, "Economic Calculation in the Socialist Commonwealth," in Collectivist Economic Planning, pp. 112- 118. 32 any socialist system, attempting to induce competition by parceling out the ownership and the employment of the factors of production would cease to be a system of state socialism, but instead a form of workers' capitalism or 28 syndicalism. Thus, socialism with economic efficiency remains a theoretical impossibility from Mises' viewpoint. Mises discusses lastly another issue associated with resource allocation under socialism. He notes, for example,, that economic calculation ceases to be a problem in the stationary or static state of equilibrium. But he consi ders this fact to be irrelevant to the problem of economic rationality of socialism, since such state is only a conceptual possibility and not certainly obtainable in 29 real life where economic data are changing. Other Critics of the Economic Rationality of Socialism Following Mises' position that economic calculation in socialism is an impossibility, a variety of other criticism proceeded - though none of them broke signifi cantly new ground. Max Weber, for example, in a work published in 1921, maintained that socialism made rational economic calculation impossible since it lacked money i 28Ibid., p. 112. I 29Ibid., p. 109. | ■ ■ I ' i t i 33 30 prices for the means of production. The same charge, raised in the context of actual Soviet planning experiences, 31 was made by Russian economics professor, Boris Brutzkus. A decade later, Lionel Robbins, George Halm, and Friedrich von Hayek gave attention to the same issue and discussed it from another angle. They argued that socialism was practically incapable of rational economic calculation. Since these later economists gave interesting contributions to the problem, their comments are examined briefly below. George Halm on the Possibility of Adequate Calculation in Decentralized Socialism Halm begins his essay by specifying the type of socialism that he has in mind. For Halm, socialism is a mixture of capitalism and communism. "Like capitalism it permits freedom of choice in consumption and occupation . . . But like communism, socialism envisages the nationalization of capital goods and land, the elimination of unearned incomes, and the central control of economic life by the 32 . State." in essence, Halm defines a type of socialism which is similar in all important respects to the system debated by Mises in the analysis above. 30 Max Weber, The Theory of Social and Economic Or.ganJJsati-Qn (New York: The Free Press,1947), pp. 194, 207. 21cited in Collectivist Economic Planning, p. 35. ^2George Halm, "The Possibility of Adequate Calculation," in Collectivist Economic Planning, p. 137. 34 Before discussing the problem of efficiency under socialism, he notes that the terms planning and consumer choice, as used in the socialist context, seem to be con tradictory in their essence for determining the direction of state production. As Halm puts it, "Planning and free- 3 ; dom of choice cannot possibly be realized simultaneously." Planning suggests that consumer and capital goods will be produced in accordance with a central plan executed by the state. Consumer choice on the other hand, implies that commodities will be produced in accordance with the demands of consumers as indicated by final price movements. A socialism which uses planning will eliminate or reduce the scope of consumer choice and any system that adopts con- M <| sumer choice must reject planning. The integration of both, Halm holds, is doomed to failure. Though presumably consumers will exercise free choice in directing production under socialism, Halm maintains that the state will find it impossible to allocate the factors of production so that supply of goods is effi ciently adjusted to consumer demand for them. Price movements alone as vehicles for adjusting supply with de mand are insufficient guides to rational production. "Only when the values of the means of production can be 33lbid., p. 150. 3^Ibid., p. 149. 35 compared with one another and with the values of their 35 products is economic management possible ..." There fore, it is the movement of final prices in relation to costs of production and also costs of intermediate goods that allow the selection of the most efficient techniques of production. Since Halm holds that socialism is a system in which all land and capital are state-owned, he concludes that the prices of these factors as well as those of the intermediate goods cannot be determined objectively and hence socialism will not be able to operate in a rational 36 manner. Comparing Halm's argument with Mises1, both are similar in the notion that objective factor pricing is impossible without private-ownership of factors and free, competitive markets. Halm explicitly refuses to admit that the adoption of some fictitious rate of interest by the state will solve the pricing or allocation problem of capital goods. He writes: Now it is unfortunate that this allowance of interest, the need for which is urgently dicta ted by economic conditions, cannot be adopted in the socialist economy. Perhaps this is the most serious objection that can be maintained against socialism. Halm bases his contention on the notion that interest determination is not possible in a society in which all 35ibid., p. 151. 36Ibid., p. 173. ^7Ibid., p. 161. 36 capital goods are owned by the state. This means that they are not owned by many individuals and so there cannot be a free market with supply and demand for them, and therefore it is impossible to arrive at a price for them. Thus, the cost of capital goods must be indeterminate and arbitrary. In addition, units of labor cannot be objectively priced because "under modern conditions, practically every kind of goods is produced by both labor and capital," and therefore "it will hardly ever be possible to derive the 38 value of the labor from the value of product." Thus, it is difficult for the state to generate a demand for factors whose value cannot be separated from the contributions of land and capital goods. In sum, Halm concludes that arbitrary costs of factors of production on the one hand, and monopolistically determined consumer-goods prices due to the lack of their dependence on costs on the other, appear to make rational economic calculation impossible. Any residual as money differential could hardly be used as a guide to efficiency since this profit might be the result of some arbitrary interaction between cost and price. Hence for Halm, as for Mises, it is the absence of an objective price system which makes socialism rationally impossible. 38Ibid., p. 168. 37 Lionel Robbins on Socialism's Central Problem Robbins discusses the problem of resource allocation under socialism from another viewpoint. He argues that though it is possible to solve the problem of rational resource allocation by a series of mathematical calcula tions, it is, however, impossible to get this solution in practice. He writes: On paper we can conceive this probelm to be solved by a series of mathematical calculations. We can imagine tables to be drawn up expressing the con sumers' demands for all the different commodities at all conceivable prices. And we can conceive technical information giving us the productivity, in terms of each of the different commodities, which could be produced by each of the various possible combinations of the factors of production. On such a system simultaneous equations could be constructed whose solution would show the equili brium distribution of factors and the equilibrium production of commodities. But in practice this solution is quite unworkable. It would necessi tate the drawing up of millions of equations on the basis of millions of statistical tables on many more millions of individual computations. By the time the equations were solved, the informa tion on which they were based would have become obsolete and they would need to be calculated anew.3 9 Robbins concludes by noting that those who suggest such solution have not yet grasped what it means. ■^Lionel Robbins, The Great Depression (New York: The Macmillan Company, 1934,), p. 151. 38 Friedrich von Hayek on the Mathematical Approach to Resource Allocation and its Use of Competition One of Hayek's major contributions to the discussion under socialism involves his analysis of the so-called mathematical solution, or the idea that a rational alloca tion of factors can be solved by a set of simultaneous equations. While he admits that such a solution "is not an impossibility in the sense that it is logically contra dictory," he would rule out the method as being "humanly 40 impractical and impossible." It is evident that the operation of such method requires the assembling of statis tical data and the quantification of technical knowledge necessary to formulate the correct equations for such a solution. Hayek considers such a task beyond human capacity. Even if the data were accumulated, thousands of simultaneous equations would have to be resolved for every change in the economic data, and the new solutions con tinuously conveyed to the socialist director who would, in i turn, attempt to execute them. Hayek notes that such 41 tasks "could not be carried in a lifetime." Hence for Hayek, as for Robbins, the mathematical solution is not practicable. ^Friedrich A. von Hayek, Individualism and Economic Order (Chicago: The University of Chicago Press, 1963), p. 153. 41Ibid. 39 Hayek's second contribution to the discussion is his recognition of the fact that most thoughtful socialists have accepted the logic of Mises' and Halm's criticisms and have, therefore, attempted to re-introduce the element of competition into their plans for an efficient socialism. While Hayek believes that the introduction of such pseudo competition, as it is injected into the system in the con text of public ownership of the means of production, is pure illusion, his important comment is to point out that socialist planning and competition are irreconcilable in socialism. In this way, Hayek asks, "Is it fully realized how much of the hopes commonly associated with a socialist system are already abandoned when it is proposed to sub stitute for the centrally planned system, which was regarded as highly superior to any competitive system, a 42 more or less successful imitation of competition?" In such situations, he continues, "the hope of a vastly super ior productivity of a planned system over that of 'chaotic' competition" has to give place to the adoption of the capitalist pricing mechanism; and the "expectation that the 'wage system' would be abolished" has to be introduced again.^ Thus, Hayek concludes that the socialists appear to dismiss all their principles in their search for an efficient economic mechanism. "Against all this," Hayek ^Ibid., p. 177. 43lbid. 40 adds, "there is, of course, the advantage that it would be possible to improve the relative position of the working class by giving them a share in the returns from land and 44 capital. This is, after all, the mam aim of socialism." But this advantage depends on the potential productivity of a system of decentralized socialism, a system which Hayek, Mises and Halm feel could surely be less efficient than competitive market capitalism. The above economic arguments against socialism in time stimulated rebuttals from those who believed that a socialist system could acieve efficiency in allocating its resources. The following development will, in turn, con sider these counter-arguments. Reactions to Critics of Socialism - A Famous Debate Although Mises was not the first to be concerned with the question of efficient resource allocation under socialism, he dealt with it with such a vigor that resulted in effect to a challenge to the entire concept of socialism. And in the 1920's and 1930's, when the Soviet Union was initiating the biggest socialist experiment on earth, economic efficiency was a favorii.te topic of discussion among academic supporters and opponents of socialism. The former group agreed that what was impossible to achieve by 44Ibid., p. 178. 1 41 a private-market economy could be easily achieved by letting government own and control the means of production and thereby "run the show." The latter group, under the leadership of Mises, argued that "efficient socialism is a logical impossibility." Among others within this group, Robbins and Hayek concluded that "socialism is of course possible, but operationally impractical." However, it should be emphasized that it was Mises' argument which, in effect, called for an army of socialist theoreticians. The importance of Mises' argument is acknowledged by Oskar Lange who begins his Economic Theory of Socialism with the remarks that socialists "have certainly good reason to be grateful to Professor Mises . . . for it was his powerful challenge that forced the socialists to recognize the importance of an adequate system of economic accounting to 45 guide the allocation resources in a socialist economy." The solutions to Mises1 challenge fall into four categories: (1) solutions that aim at a natural economy, or on the labor theory of value; its proposals will not be discussed further because, as already noted above, it would be virtually impossible for economic calculation to be made on these bases; (2) mathematical solutions and those which recommend the trial and error method; a proposal which will be discussed briefly in the present chapter and more i i ^Lange, op. cit., p. 57. 42 rigorously in Chapter III; (3) those that recommend margi nal costing which will be discussed in this chapter; and (4) the centralized solution which emphasized central planning at the expense of consumer sovereignty; a proposal which will be discussed briefly in this chapter and more fully and analytically in Chapter IV. Mathematical Solutions and the Trial-and-Error Method It has been suggested that resource allocation could be handled by a system of simultaneous equations which could be solved and would, in one tremendous comprehensive calculation, determine the interrelated prices of consumer goods, intermediate goods, and the factors of production. For instance, the Italian economist, Enrico Barone, as early as 1908, had shown the theoretical possibility of an economy under centralized direction by a socialist govern ment. He pointed to the possibility of using a system of equations, as had been shown earlier by Leon Walras, to show that the Ministry of Production in a collectivist state would have to use "all the economic categories of the old regime . . .: prices, salaries, interest, rent, Ac profit, savings and so forth?" ° Such equations, Barone showed, coincided, whether expressing the economic 46Encrico Barone, "The Ministry of Production in the Collec tivist State," in Collective Economic Planning, Appendix A, p. 287. 43 relationships of perfectly competitive capitalism of those of a socialist economy. The formal solution is independent of who owns the resources available. Barone, however, was the first to recognize the impracticability of a central ized solution of this kind. He writes that "it is con ceivable . . . that with a vast organization for this work it would be possible to collect the individual schedules for every given series of various equivalents, including the premium for deferred consumption." But, he continues, "it is frankly inconceivable that the economic determination of the technical coefficients can be made a priori, in such a way as to satisfy the condition of minimum cost of pro duction."^ Another attempt was provided by Gustav Cassel, a Swedish economist, who defined "the; exchange economy in the widest sense, stipulating only that it shall allow the individual freedom of occupation and freedom of consumption 48 within the limits imposed by his means." The principles of pricing, therefore, "hold good for every exchange economy, and are independent of the particular organiza tion of production within the economy . . . these princi ples would remain unchanged in an exchange economy in 47Ibid. 48 Gustav Cassel, The Theory of Social Economy (New York: Harcourt, Brace & World, Inc., 1932), p. 132. 44 which the State had assumed control of production and reserved for itself the ownership of the material factors 49 of production." Halm, in criticizing Cassel, writes: It is clear that what Professor Cassel provides us with here is not an explanation that will fit actual processes, but an ideal price scheme to which actual processes are to be fitted. Instead of a causal explanation, he gives us rules and principles. He does not help us 'to understand the type of connection between cause and effectQ that is characteristic of the social economy.' Hoff confirms Halm's criticism and writes that "Professor Cassel never regarded his equations as a basis for an arithmetical or a mathematical computation of prices, but merely as an expression of principles that are 51 generally applicable to an exchange economy." Vilfredo Pareto, who, like Cassel and Barone, uses a system of simultaneous equations, says: It may be mentioned here that his determination has by no means the purpose to arrive at a numer ical calculation of prices. Let us make the most favorable assumption for such a calculation, let us assume that we have triumphed over all the difficulties of finding the data of the problem 49Ibid. ^George Halm, "Further Considerations on the Possibility of Adequate Calculation in a Socialist Economy," in Collectivist Economic Planning, p. 185. ^Hoff, op. cit., p. 132 45 and that we know the ophelimites of all the dif ferent commodities for each individual, and all the conditions of production for all the commo dities, etc. This is already an absurd hypothesis to make. Yet it is not sufficient to make the solution of the problem possible. We have seen that in the case of 100 persons and 700 commodities there will be 70,699 conditions (actually a great number of circumstances which we have so far neg lected will still increase that number); we shall therefore have to solve a system of 70,699 equa tions. This exceeds practically the power of alge braic analysis, and this is even more true if one contemplates the fabulous number of equations which one obtains for a population of forty millions and several thousands commodities. In this case the roles would be changed: it would not be math ematics which would assist political economy, but political economy would assist mathematics. In other words, if one really would know all these equations, the only means to solve them which is available to human powers is to observe the prac tical solution given by the market. 2 It is interesting to note that the three authors, Barone, Cassel, and Pareto, whose equations have been used to provide a rationale for efficient socialism, are con vinced that their schemes do not offer a practical solution for the problems of socialist resource allocation. H. D. Dickinson, an English economist, also suggests a mathematical solution. "Given, at each end of the chain of production," he says, "a free market for finished goods and for productive services, the prices and the quantities that would exist if the intermediate goods were sold in a market, could, theoretically, be determined . . . Once the 52Quoted in Friedrich A. von Hayek, Individualism and Economic Order, pp. 181-182. 46 economic system of socialism has been set going, it would be unnecessary to create in this way within the framework of the socialist community a sort of working model of capitalist production, but that it would be possible to deal with the problems mathematically, on the basis of the full statistical information that would be at the disposal 53 of the Supreme Economic Council (S.E.C.)." What does "theoretical" mean in this case? Since Dickinson's purpose is to prove only "that as far as pure economics is concerned, a socialist economy is at least 54 theoretically possible," there is nothing to argue about. He then proceeds to show in detail how a socialist economy would work on the basis of actual data produced by the market "at each end of the chain of production." In this position, Dickinson abandons the abstract nature of the Casselian system by letting his equations rest on these data. Dickinson, thus, asserts that it is possible for socialism to solve the problem of rational economic calcu lation by solving thousands or millions of equations. It would be noted that Dickinson admits that the method of trial and error, which will be discussed below, would not be: 33H. D. Dickinson, Economics of Socialism (New York: Oxford University Press, 1939), p. 104. ^Ibid., p. 13. 47 . . . replaced entirely by the solution of thou sands of simultaneous equations .... The reason is that the data themselves which would have to be fed into the equation machine are con tinually changing. The condition of demand and supply and the technical conditions of production are. not static . . . , they can be described by dynamic parameters subject to perpetual altera tion. to determine these parameters requires continuous observation of the primary data of the market. The economic organs of the community will be engaged all the time in gathering these data and in reporting them to the statistical organs of the S.E.C. Since this is so it would be easier to give them at the same time and the task of making the necessary adjustment of prices and quantities. The statistical determination of demand schedules would then take its proper place as an aid to, and not a substitute for, the pedestrian method of trial and error. Even so, the statistical service of a socialist com munity might very well undertake the task of establishing the numerical values of the constants in the Walrasian equations of equilibrium. 5 The group of solutions based on the trial and error method is closely related to the mathematical solutions. The greatest exponent of this method is Fred M. Taylor who, in his presidential address delivered at the 1928 meeting of the American Economic Association, developed in a detailed fashion the concept of trial-and-error to the resource allocation problem under socialism. His contri bution came as the first important step toward answering Mises-type criticism. He thought that the central author ity, by taking account of the consumers' demand as expressed in surplus or shortage of consumer goods, would: 55Ibid., pp. 104-105. 48 . . . ascertain with a sufficient degree of accuracy these effective importances or values of all the different kinds of primary factors, and that they will have embodied the results in arithmetic tables, which I shall usually designate as factor-valuation tables.56 It is the reference to "arithmetic tables" and "factor-valuation tables" that makes it possible to put Taylor's solution with the mathematical solution. It has been gloriously described by Lange as the only step forward made in the discussion since Barone's treatment of the problem, and has emphasized that "Taylor indicates a 57 solution by trial and error." Taylor pointed out that the basic problem in a social ist system is the determination of proper values for the primary factors of production. He suggested that an initial price be given to each factor and that the managers of the socialized industries be directed to act as though these prices are accurate. There would be a surplus supply of any factor whose initial price had been set too high and a shortage of any factor with a price set too low. Shortages and surpluses of the various productive factors at the end of an accounting period would provide guides to the authorities for revisions in factor prices. 56Fred M. Taylor, "The Guidance of Production in a Socialis ; State," American Economic Review, XIX, (March, 1929), p. 4. 5?Lange, op. cit., p. 87. 49 Through a process of trial and error, Taylor stated that, over time, appropriate prices for the various factors could be determined. It should be noted that Taylor was discussing a decentralized socialist economy in which consumer demand would give direction to production and in which the prices of commodities will be set by the authori ties at levels which will cover their costs of production. The pattern of income distribution would be determined by the state. Taylor concludes by affirming rather dogmatically that? ... if the economic authorities of a socialist state would recognize equality between cost of production on the one hand and the demand price of the buyer on the other as being the adequate and the only proof that the commodity in question ought to be produced, they could, under all ordi nary conditions, perform their duties, as the persons who were immediately responsible for the guidance of production, with well-founded confi dence that they would never make any other than the right use for the economic resources placed at their disposal.58 Thus, the economic authorities in a socialist state can solve effectively and practically the resource allocation. Oskar Lange's Reaction Oskar Lange's attempt to solve the problem of econo mic calculation through a process of trial and error 58Taylor, op. cit., pp. 90-130. 50 deserves special attention. Abba Lerner has called it "the most up-to-date of what has been so far written on the subject ... . these words (used) in a rather special 59 sense." First, Lange developed a strong attack on Mises1 criticism in his well-known article, using more formally 6 0 the trial-and-error method introduced by Taylor. In rebutting Mises1 contention regarding the impos sibility of achieving a rational allocation of resources under socialism, Lange used the point made by Phillip Wicksteed that prices can be considered either in the market-determined sense or in the broader sense of the terms on which alternatives are available.61 It is prices in the latter sense that are relevant for a socialist system. Thus, Lange says that Mises' view "is based on a confusion concerning the nature of prices," and he is wrong in holding that where capital is privately owned and the prices of capital goods are determined by market forces can there be a rational allocation of resources. ^9Abba Lerner, "A Note on Socialistic Economics," Review of Economic Studies, IV(October, 1936), p. 76. 600skar Lange, "On the Economic Theory of Socialism," Review of Economic Studies, IV, No. 1, October, 1936, and No. 2, February, 1937. TKis article is reprinted in Oskar Lange and Fred M. Taylor, op. cit., pp. 57-142. H. Wicksteed, The Common Sense of Political Economy (London: G. Routledge and Sons, Ltd., 1933), p. 28. 51 All that is needed, Lange maintains, is the establishment of the terms on which various capital goods are offered. This can be done by administrative decree and does not have to be done by free-market forces. In establishing the relative prices of capital goods under socialism, produc tion functions would have to be considered and Lange points out that "the administrators of socialist economy will have 1 exactly the same knowledge, or lack of ^knowledge, of the production functions as the capitalist entrepreneurs 62 have." Lange next tunned attention to the arguments of Hayek and Robbins, who, unlike Mises, accepted the theoretical possibility of Barone's approach, but who concluded that it did not provide a practical solution to the resource allocation problem under socialism because of the extremely large number of equations that have to be formulated and solved. Lange indicated that Hayek and Robbins had missed the significance of Taylor's solution which showed how simply Barone's trial-and-error method could be applied in a socialist economy. Lange then proceeded in his article to develop the concept of trial-and-error approach in detail. This will be developed more fully in Chapter III. It is useful at this point, however, to outline the main aspects of the Lange model in the following words. ®2Lange, op. cit., p. 61. | In the Lange model of decentralized socialism ! ! !households, the Central Planning Board (CPB), and socialistj i i | i managers share in the decisions which guide the economy. ! Consumer preferences, expressed in a market for consumer goods, decide the goods to be produced. The CPB, by trial and error sets the prices of consumer and producer goods so as to equate supply and demand for each good. Given these "parametric" prices, the managers of socialist enterprises and industries determine their inputs and outputs according! ) to two broad rules. First, they must combine factors of production so as to minimize the average cost of production for any output. Second, they must choose to produce the specific quantity of output for which marginal cost equals the price set by the CPB. In effect these two rules provide the most economical production of the optimum output. The CPB distributes a social dividend to households which reduces the inequality of income resulting from market-determined wages. It also decides the rate of investment and then sets an interest rate on investment i i funds which equates the demand for investment funds, on the part of socialist managers to the amount available. Dickinson's Response One of the first to discuss socialist pricing in the light of Mises' critique was H. D. Dickinson in 1933 in an • . - 53 ; I 02 article on "Price Formation in a Socialist Community." |The following development will focus on the main aspects ;of his article. If the decentralized socialist economy is to rest j I on a comprehensive pricing process, this process must be j j more than an abstract scheme; it must be a scheme which j i can be realized into practice. Each person - consumer, j worker, plant and industry manager - must have data on j jwhich to base his own decisions. Such a pricing process ! i i must be very similar to the price mechanism under capital- j ism. This similarity is expressed by W. Crosley Roper in the following words: Our socialist state would be justified in claim ing success, if it could point to a productive structure based on a pricing mechanism as near exactness as that of present economy . . . Eco nomically it is perfectly conceivable.64 The basic problem of decentralized socialism in the econo mic sphere is therefore the creation of such a pricing process within the structural environment of socialism. A pre-condition for this process is the existence of a sufficient degree of competition. Dickinson's proposals 63H. D. Dickinson, "Price Formation in a Socialist Commun ity," Economic Journal, XLIII, (June, 1933), pp. 239-250. 64 W. Crosley Roper, Jr., The Problem of Pricing in a Socialist State (Cambridge: Harvard University Press, 1931), p. 60. j 54 : for making use of competition were vague but still in the right direction. At one point among his original postu- j lates he presumes that "all production is undertaken by j 1 the community,"^5 but he later assumes "a free market at j i each end of the chain of production, for finished goods f i f i ' and for productive services." Given the latter assumption, i i and supposing no real markets for producers' goods and pro- j ductive services except labor, Dickinson then proceeds to i explain how the pricing process works in attaining equili brium prices for consumer goods and factors of production. Pricing of Consumer Goods. The trial-and-error blueprint of the decentralized socialist economy establishes a decentralized system with genuine markets for consumer goods. On the basis of a complete set of prices, consumers will buy whichever commodities they desire to buy. Then, "the selling agency will sell on the basis of what the market will bear, raising price when stocks fall short and lowering it when tfre^ accumulate. In this way the sales agency will be able to draw up a demand schedule for each 67 type of goods sold." Given the demand and supply of goods, real market prices are thus obtained for consumer ^5Dickinson, op. cit., p. 238. 66Ibid., p. 242. 6?Ibid., pp. 239-240. | 55 : ■goods. If these prices correspond to the original prices set by the Supreme Economic Council (SEC) or the CPB, then the system has obtained equilibrium prices. If not, the CPB has to adjust the set prices. In short, by a process of successive approximation equilibrium prices are reached for consumer goods, j Pricing of Factors of Production. As far as the factors of production are concerned, a similar process of successive approximation would establish equilibrium j positions for their markets. Given the quantity of these j | factors (parcels of land of known area and quality, defi- | nite quantities of mineral and other resources, and certain number of workers registered as willing to do certain jobs) the SEC will fix a price for each factor. This price, in conjunction with the demand schedule, will just ensure its full employment. On the basis of these provisional prices, the costs of production can now be figured. Then the productive organizations will either slow down or stop the production of those goods whose demand price is below the cost price and will expand the production of those goods j i whose demand price is above cost. Besides, it is possible for these organizations to substitute one factor for another on the basis of possible alternatives in methods of production, thus modifying their demand for such factors. Ultimately, Dickinson points out: 56 . . . by a process o£ successive approximation, a true economic price for each factor will be established, which can then be used for costing purposes whenever the factor is used. In this way the costs are imputed from the demand for the marginal product and then deputed back to all products. Also factors of production will be alloted to different uses so as to bring in equal returns.®8 In regard to producers' goods and productive re sources outside labor and the ones already noted, since i I there is no market for them, their prices are, as Lange notes, "mere indices of alternatives available, fixed for 69 ! accounting purposes." The same is also true for interest | |rate as it "will be used for all accounting purposes i (depreciation, insurance, etc.) and the capital will be supplied to undertakings in accordance with their original demand schedules."^8 i j In sum, the working principles of Dickinson's !system (as well as the Lange model) of decentralized socialism are as follows: Consumers, workers, and |managers make their decisions on the basis of given prices. Consumers and workers will act in the same fashion as they do under competitive market capitalism. The principles and motivations of their actions are therefore easy to describe 68Ibid., p. 241. 68Lange, op. cit., p. 73. 70 H. D. Dickinson, "Price Formation in a Socialist Commun ity,"^^ EcwiomieJournal, XLIII (June, 1933), p. 244. i on one hand, given freedom of consumer choice, prices of i goods and income, consumers will maximize their satisfac- j tion; on the other hand, given freedom of occupational ] choice and the wage rate, workers will work Where their skills are offered the highest wages. Self-interest will j i be sufficiently strong and the desire for acquisition will j express itself through price movements on genuine markets - i j provided that managers who sell consumer goods and hire j labor do play the rules of the game: that they will try to keep the costs of production as low as possible; that they will produce only commodities whose prices are equal to their marginal costs of production, and in their obedience of the rules they take prices as given. But will they take prices as parameters? Lange assumes implicitly that they do. However, it is highly improbable that managers can be induced to take prices as given when they have monopolistic and monopsonistic power. For this reason, some critics contend that a system of artificial pricing as proposed by Dickinson and Lange in their model of decentralized socialism would not lead to the desired results as they expected. This point will be developed more fully in Chapter V. Another criticism comes from centralized socialists, who emphasize central planning. A system of trial and error implies, according to these critics, a degree of decentralization that would not leave enough room for iplanned action. This brings us to their solution to the i i ! Mises problem. j I ! The Centralized Solution The group of economists emphasizing central planning at the expense of consumer sovereignty are Maurice Dobb, Paul Sweezy, and Paul Baran. The great exponent of this method is Dobb, whose ideas will be briefly mentioned here. A deeper examination of his ideas as well as those of Sweezy and Baran will be developed in Chapter IV. Dobb begins by attacking the generally accepted conception of the universal applicability of the economic theory. He mentions Mises' and Brutzkus1 view that social ism cannot be carried out, because the socialist society will lack a free market and a free price system, and that H. D. Dickinson has disputed this, maintaining that it is a question of combining socialism with a price system. In a footnote Dobb explains that he used to hold the same view, but that he now considers it to be false. Next, he points out that it has become fashionable to abandon the old hedonistic basis for the modern theory of value, and to treat economics as a non-normative equili brium theory. He mentions Robbins as having carried this viewpoint to its logical conclusion and defined the entirely formalistic character of the economic theory, but without, in Dobb's opinion, entirely realizing what this 59 ; involves. In this way, Dobb writes: Yet, when it comes to such judgments, the equili brium theoriest, of course, tacitly appeals to a norm. Despite his trumpetings against the wel fare economist, he in fact secretly imports an assumption which at once places him precisely on the same ground as the hedonist whom he has pre tended to disown. And in this assumption the whole | apparatus of utility and welfare, which it was j his pride to dispense with, is implied. But the manoeuvre has not been for nothing; it has enabled I the scientific dignity of an ethical neutrality j to be combined with an undiminished capacity to ! deliver judgments on practical affairs. The j crucial assumption is as simple as it is question able: it amounts to the sacredness of consumers' preferences (as a general rule, and subject to unimportant exceptions here and there). J Dobb thus says that this "sacredness" is attacked by advertisers and the magnates of the press. Consequently, in the economic sphere, there is no equal voting rights; on the contrary, a widely graded system of plural voting emerges. In this picture, the "central dilemma" is the following: Precisely because consumers are also producers, both 'costs' and 'needs' are precluded from re ceiving simultaneous expression in the same sys tem of market valuations. Precisely to the extent that market valuations are rendered adequate in one direction they lose their significance in the other. Mr. Dickinson cannot have it in-both ways.^2 ^-^Maurice Dobb, On Economic Theory and Socialism: Collected Papers (New York: International Publishers, 1955), p. 36. 72Ibid., p. 37. Dobb sees no reason to expect the consumers to be I ! in a different position under socialism. In a competing society, whether socialist or capitalist, they will be subject to influence. Thus socialism cannot be combined j with the price system - as the latter brings a distortion j upon consumers' sovereignty leading to "plural voting" due l : | i !to inequality of income distribution. I Socialism and Optimum Welfare Conditions | In the course of the 1930's, the debate which j followed Mises' challenge went against those who started the polemic: at least to the extent that it came to be held that there is no fundamental inconsistency between social ownership of the means of production and rational economic calculation as the Mises-school assumed there to be and tried to demonstrate by a simple a priori argument. Abram Bergson clearly stated the matter in 1949: "By now it seems generally agreed that the argument on those questions advanced by Mises himself, at least according to 73 one interpretation, is without much force." Indeed, during this period the argument of the disciples of Mises shifted its ground, and as Lange pointed out: anti- socialists of the Mises-Hayek persuasion "do not deny the theoretical possibility of a rational allocation of ^3Abram Bergson, "Socialist Economics," in A Survey of | Contemporary Economics, Vol. I, ed. Howard Ellis (Homewood,! I Illinois: Richard D. Irwin, Inc., 1968), p. 412. I 61 I ! resources in a socialist economy; they only doubt the i |possibility of a satisfactory practical solution of the I 74 I problem." By the end of the thirties, the general course of the debate had been turned toward the analysis of "optimum conditions" for maximizing welfare as having a favorable j i i position under socialism, rather than an unfavorable one. This, according to Dobb, was largely due to "the renewed attention paid by the economists in the twenties and early j thirties to cases of so-called decreasing costs lines of j production (where marginal cost is below average cost, ex-definitione). Since analysis of these cases carried the implication that only under socialism (where the making of profit was no object and industries could be run, if need be, at a loss) could the principle of equating price with marginal cost be rigourously and uniformly applied."^5 By the time of the Second World War the debate seemed to rest. Yet, on the formal side there had been considerable attention given to the question of "welfare" i under socialism. In this context, Abram Bergson, in an article which he wrote in 1949, made interesting contribu tions by refining the "optimum welfare conditions" and ^Lange, pp. cit., p. 62. ^^Dobb, op. cit., p. 59. applying them through a conceptual framework, as guidelines! i to assist the Central Planning Board to formulate a satis- | I 7 6 i factory scale of values to guide the economy. The fol- j ; 1 |lowing development is a partial summary of his article -as! ! ; related to the topic at hand. Bergson's conceptual framework serves two purposes. First, it in effect poses for the Board a series of ques tions on ends: consumer sovereignty, saving and investment, communal consumption, and income distribution. According to Bergson, whatever the ends the Board serves, its task j ! is to assure as far as practicable that the available resources are utilized to the optimum advantage. Of the writings he reviews to define the allocation of resources that would be an optimum, he not only refers to the works of Alfred Marshall and Arthur Pigou in the field of welfare economics, but also mentions those of Vilfredo Pareto and Enrico Barone in the field of socialist economics. In the former case, "the needed scale of values is given immediately in their proverbial conception of 'welfare' as the sum of the utilities of the individual j households in the community. It is supposed that for different persons of equal sensitivity the marginal utility of income is the same when incomes are equal. The optimum allocation of resources, then, is one which maximizes ^Bergson, op. cit., pp. 412-448. 63 I 77 welfare in this sense." This definition of the optimum allocation of resources involves the formulation of a scale of values on the basis of which the alternative I ! uses of resources are to be evaluated. This, according to Bergson, might be considered as representing the ends i which the Central Planning Board serves. "In the case of Pareto and Barone,: Bergson con tinues, "The criterion for an optimum allocation of i iresources is somewhat more complex: it must be impossible jby any reallocation of resources to enhance the welfare of ! lone household without reducing that of another. If a i reallocation which would lead to this result were possible, j j I it is reasoned, the resources of the community could be used to better advantage by making it; in the optimum such j opportunities already must have been completely ex- |ploited."78 For Pareto and Barone, this formulation had one outstanding advantage: it is possible to define the opti- j mum allocation of resources without assuming, as Marshall and Pigou did, that welfare is the sum of the utilities of individual households. Another point to be made about the welfare economics of Pareto and Barone is that it does not define a point but a range of possible optimum points. The significance of any movement along this range 77Ibid., p. 413. 78Ibid., p. 414. 64 : is crucial, because, according to Kenneth Boulding, we j cannot define a maximum position on this range, unless we i 79 j go to Bergson's Social Welfare Function. j The value of this function depends on all the variables that might affect welfare, such as the amount of j | goods consumed by and services performed by the household and the amount of capital investment undertaken. This i welfare function is understood to be general in character; j its shape is determined by the specific decisions on ends. Given the decisions on ends, the welfare function is j transformed into a scale of values for evaluating alterna- j tive uses of resources. On this basis, Bergson argues, J decisions on the following questions on ends are involved in the formulation of the welfare function. Consumer Sovereignty Should social welfare be a function of the welfare functions for each individual, for instance the sum total of individual utilities, or should it contain judgments by others than these individuals? Bergson's welfare function is generalized in the sense that it may represent both the j utilities of individual households and the Board's own preferences. 7^Kenneth Boulding, "Welfare Economics," in A Survey of Contemporary Economics, Vol. II, ed. Bernard F. Haley (Homewood, Illinois: Richard D. Irwin, Inc., 1968), p. 16. 65 Interesting contributions have been made to this i topic by Jan Drewnowski who denies that only individual ' utility functions should be the building blocks of the j 80 social welfare function. He makes a distinction between I variables appearing in individual utility functions and variables appearing in a state preference function. The reason why he makes this distinction is that some variables! can be chosen by individuals, for instance, in making pur- ! i chases in shops, and other variables can only be chosen by j | the state. Drewnowski therefore seems to advocate, although I he does not give any precise formula, a social welfare j function composed of individual preference functions and of a state preference function. Income Distribution. Bergson follows Pareto in thinking that utilities are not measurable, and agrees with Robbins that because of this, principles of income distribution cannot be deduced from the utility calculus either by the rules of logic or by empirical investigations. Consequently, he rejects the appeal of Lerner and Lange as having anything to meet the issue: that we must "assume" the comparability of utilities 8 X in order to establish a basis for normative precepts. 8 8 Jan Drewnowski, "The Economic Theory of Socialism: A Suggestion for Reconsideration," Journal of Political ! Economy, LXIX (August, 1961), pp. 341-354. O 1 °•‘ •Bergson, op. cit., p. 418. ! 66 | But the knob of the argument is related to a deci sion on ends. As Bergson sees it, "ends are essentially principles for the evaluation of alternatives that other wise are incommensurable. That is why an evaluation is needed. Once an evaluation is made, the alternatives are | indeed commensurable. Given the ethical principle accor- i ding to which incomes are to be distributed, the marginal j welfare per 'dollar' for different households necessarily j | is the same in the light of this principle when the distri- 8 2 bution is realized." Interrelations in the Welfare of Different Households Bergson rejects the Marshall-Pigou formulation on the effect that interrelations in the utilities of the different households have a zero social value for the purpose of analyzing the optimum allocation. This means that "the magnitude of the change in the community's welfare resulting from a change in the budget position of any one family does not depend at all on the living stan dards enjoyed by other households" is a dubious case, and that the relevant propositions can be deduced from the 8 3 more general function in the formula given above. 82Ibid. 83ibid. 67 The second purpose to which Bergson's conceptual framework is directed is to establish the implications of the given ends. These implications are the optimum welfare conditions which, on the basis of these ends, must be satisfied if the optimum allocation is to be achieved. j These conditions are sufficient in number to determine the | i amounts of each good and service allocated to every use. Thus, given the ends and the scale of values implied by them and the available techniques and stocks of resources, it is possible to state the optimum conditions. In this connection it is necessary to make a special acknowledge ment, as Bergson does, to Lerner who introduced them into 84 the English language treatment of welfare economics. Excluding interpersonal comparisons of utility from his analysis, Lerner not only defined maximum welfare as a situation which would show itself in the impossibility of any individual being put into a preferred position without putting some other individual into a worse position, but he also stated that this situation was the social optimum relative to a given distribution of income among individuals. By setting up the optimum conditions in this form, Lerner provided the final element that was needed to build the structure of welfare economics. S^Abba Lerner, "The Concept of Monopoly and the Measurement of Monopoly Power," Review of Economic Studies, I, (June, 1934), pp. 157-75. The main conditions, according to Bergson, are, then, as follows: (1) The ratio of the marginal utilities (the marginal rate of substitution) for each pair of consumers' i goods must be the same for all households. (2) In every industry factors must be combined in a technologically 1 j optimum manner, in the sense that it is not possible j i technologically to dispense with any amount of any factor without a reduction in output. (3) The marginal value productivity of each factor must be the same in every j industry. (4) In the optimum, there must be no possibility f of shifting a worker from one occupation to another to increase the value of output by more than would be required to compensate the worker for the change. (5) Occupa tional wage differentials must correspond at one and the same time to differences in marginal value productivity and for marginal workers, to differences in disutility. (6) The social dividend or tax, however, must be determined independently of the worker's occupation or earnings. The establishment of these conditions would seem to be a prerequisite for the construction of a ' planning scheme which might approximate the given ends in practice. In this way, provided that it had at its disposal the neces- * sary data, the Board might compare alternatives of resources pair-by*-pair and try to distribute any given resources to the best advantage between each pair of alternatives in 69 | turn. For purposes of planning, Bergson concludes that such method of successive approximation is all to the good, and there is no need for the Board to run into the problem of j solving millions of equations at one blow. Thus, Hayek's ! and Robbins' criticism can be avoided. S Thus far the central part of the discussion has I focused on the question of how to maximize welfare on the j i i basis of given conditions. Reviewing different contribu tions on this matter, Dobb believes that economists have I been confronted with a crucial difficulty: how to handle the matter of income distribution. He states that, historically, there have been two views to deal with this problem, positivists' and Lerner's views; Positivists 1 Views The positivists whether as cardinalists or ordin- alists, take the distribution of income as given and enunciate propositions about the optimum allocations of resources. These propositions were outlined in previous pages. To Dobb, such a course of action is unacceptable, because it is "absurd ... to enunciate certain conditions for maximizing welfare," when it is clear to all that "with the existing distribution of income, welfare could be 8 5 increased by deliberately violating these conditions." Then, Dobb turns to Lerner's views with favorable insights. 85Dobb, op. cit., p. 61. J Lernerfs Views In his Economics of Control, Lerner takes the posi tion of including some statement about distribution among the optimum conditions themselves and thereby positing that "the probable value of total satisfaction is maximized 8 6 by dividing income evenly." This assertion is possible in the absence of interpersonal measures of the marginal utilities of income. The claim is that the rule of equality maximizes the expected value of the total utility of the participants in society "... from the consideration that a transfer of income from a richer to a poorer individual would increase total satisfaction, for in that case the shift of income would be a movement toward the equal distribution which would make their marginal utilities 87 equal." Such an equality of capacities for satisfaction cannot, however, be assumed to be the case. . In other words, Lerner continues, "if the poorer man has a greater capacity, the gain is increased on that account; If the richer man has the greater capacity, the gain is diminished on that account .... The possibility of an increase in gain offsets the possibility of the diminution of gain since they are equally likely to occur in any particular 88Abba Lerner, Economics of Control, (New York; The Mac millan Co., 1944), p. 29. 87Ibid. case. There remains the net gain that is seen by itself in the case of equal capacities but which becomes only a probable gain on account of the possible increase or diminu 88 tion of the gain which raises with unequal capacities.” Welfare Economics and Socialism: Policy Implications In this section, the foregoing analysis of optimum conditions will be restated in terms of costs and some of the practical problems which have emerged historically through the welfare application of these conditions will be examined. One of the main justifications for a competitive economy in classical and neo-classical economics was the view that such a social organization can reach a social optimum. Under this framework, the total cost incurred in the production of the optimum output must be at a minimum and price must be equal to marginal cost. If these two rules are met, the following three main optimum conditions (previously stated in this chapter) will be also satisfied: (1) factors employed in each firm will be combined in a technologically optimum manner; (2) the marginal value productivity will be the same in every use; and (3) differ ences in the wages of different kinds of labor will equal differences in thier value productivity. 88Ibid., pp. 29-30. Upon following these two rules and satisfying these j i optimum conditions, a decentralized socialist economy j would be in a position to determine the importance of products through consideration of alternatives foregone. i As Lerner writes: ! If we so order the economic activity of the society that no commodity is produced unless its importance is greater than that of the al ternative that is sacrificed, we shall have completely achieved the ideal that the economic calculus of a socialist state sets before it self.89 This can be done, Lerner notes, by allowing the central authority to take its indications from a free consumers' market. If this is the case, the question arises as to whether changes in prices are to be made by the central authority or by autonomous enterprises. Lerner states: This assumes that individuals choose best for themselves. Whenever this is not considered to be the case, others - normally in the form of the State - can choose for them either wholly or partly (i.e., by influencing particular prices by taxes or bounties). These others are then the consumers and the whole scheme formally re mains the same. Thus, it is important that prices are determined in a free market for consumers' goods, because only then "we B^Abba 'Lerner, "Statics and Dynamics in Socialist Econo mics," Economic Journal, ILVII, (June, 1937), p. 253. 90 ibid. 73 can take the ratio between the prices at which goods sell freely on the market as measuring the ratio between the 91 marginal significance of the commodities." In this manner, he upholds the democratic character of the price system by stressing that if the central authority deter mines the scales of consumption and needs, it would be irreconcilable with socialist needs. Just as the bureaucracy tries to free itself from the direct democratic control of the masses whom it comes to despise, so it is anxious to be above and beyond the external control of a still more democratic pricing machine to which it would in certain respects be subservient.92 Needless to say, any argument for perfect competi tion immediately runs into the difficulty that perfect competition is impossible unless the size of the unit of economic decision is small relative to the market. Con sequently, we run into the case of "fixed factors" and indivisibilities. These two cases have been discussed in some detail by Lerner in his Economics of Control. He clearly states: "With significant indivisibility, perfect competition . . . must result in the firm's running a loss, so that the optimum use of resources is possible only in a 9- ^ Ibid. , p. 256 . 92Abba Lerner, "Economic Theory and Socialist Economy," Review of Economic Studies, II (October, 1934), p. 58. 7 4 ! 93 collectivist or subsidized agency." What is of concern here is that because of very heavy overhead and the rela tively limited importance of variable costs, average cost per unit will not follow the familiar U-shaped pattern, but i instead will continue to decline for a wide range of out- j put variations. According to the standard average-marginalj i ) relations, when average costs are falling, marginal cost xsj less than average cost? consequently, if the firm sells at j ! a unit price equal to marginal cost, the price must be | j less than average cost. In effect, unit costs exceed unit j I returns, and the firm loses money on each and every unit 94 it sells. The only answer to this dilemma seems to be public operation or control of these large-scale enter prises in order to secure "marginal cost pricing," for it is only when price is equal to marginal cost that marginal conditions of the social optimum can be met. This con clusion has been the subject of an extensive controversy in the literature; for this reason, it deserves special attention in this study. I The Marginal Cost Pricing Controversy As already noted, it has been maintained for a long time that the best price system is the one resulting in ^•^Abba Lerner, Economics of Control, p. 177. ^Incidentally, this phenomenon is also true under decen tralized socialism in case of decreasing cost industries when the socialist managers obey Lange's rules. 75 prices covering properly defined total costs of production. But then, with the development of welfare economics, that principle was challenged and the following proposition was made: Prices should be devised in such a way that no commodity is produced unless its importance is greater than that of the alternative sacrificed . . . . Accordingly the new principle . . . re quires that price is equated with marginal cost. And if a collection of commodities is produced such that the marginal units of all components are of equal 'importance,' then there is no con ceivable better allocation of resources, and the economy has achieved an optimum result. 1 3 The notion that allocation of resources might be improved by subsidizing decreasing cost industries was in the Marshallian tradition, and was advocated by Harold 96 97 99 ' Hotelling, Oskar Lange, and Abba Lerner. The central problem relates to a divergence between average and marginal costs. The Hotelling-Lange-Lerner solution would presumably be that the amount which consumers should pay for each unit of product or service be equal only to marginal cost. The ^5Horvat Brankp, Towards a Theory of Planned Economy (Beo grad: Yugoslav Institute oi: Economic Research, 1964), pp. 17-18. ^Harold Hotelling, "The General Welfare in Relation to Problems of Taxation and of Railway and Utility Rates, Econometrics, VI (July, 1938), pp. 242-269. ^Lange, op. cit. ^Abba Lerner, Economics of Control, pp. 174-227. 76 effect would be for the consumer to pay the cost of the product and for the government, or rather the taxpayer, to bear the difference between average and marginal cost. It is the validity of this solution which has been subject to many objections. Before examining them, it is necessary to briefly elaborate on this principle and some of its related issues to welfare economics, with special reference to its greatest advocate, Hotelling. The starting point in Hotelling's analysis is his 99 reference to the classic example of Jules Dupuit's bridge. Dupuit, after assuming that the cost of using the bridge is zero, defined its total benefit (being measured by the whole area under the demand curve) as the aggregate of the maximum prices which a perfectly discriminating monopolist could charge, equal to the costs of the best alternatives to its use. Applying this definition to the search for a method of maximizing the total benefit, he reasoned that once the bridge is built maximum benefit would require toll-free use to anyone who would derive any individual benefit at all from using it. Dupuit's argument was based on a concept of measurable utility and free interpersonal comparison, but Hotelling maintained that through modern mathematical meth ods the essence of Dupuit's propositions could be reached without any necessity for such dependence. Jules Dupuit, "On the Measurement of the Utility of Pub lic Works," International Economic Papers, No. 2 (London: Macmillan and Co., Ltd., 1952), pp.' 83-110. 77 In this way, Hotelling conceived of an economy in which "marginal cost pricing" is the rule of the game, and the difference between marginal cost and average cost is made up by taxation. He then proved algebraically the fundamental theorem that "if a person must pay a certain sum of money in taxes, his satisfaction will be greater if the levy is made directly on him as a fixed amount then if it is made through a system of excise taxes which he can to some extent avoid by rearranging his production and consumption."10° Hotelling then extended his analysis from one individual to the entire community, postulating that "if government revenue is produced by any system of excise taxes, there exists a possible distribution of personal levies among the individuals of the community such that the abolition of the excise taxes and their replacement by these levies will yield the same revenue while leaving each person in a state more satisfactory to himself than before."101 On this basis, following the Marshallian tradition, he recommended a system of pricing at marginal cost. The deficits which would occur in decreasing cost industries should be made up out of the public treasury, he said, with the requisite funds collected by lump-sum taxes. 100 101 Hotelling, op. cit., p. 252. Ibid. 78 The main issues from the point of view of welfare economics have been first, whether proportionality of price to marginal cost rather than equality would not equally satisfy the marginal conditions for an optimum. 102 (This was proposed by Ragnar Frisch.) According to this view, using Marshallian language, the need for paying ! bounties on commodities which are produced under decreasing cost conditions can be avoided altogether by making prices proportional to rather than equal to marginal cost. But the fallacy of this argument has also repeatedly been pointed at by Lerner who said that "proportionality cannot 103 be universal unless it is really equality," and Bergson, who argues that "if prices are proportional but not equal to marginal costs," the optimum conditions concerning the 104 allocation and substitution of factors will be violated. A second issue of the controversy was whether com plete compensation was necessary: this view is a distinct contribution of Hotelling to the theory of interpersonal comparisons, which is aptly summarized by Nancy Ruggles in the following words: 102 Ragnar Frisch, "The Dupuit Taxation Theorem," Econometrica, VII (April, 1939), pp. 145-150. ■^■^Abba Lerner, Economics of Control, p. 102. •^^Abram Bergson, "Socialist Economics," p. 428. This was the furthering of the concept of com pensations - that an optimum can be achieved by a process of change plus a system of collec tions and compensations such that everyone will be better off than before. As a practical mat ter, however, he argued that in some cases the compensation need not necessarily be paid to those who suffer a decrease in welfare, i.e., that the general welfare can be purchased at the welfare of sacrifices by some. Frisch drew attention to the fact that this con clusion represents a departure from the original definition of the optimum he had adopted from Pareto in order to avoid the need for interpersonal comparisons. Frisch pointed out that as long as some individuals do make sacrifices and others do gain, no judgement can be made about the general welfare without introducing interper sonal comparisons. For this reason, Frisch claimed that Hotelling's conclusions with regard to the desirability of marginal cost pricing do not follow from the propositions he had made. A third issue of the controversy concerned the means of raising money for the necessary subsidies Hotel ling advocated that the necessary revenue be raised by taxes on inheritances, rent of land and incomes, since, he argues, all these are lump-sum taxes and therefore would not interfere with the marginal conditions. "A true l^Nancy Ruggles, "The Welfare Basis of the Marginal Cost Pricing," Review of Economic Studies, IVII (1949-50), p. 36, lump-sum tax is by definition one which falls on either producers' or consumers1 surplus and therefore does not 106 violate the marginal conditions." Taxes on inheritances | and taxes on the rent of land do fall into this category, i and should be the revenues for meeting the subsidies. But Hotelling does not expect this to be true in regard to income taxes, as they are of a different matter. They are in effect excise taxes on the supply of factors of production and as such violate the marginal conditions of production, thus distorting the optimal distribution of time between work and leisure. Critique of Marginal Cost Pricing The arguments which have been used as grounds to reject the marginal-cost principle have shown considerable variety both in character and in weight. The ones that have exercised the most influence are summarized below. First, it has been maintained that the policy of setting price at marginal cost is faced with the problem of administrative difficulty. This is because reality does not conform to the regular and perfectly defined curves of the theorist, so that, in practice, marginal cost may not only be difficult to determine with accuracy but also subject to extreme and erratic fluctuation, 10^Nancy Ruggles, "Recent Developments in the Theory of Marginal Cost Pricing," Review of Economic Studies, IVII (1949-50), p. 36. 81 depending on circumstances. This view is stressed by Harry 107 Norris. By contrast, to base prices on average total costs has the advantage of administrative simplicity. It is simple to tell managers that they must cover cost and aim at making profit,' and to take the occurrence of a balance-sheet as prima facie evidence of expanding or contracting produc tion. On careful examination, this contention seems to have i less force than appears at first sight. Quoting Dobb: Since some form of tax is probably included in the expenses side of the balance-sheet, even at times being included in the calculation of cost (notionally if not actually), there seems to be no convincing reason why a subsidy (as a negative tax) should not be included. All that managers and accountants need in this case learn to do, is to reverse a sign from plus to minus. In cases where marginal is below average cost a subsidy of some kind would necessarily be void; and an ob vious method of doing this would be to assess a fixed (annual) subsidy equal to the estimated difference, and to pay this to the enterprise or industry by writing-off fixed capital cost (pos sibly with the condition attached that selling price should not be fixed above a certain level.) However, Dobb admits that insofar as marginal- cost pricing is interpreted as an instruction to management to make a separate calculation of additional cost in i each situation on a variety of circumstances, and to fix lO^Harry Norris, "State Enterprise and Output Policy and the: Problem of Cost Imputation," Econometrics, XIV (February, 1947), pp. 54-62. • L08Maurice Dobb, Welfare Economics and Economics of Social ism: Towards a Commonsense Critique (Cambridge; Cambridge University Press, 1$(>9), p. 243. 82 price and output accordingly, the principle retains some difficulty with regard to its administrative feasibility. Second, average-cost pricing, it is said, does at least afford a conveniently simple investment-criterion which otherwise would be lacking: a balance-sheet profit and loss scheme indicating which projects should be under taken and which abandoned. In the case of marginal-cost pricing policy for decreasing cost industries, the admitted necessity for a subsidy leaves no simple test as to whether or not the project is worthwhile as a whole. Under competitive conditions, where decreasing- cost conditions are absent or insignificant,1 the amount of profit or loss furnishes not only a prima facie test of the relative efficiency of the management but a guide as to whether or not the industry or activity should be expanded, contracted, or ultimately abandoned. 09 In a dynamic world, however, it must be admitted that these conditions do not exist in a perfect way. The existence of substantial indivisibilities, as already noted was used by Hotelling as an argument for socialization in all such cases, since private enterprise may be unwilling to undertake the investment where this is socially justi fied since total cost cannot be recovered by any system of uniform prices. To this some have reacted by suggesting a system of "discriminating monopoly/" while stressing that ^^William Vickery, "Some Objections to Marginal Cost Pric ing," Journal of Political Economy, LVI (June, 1948), p.218 83 discrimination can at times yield a better allocation of resources than can flat rates that must cover total costs. For example, R. Coase has suggested that in certain special circumstances, it may, to be sure, be possible to develop methods of discriminatory pricing which will enable costs to be recovered from revenues without substantial departure from the optimum allocation of resources produced with marginal-cost prices. This result may be achieved by "multi-part pricing," in which the total amount charged each customer is the sum of a flat "customer charge" for each customer regardless of the quantity of the service taken (provided it be greater than zero), and a charge per unit of service taken, set at the marginal cost level. William Vickery is critical of this method when he writes: But this device can achieve the desired result in but a limited number of cases, and, in many of these cases, success in achieving the optimum allocation of resources may require information offthe same order as that required to determine whether or not the project as a whole is worth while under a policy of uniform marginal cost- prices. 3-11 Third, another dissent came earlier also from Coase who did not disagree with the thesis that price should equal marginal cost,’ but argued that total cost would also ^°R. H. Coase, "The Marginal Cost Controversy," Econo metrics, XIII (August, 1946), pp. 169-182. Hlvickery, op. cit., p. 219. 84 have to be covered if there was not to be a redistribution of income in favor of the consumers of products in which fixed costs or a high proportion of total costs. He was in effect pointing out that marginal cost pricing without compensation leads to a change in the income distribution, so its result cannot be compared in welfare terms with that of average cost pricing. "Correct price discrimina tion, " Coase said, "would permit both the marginal and the 112 total conditions to be met." Fourth, an objection raised by Arthur Lewis to marginal cost as a basis for pricing is that it has no unique definition, but rather a considerable variety of definitions, each of them contingent upon the special circumstances of a particular case. Accordingly, it is unsuitable as a basis for any general rule. There is no such quantity as the 'marginal cost of output'; there is not even a simple choice between two quantities, short- and long-run cost; there is a large variety of costs to choose from, depending merely on how far ahead you choose to look, and this collection of costs itself varies from day to day as current commitments alter.113 112R. H. Coase, "Price and Output Policy of State Enter prise: A Comment," Economic Journal, LV (April, 1945), p. 111. 113William A. Lewis, Overhead Cost: Some Essays in Economic: Analysis (London: Allen & Unwin, 1949), p. 12. Lerner has provided an answer to this objection: namely, that this type of objection is based on a misunder-j i (standing of the modus operandi of the marginal rule, which | is to be regarded essentially, not as a rule for price- I fixing, but for fixing output. All that is necessary is j i to tell managers when taking decisions about the scale of output to use that definition of marginal cost which fits the particular decision they are taking. Given the price as given, what they should do in any circumstance is to calculate the additional cost involved in the activity and compare it with the value of additional output: if the latter exceeds the former, output should be increased and if the reverse is true, output should be contracted. In short, Lerner writes: Price must be made equal to marginal cost. This is the contribution that pure economic theory has to make to the building up of a socialist economy.114 Dobb admits that the Lerner answer is effective only if prices remain flexible, but in cases where they cannot be indefintely flexible but have to take the form of "announced prices" or "list prices" announced for some i time ahead (as is true with public utilities), it cannot 114Abba Lerner, "Statics and Dynamics in Socialist Econo mics," p. 270. 86 ; i be of much help. Here, Dobb says, the Lewis problem 115 seems to remain as a serious obstacle in practice. I Fifth, as already noted, the marginal cost principle! | would involve running a number of industries at a loss; i this, according to Dobb, would involve the subsidizing of some groups at the expense of others and have therefore significant effects on income distribution. If this effect was seriously adverse, then marginal cost principle loses j its rationale. With this objection, Dobb points out: "one j j can never divorce a supposedly optimum principle affecting pricing or output from the effect on income distribution 116 of applying it." What conclusion, then do we reach after this survey of marginal cost pricing? It should be clear that this principle may very well increase welfare in certain specific situations. The fact that it is not applicable in all instances does not mean that it should be completely disregarded. Certain utility rates do provide an area in which marginal cost pricing would increase welfare and as Ruggles points out: "Hotelling was undoubtedly right in i pointing out that the gain enjoyed by those who benefit ^Maurice Dobb, Welfare Economics and Economics of Socialism: Towards a Commonsense Critique, p. 246. 116Ibid., p. 248. 87 from the lower price is frequently greater than the loss borne by those helping to subsidize the industry . . . "H? As far as the welfare implications of marginal cost pricing in defense of socialism is concerned, it is argued « that as perfect competition is impossible in a market economy, the marginal conditions for the social optimum cannot be easily met under capitalism and can only be satisfied in a socialist economy which is planning con sciously on that end. In other owrds, equalization of price and marginal cost by a price-fixing agency may j attain optimum welfare conditions faster and smoother. This view is associated with Lange whose arguments will be j |examined more deeply in Chapter IV. i i • . i Economic Theory of Socialism under Reconsideration Organizational Behavior of Enterprises I I Until recently, little attention was paid to how i the individual enterprise would behave in a completely decentralized socialistic economy. This question cannot be answered without considering the problem of worker and especially manager incentive. The Lange model of decen tralized socialism left this question unanswered, as 117 Nancy Ruggles, "Recent Developments in the Theory of Marginal Cost Pricing," p. 125. 88 it merely provided the Central Planning Board the authority to order the individual workers and managers to maximize profits. To many behavioral economists, this is not suf ficient to insure that they will do so. Their motivation lmust come from a selfish interest in achieving profit maximization rather than utopian collective cooperation. The problem was ignored after the Lange articles, probably because the practical problem of an adequate incentive system was primarily considered to be concerned with a centrally-planned economy as has evolved in Russia and Eastern Europe. But in the 1960's, the Soviet block countries began to institute reforms that were quasi- capitalistic most important of which is the institution of profits as the criterion for individual enterprise per formance rather than output targets. These reforms have become familiar to the Western reader under the "Liberman Discussion" after Evsey G. Liberman, the Russian Economics Professor and have revived the .topic of decentralized socialism by stimulating post-Liberman economists such as Benjamin Ward to tackle the problem of how an individual enterprise would behave with a specific incentive system. Accordingly, it is first necessary to be acquainted with the "Liberman plan" and then examine Ward's contributions. Finally, a glance will be taken at Jan Drewnowski's effort to reconstruct the economics theory of socialism as a post-Lange economist. 89 ! The Liberman Plan Liberman does not attack the central plan, or the state preference function, or the fact that the Soviet system does not rest on consumer sovereignty. He does not criticize the main structure of the authoritarian socialist j economy in which planners determine the targets without | I the benefit of economic calculations in terms of oppor- j tunity costs. Thus, he has nothing in common with Lange, j as far as his model of decentralized socialsim is concerned. Liberman's disapproval concerns almost exclusively the bonus system of the Soviet economy. According to ! Liberman, the managers are practically forced into misin forming the planning authorities about the true capacity of their enterprise. Such weakness can be shown when he criticizes the present incentive system, saying that "how can the enterprise be entrusted with the job of working out plans when at present all their draft targets are X18 usually much lower than their actual capacities." And, since the managers have only the needed knowledge for operational planning, an incentive system, based on profits and on greater managerial freedom, must be introduced in order to make it profitable for the manager to reduce H8Evsey G. Liberman, "Plan, Profits and Bonuses," in The Liberman Discussion; A New Phase in Soviet Economics Thought, Vol. I of Planning, Profit and Incentives in the USSR, ed. Myron Sharpe (New York: International Arts and Sciences, 1966), p. 353. costs and improve output in- exact accordance with the targets of the plan. In this way, Liberman, in the context of a centrally planned economy, proposes certain new arrangements which assure that "what is profitable for society, as represented by the state, must be profitable for every collective of 119 the enterprise and every member of that collective." This can be achieved, Liberman states, by assuring that'i . . . the enterprises are presented with plans only with respect to the volume of output and the assortment and dates of deliveries .... There is every reason to assert that if the sys tem proposed will relieve centralized planning of petty tutelage over enterprises, of the expensive attempts to influence production not by economic measures, but by adminstrative technique. The enterprise itself best knows its reserves and can find them. But in doing so, it should not be afraid that its good work will place it in a difficult position in the following year. All the main levers of centralized planning - prices, finances, the budget, accounting, large capital investments - and, finally, the value, labor and major physical indices of rates and proportions in the speres of production, distribution and consumption - will be determined centrally. This change-over from adminstrative techniques to "economic levers" is to be achieved through the use of a profit system in which a "profitability rate" that expresses enterprise profits as a percentage of production capital is to be compared with a long-term "profitability norm" 119Ibid., p. 217. 120Ibid,, pp. 79, 82. 91 ! I that the central authorities will establish for every j branch of production. I These are the main features of the Liberman Plan. It is obvious that Liberman does not try to introduce a i decentralized socialist system a la Lange. Yet, it is j I I interesting to compare Liberman's proposals with the Lange j i model of decentralized socialism. Lange is interested in a decentralized socialist economy which satisfies the following conditions: (1) the consumers are sovereign, (2) while the Central Planning Board determines the division between consumption and investment (capital i goods production), such production is indirectly guided by the changing wishes of the consumers, (3) there exist genuine markets for consumer goods and labor, (4) the prices for investment goods and investment funds are set by the Central Planning Board and are changed when they do not lead to equilibrium between demand and supply, (5) the managers act as if all prices were constant and try to achieve equality of product price and marginal cost of the plants comprising the industry; they do not try to maximize profit, and (6) the Central Planning Board has not only the function of determining that rate of accumulation, it also must distribute investment funds among the different industries. This allocation takes place via a uniform rate of interest. Only those managers whose products will sell at a price that covers the cost of production, 92 including the rate of interest, can count on obtaining j additional investment funds. These conditions are based 121 on L.ange's article on Economic Theory of Socialism. Comparing the Lange model as outlined above with Liberman's proposals, the following differences are evident1 ; I Liberman's managers will maximize the profits of their enterprises but their action will not influence the plan or the state preference function. Lange's managers will try to equalize prices and marginal costs and their i I actions will lead to corresponding changes in national factor allocation. Ward's Contribution Ward's main contribution to the problem of a specific incentive system in regard to the behavior of socialist enterprise lies in its microeconomic aspects of resource allocation. Under the Lange scheme, the manager of a production unit is supposed to follow certain rules; that of minimum cost and that of maximum of profit. How such behavior might be assured has been subject to criti cism. Ward has explored an alternative model of market socialism in which the organization of the production unit is approached rather differently. In such model or Illyria, as he calls it, the state owns the means of production, but the administration is by worker-managers. 191 Lange, op. cit., pp. 90-91, 95. 93 Because the workers are at the same time managers, they are interested in profits as well as wages - as Ward assumes the existence of individual material self-interest as the dominant, human motivation. On the other hand, since the markets are the means of allocating resources, "the incentives of the worker-managers . . . play a key role in the allocative process. They are the Illyrian equivalent of the Soviet incentive and the capitalist's profit incen- 122 tive." The state plays a special role in relation to the Illyrian economy and that is to levy a tax, R, on the firm as a charge for the use of state's property. To refer to a simple case, as considered by Ward, suppose labor - as the only variable input - is homogeneousJ Variation in output can be achieved only by varying the number of workers employed since the hours of work are fixed by the state. Thus, Ward arrives at a production function which describes the technical conditions under which the firm may transform labor, X, into the salable output, Y: Y = f (X) Over the feasible range of output, the marginal product of labor will be assumed to be positive but declining as out put increases. 122Benjamin Ward, The Socialist Economy: A Study of Organi zational Alternatives (New York; Random House, 1967), p. 183. 9.4 What would be the nature of managerial behavior? What is the manager's criterion as to how much to produce? This is Ward's specific contribution. He writes as follows: The workers' council is interested in maximizing the incomes of the workers. Indeed, each member of the workers' council is interested in maximi zing his own income. But in this case there is no conflict of interest among the workers, since each receives the same wage and the same share of profits. The workers' council instructs the manager to produce up to the point at which the average income (wage plus profits share over the time period in question) per worker is a miximum . . . . The manager's job now is to calculate the desired output and then to produce it. As a basis for his calculation he knows the firm's production function1 , the prices P and W - given by the market and the state respectively - and the criterion prescribed by the workers' council. He might proceed by considering U = PY/X the average receipts per workers, and K = W + R/X 123 the average costs per worker. The difference between U and K is average profits per worker, so maximizing this difference will satisfy the workers' council criterion - as envisioned by Ward. When this difference is maximized, the Illyrian competitive firm is said to be in equilibrium. What is the meaning of this equilibrium as well as some of its implications when compared with the capitalist l23Ibid., p. 186. 95 condition of profit-maximizing behavior and the Lange model? According to Ward, the Illyrian conditon of equilibrium states that "wages per worker (or, what amounts to the same thing, projects per worker) are maximized if the competitive firm chooses the output at which marginal per 124 worker-revenue equals marginal cost per worker." As such, it is the equivalent of the capitalist condition that price will equal marginal cost or of the Lange rule that managers act so as to set marginal cost equal to price. The Illyrian rule has more in common with the capitalist rule than with the Lange rule. For, as Ward points out, "The Illyrian rule represents the result of behavior of a specific kind (wage-maximizing behavior). In the market socialist economy of the Lange . . . type, however, the managers are directed by the state to act in a certain way, the rule not being connected explicitly with 125 the motivations of the managers." Comparing the reaction of an Illyrian firm to a change in their environment, ceteris paribus, with that of its capitalistic counterpart, Ward comes to very peculiar results. In Illyria, output does not only change with a change in labor under a static model, it also changes if the parameters of the static model are altered. As Ward points out, the amount of output that an Illyrian firm 124Ibid., p. 188. 125Ibid. 96 produces depends also on the tax. By varying the amount of this levy independently for different firms the government conceivably could still assure that marginal returns to labor were the same. In effect, "a change in the fixed costs of the competitive firm leads to a change in output 126 in the same direction." In the capitalist model, however, output would remain the same and only economic profit would change in case of a change in fixed costs. Curiously, as the going price changes, Ward comes to the peculiar proposition that the firm tends to vary its output in the contrary direction. Consequently, a nega tively sloped supply curve is reached, which could be a source of economic instability depending on the slopes of resulting supply curve and the given demand curve. In contrast to the Lange model, the Illyrian firm as depicted by Ward assumes that determination of prices is left to the market rather than being made the task of a CPB. Ward's analysis thus far relates to a competitive firm which takes the price as a datum. As Ward explains, should the firm have any monopoly power it would tend to restrict output below the competitive level. To conclude Ward's discussion, it is of significant importance to refer to his main discovery when comparing the Illyrian firm with its capitalist counterpart. Abram Bergson, upon calling the arrangements depicted by Ward's 126Ibid., p. 190. model as the cooperative variant, points out that they might have a favorable effect on workers1 attitudes and in this way tend to increase productivity. But there is no basis otherwise, Bergson continues, to quarrel with Ward's discovery that the cooperative variant could be inherently inefficient when compared to a competitive enterprise under capitalism. Bergson's reasoning is as follows: . . . suppose labor is homogeneous and that net earnings are divided equally among employed work ers, but that more senior workers are free to vary the employment of junior ones. Also labor is the only variable input. The more senior workers presumably will seek to determine total employment and output in such a way that average earnings per employed worker or the per worker average of sales revenue net of government tax . . . are a maximum .... In any more realistic case of working arrangements such as are in ques tion, employment most likely could be varied upward more readily than downward, but granting this, marginal returns to labor in different firms could still diverge materially. Hence the conflict between cooperation and efficiency, which Ward discovered would still prevail. Drewnowski's Contribution As a post-Lange economist, Drewnowski points out that the Lange model of decentralized socialism, in which consumer sovereignty is largely held, is not applicable to the centralized socialist economies of the Communist countries, in which planners' sovereignty predominates. He •^'7 A b r a m Bergson, "Market Socialism Revisited," The Journal of Political Economy, LXXV, (October, 1967), pp. 667, 668. 98 writes that "Lange's solution was intended as an answer to criticism based on practical considerations, but in fact it had nothing to do with practice, that is, with the condi tions that existed in the only place where socialism in 128 practice could be found at that time - the Soviet Union." Drewnowski undertakes to formulate a model of socialism relevant to these countries by analyzing how state and individual preferences can combine to guide the economy. In socialism (and also in capitalism), two systems of preferences must be distinguished: the multiple system of; individual preference functions of consumers and the single ; state preference function. "The important point to bear in ; mind is that, these two systems of valuations are not mere 129 theoretical models but do exist in actual life." The individual preference function embodies those decisions, as revealed by individuals through their scales of value. The state preference function reveals those decisions, as formulated by the government through its economic policy. As a suggestion for reconsideration, Drewnowski stresses that the theory of a socialist economy must be founded on the basis of the existence of such a dual-valuation system. While stating that the crucial problem of an economic; theory of socialism is the interaction of the state and individual preferences, Drewnowski distinguishes three 128orewnows] cif op. cit., p. 342. 129Ibid., p. 350. 99 possible combinations of state and individual preferences, with increasing degrees of influence for the latter. In the "first-degree market economy," households possess only consumer choice in the purchase of consumer goods, the quantities of which are fixed by the state. "The state, being anxious to sell what is produced, will adjust the prices to consumer demand so as to have no unsold stocks." In the "second-degree market economy," consumer preferences also influence which goods are to be produced, with the resources allocated by the planners, but the existing plants producing consumer goods. In the "third-degree market 130 economy." The pattern of new investments in plants producing consumer goods also responds to consumer demand. But, planners' preferences determine the overall magnitude of consumption its share in national product and the amount of investment devoted to consumer goods industries. Drew- noski concludes that most of the Communist countries are now in transition from "first-degree market economy," to a "second-degree market economy," extending the sphere of the influence of individual preferences. The Present State of the Debate Such have been the main developments during the course of the socialist controversy, which might be said to 13QIbid., p. 351. 100 have formally ended with Bergson's critical re-evaluation of the issues in 1967. By that year, there was no question about the theoretic issue on socialist economic rationality. The planning system designed by Lange and Dickinson demon strated the plausibility of this issue to most economists. Despite all this, there appears to remain certain diffi culties about the feasibility of the Lange-type model of socialist economic organization. | In the first part of his article, Bergson discusses these difficulties and in the second part he examines alternative organizational forms of socialism. The following development will briefly outline his arguments. To begin with, there seems to be no clear-cut answers about the establishment of a "practical success criterion for managers," and this according to Bergson, "represents 131 a major deficiency of the Competitive Solution." Obvi- i ously, the real test for success is profits. But this behavior is not followed by Lange's managers; instead, they are supposed to conform to Lange's rules: on one hand they must combine factors of production so as to minimize the average cost of production for any output; on the other hand, they must choose the specific quantity of output for which marginal cost equals the price set by the CPB. A pre-condition for the successful operation of these two 131 Bergson, op. cit., p. 657. 101 rules is that the socialist managers must take prices as given, as Lange assumes that they ignore all opportunity for monopoly gains. This is a dubious assumption because it is highly improbably that managers can be induced to follow rules that every business instinct must urge them to reject. Consequently, they might not take prices as data whenever their production units are large in relation to the market supplied and thus they might be able, through their output decisions, to influence the CPB's decisions on prices and so find it more profitable to violate than to observe the rules. "Rather than behave competitively," Berson says, "the managers would be led to restrict output 132 much as monopolists do under capitalism." This monopo listic violation of the rules is especially true for the industry managers who would always have monopoly power. With regard to plant managers, even if their output were not large in any conventional sense, should profits be the test of success they would still be tempted to violate the rules provided that their suppliers or their customers for any reason remained more or less attached to them. Given such an attitude, it would be difficult to assure conformity to Lange's rules, and, as a result, the construction of a satisfactory incentive system would remain as a difficult task. 132Ibid. The difficulties regarding the managerial success criterion that have been described must arise even if there should be no "indivisibilities" in production, but they would be compounded if such indivisibilities are present. Bergson points out that it is especially difficult in such cases to establish a suitable managerial success criterion to assure conformity to Rule 2. This is because of the large overhead costs which would create losses if the cur^ rent level of output is chosen where price equals marginal cost. It should also be noted that the application of Rule 2 to a decreasing cost industry would also incur losses for the industry. Here, too, profit maximization becomes inappropriate. Convergence toward equilibrium prices would be another formidable process. In this respect, Bergson, in line with Hayek's argument, writes: Almost inevitably, the Board would find it dif ficult to respond quickly to continually occur ring changes in supply and demand. It would also be unable to fix prices in sufficient detail to take into account almost endlessly diverse varieties of goods produced by a modern economy. As far as the alternative organizational forms of socialism are concerned, Bergson finds himself in agreement with the idea of introducing decentralization of price fixing into a scheme of centralized planning system in 31bicl. , p. 662. 103 which the CPB seeks to approach equilibrium levels of prices by applying mathematical techniques. This is because of a burdensome communication system which might arise between the CPB and the managers of production units. Needless to say, in fixing prices comprehensively, managers might be called on to communicate to the Board certain data ; regarding their predictions on the ever-changing constraints^ and opportunities which confront them in the economic system; and the Board would have to digest such information i and to communicate the results of its deliberations to the managers. In this case, computers may be helpful, but ; "with all the progress that has been made the use of computers still entails a cost."'L3^ In short, with all its | limitations decentralized socialism, where introduced, will i tend to be more efficient than conetralized planning. Summary This chapter has presented a historical review of the pros and cons of the controversial issue of whether a socialist economy can attain efficiency in allocating its resources. This review began with Mises1 criticism that rational economic calculation and efficient allocation of resources were in principle impossible in a socialist economy. Mises1 views were used as a groundwork by various •^^Ibid., p. 664. prominent economists in the 1920's for their conclusion that efficient allocation of resources is either impossible or impractical under public ownership of the means of production. To refute this conclusion, several reactions developed. The most important one came from Lange who developed, for the first time, a clear blueprint for resource allocation under socialism. While Lange's model provided a satisfactory answer to Mises-type criticism, it was not used in practice in the communist world. Additionally, it did not furnish a successful incentive system for manager behavior. These limitations stimulated economists in the 1950's to look carefully at the Lange model and give suggestions for a "reconstituted model" of socialism. Ward's and Drewnowski'i contributions were of such nature. 105 CHAPTER III LANGE'S PREWAR MODEL OF DECENTRALIZED SOCIALISM An Overview of Lange's Prewar Model One of the prominent models of the operation of an ideally functioning socialist econbmic system is that of decentralized socialism presented by Oskar Lange in the late 1930's in two articles in the Review of Economic 1 o Studies. Under Johr's definitional system, Lange's model is essentially a centrally-directed economy with free consumer's choice and free occupational choice and with a genuine market for consumer goods and services of labor. In the analysis of Lange's model, it is important to remember that it is essentially an answer to the critics - von Mises, von Hayek, and Robbins - who argued insistently that the results of a purely competitive model (namely, efficient allocation through price mechanism) were either impossible or impracticable under socialism. In order to answer these critics, Lange had to show that the socialist ^Oskar Lange, "On the Economic Theory of Socialism," Review of Economic Studies, IV, October, 1936; February, 1937. Also published as O. Lange, F. M. Taylor, On the Economic Theory of Socialism, ed. Benjamin E. Lippincott, (Minnea polis: Uni tersity of Minnesota Press, 1938), ^W. A. Johr, and H. W. Singer, The Role of the Economist as Official Advisor (London: Allen & Unwin, 1955), pp. 129- Tfs:------------------- 106 economic system could achieve a Walrasian equilibrium, and, in addition, could provide certain other benefits not obtainable from the model of purely competitive capitalism. Thus, he hinged his rebuttal largely in microeconomic terms but endeavored to show socialism's benefits largely in terms of macroeconomics. Dr. John E. Elliott has developed a useful schema of analysis to compare economic systems. This schema, when 3 applied to Lange's prewar riodel, appears as follows: 1. Level of Development 2. Resource Base 3. Ownership - Control of Instruments of Production 4. Locus of Economic Power 5. Motivational System Organization of Economic Power Social Processes for Making and Coordina ting Economic Deci sions Developed Economy Capitalistic Primarily government Ownership Dispersed among Decision making Units Maximization of Indivir • dual Gain Coupled with Promotion of Social Gains Basically Decentralized, with some Central Guid ance and Supervision Mixture of Democracy, Government Hierarchy, and Price System(s) JJohn E. Elliott, Comparative Economic Systems: Theories, Philosophies, Strategies (Unpublished Manuscript), Chapter 11. This section draws heavily upon Elliott's exposition. 8. Distribution of Greater Equality of Income and Wealth Income through Reduction of Property Income Coupled with a System of Market-Determined Wage Differentials In regard to criterion "1," Lange accepted the Marxian materialistic view of history; namely, that as a country develops, it passes through a capitalistic stage and even tually evolves into socialism. The capitalist stage is devoted to industrialization; hence, by the time socialism comes, the emerging economy is economically developed. As a corollary to this, the applicable resource base, criter ion "2," was thought to be capitalistic rather than landistic or feudalistic. It is also clear that the Lange model of the 1930's, like the Marxian vision, considered socialism as a prospec tive successor to capitalism in the economically developed nations, not primarily as a substitute for capitalism in under-developed economies. Lange, however, did not make a special point of this prognostication. This view is in sharp contrast to that of the centralized socialists Maruice Dobb, Paul Baran, and Pual Sweezy and to Lange himself in his post-World War II writings, which advocated centralized planning as necessary to achieve developmental goals in the underdeveloped countries. In regard to criterion ”3," Lange visualized that the major instruments of production would be publicly 108 owned and that outside of these major industries, private ownership was permissible. However, for the purpose of his analytical framework, he assumed that all the means of production are publicly owned. This was a simplifying device which he felt would make no essential difference to his conclusion. In regard to criteria "4," "5," and "6," it should be mentioned that economic decisions are assumed to be determined in a predominantly decentralized fashion. Con sumers are assumed to be free to allocate their money income between consumption goods and between consumption and saving. Workers are assumed to be free to seek any employment desired. Furthermore, consumer sovereignty supplements freedom of.consumers' choice. Not only sure consumers free to spend their money income as they wish among existing goods; in addition, the preferences of consumers, as expressed by their demand prices, are the guiding criteria in production and in the allocation of resources. Plant and industry managers are government employees and are instructed by the Central Planning Board (CPB) to follow two fundamental rules - (1) minimization of cost of resources (and thereby maximization of output), and (2) production of specific quantities of output whose prices are equal to their marginal costs. Given these rules and given the prices of inputs and outputs, which are beyond 109 their control, these managers are free to determine the quantities and combinations of inputs and outputs. In this way, we can see that the Lange model does not include a system of comprehensive physical planning which specifies quantities of inputs and outputs to be produced and con sumed by government plants and industries. This character istic is a distinctive feature of decentralized socialism. Therefore, the CPB is not an agency of "jpliysical," central planning. It is, however, a special governmental agency which is a locus of significant central power and responsibility in an essentially decentralized system. As isuch, the CPB has six functions: first, it has the function of setting, as well as periodically readjusting, prices of i intermediate goods (e.g., coal, steel), and capital goods (machinery and buildings) and the rate(s) of interest as well. Second, it determines "corporately” the total volume of investment. "Of course," notes Lange, "the consumers remain free to save as much as they want out of individual income which is actually paid out to them and the social^: ized banks could pay interest on savings. As a matter of fact, in order to prevent hoarding, they would have to do so. But, this rate of interest would not have any i necessary connection with the marginal net productivity of j 110 capital ...1 1 which Lange suggests as a possible criterion 4 for determining the rate of capital accumulation. Third, it (or a financial subsidiary such as the Central Bank) evaluates the respective claims of different plants and industries for loanable funds for capital expan sion. Fourth, it is responsible for distributing a "social dividend" to worker-citizens as their share in the income from capital and natural resources. Fifth, it imposes the two fundamental rules on the plant and industry managers which were mentioned before and, in doing so, it supervises the actions of these managers to make sure that they are following the rules. Sixth, it provides for various "collective wants" in the public sector of the economy (national defense, education, etc.). What can be implied from Lange's model of decentral ized socialism is a democratic political system in which the citizenry would effectively control the government and, hence, the CPB. He even thought that it might be approp riate to have "a Supreme Economic Court whose function would be to safeguard the use of the nation's productive resources in accordance to the public interest. It would have the power to repeal decisions of the CPB that were in contradiction to the general rules of consistency and ^Lange, cited in Elliott, op. cit., Chapter 11, p. 10. Ill efficiency . . . just as the United States Supreme Court has 5 the power to repeal laws held unconstitutional." In brief, decentralized socialism would contain three sectors: a decentralized private sector, consisting of consumers, workers, and (in all probability) private owner-managers of small scale businesses, all interested in the pursuit of their own individual economic gain through market exchanges; a centralized public sector, consisting ofj government in general and the CPB in particular, concerned : i with the provision of certain "collective wants;" and a decentralized-centralized socialist sector, divided into decentralized plant and industry managers who are no longer | motivated by a capitalistic type of profit motive, at the ! same time, enjoy a side latitude and flexibility in the determination of input-putput quantities and relationships and a central planning board which essentially performs those functions which are normally accomplished by the market mechanism under a system of competitive capitalism. In regard to criterion "7," the social processes for making and coordinating economic degj'Sions are essentially three: One is political democracy which is only touched upon very briefly by Lange. This device is a vehicle for expression of the citizen-preferences and general government I supervision of the economy. A second is government hierrr.ro archy, within the government in general, within the CPB in i 5Ibid. I particular, and within government-owned plants and indus tries. the Third is the price system, which, according to Lange, comes in two forms. First, is the "genuine market for consumers' goods and for the services of labor."^ In these markets, prices are set by the interaction of the market or industry supply or demand of producers and the market or industry demand of consumers or supply of labor. The existence of such markets indicates that the corresponding prices have economic significance, and, therefore, a rational and efficient allocation of resources is possible within the framework of a socialistic environment. Prices of means of production, although set by the CPB, must be consistent with the prices of consumer goods. Second, then, is the prices of capital and natural resources and the rates of interest. They are set by the CPB, and constitute a government-hierarchial price system which, in Lange's view, is consistent with and controlled by a market price system in an ideally functioning socialist economy. Finally, in relation to criterion ”8," it should be mentioned that in a capitalist economy, the incomes of consumers are equal to their respective receipts from selling the services of the productive resources they own, plus entrepreneur's profits which are zero in equilibrium. 6Ibid., p. 12 113 Under socialism, where natural and capital resources are government-owned, personal incomes are not based on ownership of those resources. Thus, in a socialist society there is a greater equality of income. Specifi cally, Lange divides income of consumers into two parts: "One, wage income, determined by the market price system in the labor market; two, a 'social dividend' constituting the individual's share in the income from the capital and 7 natural resources owned by society." Behavioral Principles of the Lange Model of Decentralized''socialism Theoretical Determination of Equilibrium Under Capitaliim Because a central purpose of his theory was to show that a socialist economy could establish a substitute for the competitive price system as a social process for economic calculation and coordination, Lange started his model by a brief review of the competitive capitalist model. His treatment is traditional and corresponds with his definition of economics as "the science of administra- g tion of scarce resources in human society." Under the competitive capitalist model, the power to administer scarce resources lies in the hands of consumers, business 7Ibid. 8Oskar Lange, "The Scope and Method of Economics" Review of Economic Studies, XIII (1945-46), p. 19. firms and resource owners. Consumers are concerned with consumption and want satisfaction; business firms are primarily concerned with money profits; resource owners are primarily concerned with the acquisition of money income through the utilization by and/or the sale of their resources to business firms. The actions of these indivi dual units are independent and resolvable through the market exchange process. In a competitive market, accor ding to Lange, there is a need for two essential conditions (1) . . . the number of individuals is so great that no one of them can influence prices apprec iably by varying his demand and supply and, therefore is forced to regard prices as constant parameters independent of his behavior. (2) There is free entry and exodus from each trade or industry.9 Given these two conditions and given the preference scales of consumers, the amount of resources available, and the technical conditions of production, the essential conditions of economic equilibrium in the competitive model sure twofold: (1) the "subjective" equilibrium of all : individuals participating in the economic system, defined in terms of maximization of utility, profit, or income, - given equilibrium prices; and (2) the "objective" equili brium of the competitive market; that is, the determinatioh 9 Oskar Lange, "On the Economic Theory of Socialism," in On the Economic Theory of Socialism, p. 65. 115 of equilibrium market prices via the condition that the demand for each commodity is equal to its supply. "These two conditions," Lange says, "do not determine equilibrium unless there is added a third condition which expresses the social organization of the economic system. For our case this condition states that: the incomes of the consumers are equal to their receipts from selling the services of the productive resources they own, plus entrepreneurs' profits (which are zero in equilibrium). This condition is no equilibrium condition in the strict sense, for it holds independently of whether the economic system is in equili brium or not."10 Subjective Equilibrium!. Households and firms funcri tion both asicbuyers and sellers. As buyers, households allocate their incomes among the consumer goods in the manner which will maximize their satisfaction. In Lange's ! words, "The consumers maximize the total utility they derive from their income by spending it so that the margi nal utility of the amount available for a unit of income 11 (expressed in money) is equal for all commodities." Given prices and incomes, consumer demand is thus determined. As sellers, households maximize their income by selling their resources to the highest bidder. Given resource prices, allocation of resources among different firms and industries is thus determined. 1QIbid, pp. 65-66. 1]- Ibid., p. 66. 1X6 Firms seek to maximize profit. As buyers, they seek the "least-cost combination of inputs" at any level of output by combining the factors of production in such pro portion as to equalize the marginal productivity of the amount of each factor which can be purchased for a unit ; 12 of money." As buyers, also, firms seek to employ each resource up to the point where the (given) resource price equals the marginal revenue product (equals the value of 1 the marginal product). As sellers, firms produce that level of output which maximize profit. This is attained when the marginal cost is equal to the price of the output. Given commodity and factor prices, the supply of commodities and the demand for resources is thus determined. Assuming j freedom of entry and exit, factors will be shifted from industry to industry until in the long-run equilibrium, total output of the industry has reached that level such that the price of production is equal to the average cost. Thus under competitive conditions, the process of maximi zing profit is composed of two rules: (1) the determination of the optimum combination of factors, and (2) the determi nation of the optimum scale of output (and inputs). Objective Equilibrium. - The "objective" condition of equilibrium in Lange's analysis, is a pre-condition for subjective equilibrium. The former is attained when the j 12Ibid., p. 67 decisions of different individuals participating in the economic system are coordinated with one another. In this situation, equilibrium prices are determined by the condi tion that the demand for each commodity or factor equals its supply. Such a theoretical possibility of equilibrium is actually solved on a competitive market by a process of "trial and error," based on what Lange calls the "parametric function of prices." In other words, prices are established as a result of the collective actions of all individuals in i the system, yet each person, in viewing the market, accepts existing market prices as given and bases his behavior on them. Beginning with random or historically given prices, different individuals fulfill their subjective equilibrium condition and attain their maximum positions. If demands and supplies are equal, the process ends. If they are not, prices will rise where demands exceed supplies and vice versa if the contrary. This process continues until demand and supply are equal in each product and resource market and a general equilibrium of the competitive economy has been attained. In short, under capitalism, market prices at any time are parameters to which individuals react. Through a succession of reactions over time - that is, through a succession of trials and errors - an equilibrium set of parameters (prices) is approached. This is the process of successive tatonnements described by Leon Walras, which gave inspiration to Lange. 118 Theoretical Determination of Equilibrium Under Socialism Assumptions of the Model. In order to discuss the question of economic equilibrium in a socialist economy, it is first proper to restate what kind of socialist economy Lange has in mind. The main characteristic of this society is government ownership of the means of production. But, Lange notes that "the fact of public ownership of the means of production does not in itself determine the system of distributing consumers' goods and of allocating people to various occupations, nor the principles guiding the 13 production of commodities." At this point Lange assumes that freedom of choice in consumption and occupation are held and the preference of consumers, as expressed by their demand prices, are the guiding criteria in production and in the allocation of resources. Conditions and Rules. Having shown how equilibrium conditions are approached through a process of successive approximations under capitalism, Lange then turned his attention to the crucial problem of whether a similar method of trial and error could be applied in a socialist economy, thus achieving a rational economic calculation. His decentralized socialist system is characterized by a free labor market and a free market for consumer goods. Consumer preferences as expressed in the market give 13Ibid., p. 72. 119 direction to production and resource allocation. So far, these are the same assumptions which exist under the model of competitive market capitalism. The difference between the two systems stems from the fact that capital goods are owned by the state in Lange's decentralized socialist model. Thus, there is no free market for capital goods and their prices are set by the state and are therefore accounting prices rather than free-market determined ones. With this difference in mind, Lange then proceeds to analyze how economic equilibrium is reached under his model of decen tralized socialism. The basic idea of the Lange model of decentralized socialism is that an efficient allocation of resources could be theoretically and practically achieved within the framework of a decentralized socialist system through the incorporation of rules of managerial behavior and a trial and error process of market exchange. In talking about the theoretical determination of equilibrium, decentralized socialism entails the same three conditions as those mentioned for the model of competitive market capitalism. Subjective Equilibrium. First, under subjective equilibrium there are three groups of individuals who maximize their satisfaction respectively. (1) Assuming free choice of consumption, households as buyers maximize their utility in relation to the consumer goods market in exactly the same manner as in competitive market capitalism. Given prices, incomes, and taste, consumers allocate their income and choose that combination of goods which yield the highest satisfaction. Thus, consumer demand for products and services is determined. (2) As far as the managers of production are con cerned, contrary to the pursuit of profit maximization by the private owner-managers under competitive capitalism, they are no longer motivated by this aim. Instead, Lange substitutes a mix of two fundamental rules which should be imposed on these managers who are managing government-owned plants and industries in a socialist environment. The imposition task is, of course, the function of the CPB. One rule must impose the choice of the combina tion of factors which minimizes the average cost ... A second rule determines the scale of output by stating that output has to be fixed so that marginal cost is equal to the price of the product. The first rule simply means that plant managers (in the operation of existing plants) and industry managers (in the construction of new plants) are required to select that combination of resources for each level of output which minimize costs of production, thus attaining an opti mum mix of resource inputs. As in the case of competitive capitalist model, this occurs, given resource prices, for those resource combinations at which marginal productivity 14Ibid., pp. 75, 76. of each is the same for all resources. This rule, in short, provides a solution to the problem of determining the most optimum resource combination. But there remains the problem of determining the scale of output. Here, Lange introduced the second rule which directs the plant and industry managers to push output to the point at which marginal cost equals price. The second rule simply means that plant managers (in the operation of existing plants) and industry managers (in the construction of new plants) are required to produce that level of output of each commodity (and thus purchase that level of input of each resource) at which the marginal cost of production equals given price (and thus at which the value of the marginal product of each resource equals its price), hence attaining an optimum scale of output (and input). As Lange points out, this second rule when applied at the individual plant level is the decentralized socialist counterpart of the efforts of individual firms to maximize profits under competitive market capitalism. When applied at the industry level, it provides guidance for expansion or contraction of industries as a counterpart to the free entry and exit of firms in industries under the competitive capitalist model. Expressed in different terms this second rule tells both plant and industry managers how to adjust their scales of output. “The second rule," Lange says, "has to be carried out irrespective of whether average cost is covered or not even if it should involve 15 plants or whole industries in losses." The appearance of "profits" and "losses" would indicate the need for expan sion or contraction in various lines of production. To make it possible to follow these two rules successfully, the managers must confront given prices of both the products which they produce and the factors of production which they employ, thus avoiding all opportunity for monopoly or monopsony gains. Under the Lange model, as was mentioned before, the prices of consumer goods and of labor are determined in free markets while the prices of all capital goods would be fixed on a trial-and-error basis by the central authorities. This means that prices could perform the same parametric function in the Lange model as they do under the competitive capitalist model. For managers to do effectively, it would be necessary for them to make their decisions on the basis of the existing prices established by the CPB. Thus, managers would simply be required to follow this further rule also. The reasons for adopting the two fundamental rules are obvious. In this regard, Lange writes: . . . since prices are indices of terms on which alternatives are offered, that method of produc tion which will minimize average cost will also minimize the alternatives sacrificed. Thus the first rule means simply that each commodity must 15Ibid., p. 77. I 123 j be produced with a minimum sacrifice of altern- i atives. The second rule is a necessary conse quence of following consumers' preferences. It means that the marginal significance of each preference which is satisfied has to be equal to the marginal significance of the alternative ! preferences the satisfaction of which is sacri- ! ficed.16 | (3) Turning to the economic behavior of resource i ; owners, Lange distinguishes between two cases: first, assuming freedom of choice in occupation, and given wage rates, laborers minimize their incomes on the labor market i |by offering to sell their labor services to the highest I bidder, as under the competitive capitalist jsmodel, thus i |determining the supply of labor. Second, in regard to land i i land capital, a price has to be fixed by the CPB with the ! condition that these resources can be directed only to j I those industries that are able to pay or "account" for them |at the set prices, thus determining their supply. The |purpose of this ruling is to allocate natural and capital !resources in accordance with consumer goods market. In l this way, while these prices are given, the distribution j of these resources among the different industries are j determined. Objective Equilibrium. Second, in regard to I objective equilibrium, Lange argues in the following i fashion. As far as subjective equilibrium is concerned, ; it can be carried out only under given prices. The i I16lbid., pp. 78-79. 12.4 equilibrium prices themselves are determined by the con dition that demand for each commodity (and/or resource) equals its supply, since only under this condition are the subjective positions of maximum for all individuals participating in the economic system mutually consistent. Thus, Lange writes: Only when prices are given can the combination of the factors which minimize average cost, the output which equalizes marginal cost and the price of the product, and the best allocation of the ultimate productive resources be deter mined . But, the question arises that since there is no market for capital goods and natural resources, the prices set by the CPB must be arbitrary. Thus, prices are not objective and they are subject to bureaucratic guesswork. This is indeed von Mises' criticism. In response, Lange argues that the reason why there is an objective price structure in a competitive market is due to the existence of the "parametric function of prices," the fact that although the prices which confront the individual businessman and consumer are the result of the decisions of all indivi duals, on the market each individual regards the actual market prices as given data to which he has to adjust himself. 17Ibid., p. 79. 125 A price structure, Lange insists, as objective as one under competitive market capitalism, can be also obtained in a socialist economy if the parametric function of prices is retained. Under a socialist economy, the parametric function of prices is not automatic and spontan-j eous as it is under competitive market capitalism; instead, it would be imposed on the managers by the CPB as an "accounting rule." Therefore, all government managers and officials must regard all prices "as if" they were given and beyond their control, and make their decisions accor dingly. Once the parametric function of prices is adopted as an accounting rule, then objective equilibrium can be j established for each commodity and resource by the same kind of successive "trial and error" operative in the competitive capitalist model. As far as the laobr market and consumer goods market are concerned, the necessary conditions for progress toward; an equilibrium position are very similar to that under competitive market capitalism. Given the assumptions of the model, these markets gravitate toward equilibrium through the spontaneous and automatic operation of the social process of "trial and error." In the markets for capital goods and natural resources, the CPB itself func tions as the "market." It first establishes accounting prices in these markets. If the initially selected prices are "correct," supply will equal demand, and no adjustment i 126 will be necessary. Any divergence of actual prices from equilibrium prices, Lange says, "would announce itself in a very objective way - by a physical shortage or surplus of the quantity of the commodity or resources in question - 18 and would have to be corrected." The process of correction is simple: prices would have to be raised if demand exceeds supply and lowered if the reverse is true. Each new set of prices "serves as a basis for new decisions which result in a new set of quantities demanded and supplied. Through this process of trial and error, equilibrium prices are finally deter- 19 mined." In this way, Lange concludes that "the accounting prices in a socialist economy, far from being arbitrary, have quite the same objective character as the market prices in a regime of competition and . . . that a substi tution of planning for the functions of the market is quite 20 possible and workable." Income Distribution. Third, as far as the principle of income formation is concerned, the income of consumers is composed of two parts: one part is the receipt for labor services performed; another part is what Lange calls a 18Ibid., p. 82. 19Ibid., p. 86. 20 Ibid., p. 82, 83. "social dividend" which constitutes the individual's share in the income derived from the capital and natural resources owned by society. As far as the distribution of the social dividend is concerned, Lange emphasizes that, given the free labor market assumed for this system, it is important that the "social dividend" be distributed in a neutral fashion in relation to occupational decisions. "Therefore, the social dividend must be distributed so as to have no 21 influence on the choice of occupation." If this policy i were not followed, the payment of the social dividend would influence the choice of occupations made by those in the labor market and would therefore interfere with the attain- ! ment of objective equilibrium conditions. Practical Determination of Equilibrium Under Socialism Beyond the question of theoretical determination of equilibrium, however, is that of practicality. Lange's answer is that socialism can overcome the practical diffi culties through the same process of "trial and error," involving the same three conditions as under competitive market capitalism. This process of "trial and error" is based on the parametric function of prices. The method of its operation : is simple: the CPB starts with a given set of prices chosen ; 2^Ibid., p. 84 128 at random. Then, all government officials and Individual consumers as well as suppliers of labor make their deci sions on the basis of these prices. As a result of these decisions the quantity demanded and supplied of each com modity is determined. It may be asked: Would the CPB, in the very beginning, set these random prices purely by quesswork. The answer, Lange notes, is in the negative. The CPB would begin with "historically given prices" to which the different units of economic decisions adjust their decisions. If on the basis of these prices, quantity demanded of a commodity is equal to the quantity supplied, then the prices remain unchanged and become objective. If, |however, there is an imbalance between demand and supply, |the CPB tries a new set of prices which serves as a basis for a new set of decisions, and in this way, the process i continues until finally the equilibrium prices are reached. Thus, Lange shows that the process of price determi nation in a socialist economy is quite similar to that in a competitive economy and a substitution of decentralized socialist planning for the function of the market is quite possible and workable. The CPB performs the func tions of the market. It establishes the same essential conditions: (1) the initial setting of all prices as well as imposing their parametric use in accounting and (2) assuring the obedience of the two fundamental rules by the 129 plant and Industry managers - the optimum resource combi nations and the optimum output and input levels. In this way, the CPB enables the socialist economy to realize the economic significance of the factors of production and to make a rational allocation of resources. All this comes to Lange's conclusion that "the argument that in a socialist economy the accounting prices of capital goods and of productive resources in public ownership cannot be deter mined objectively, either because this is theoretically impossible, or because there is no adequate trial and error 22 procedure available, cannot be maintained." In this manner, Lange has brilliantly refuted the arguments of Mises, Hayek, and Robbins. With the emergence of modern electronic mathematical machines, Lange's views on the principles of the functioning of a socialist economy have substantially differed from those presented above. In this connection, Lange wrote in a recent article in London that: ... if he were to write his essay today, his task would be much simpler. His answer to Hayek and Robbins would be: so what is the trouble? Let us put the simultaneous equations in an elec tronic computer and we shall obtain the solution in less than a second. For it is an interesting point that the process determining the accounting prices (so called shadow price) with the help of an electronic computer is also achieved by a process of trial and error. Thus, both thesevmec- hanisms (the market and control accounting with 22Ibid., pp. 89-90. 130 electronic computers) may supplement each other putting in a new light the mutual relationship between centralized and decentralized models.23 Lange on Centralized Socialism Having developed his case for use of the process of successive approximation to achieve efficiency in the allocation of resources under a decentralized socialist system characterized by a free labor market and a free market for consumer goods, Lange next turns to the question whether or not the same approach could be used successfully in a system of centralized socialism. In this latter case, allocation of resources is determined by the objectives of the central authorities rather than by consumer preference, and there is not freedom of occupational choice. Here, the central authorities would determine the type and quanti ties Of goods to be produced, the basis for the distribution of consumer goods to the public through rationing, and the assignment of individuals to jobs. Under this scheme, Lange also concludes that it would be possible to achieve a rational use of resources; only in this case it would be within the context of the preference scale established by the central authorities rather than the preference scales expressed by consumers and laborers 23 Oskar Lange, "The Computer and the Market," in Socialism, Capitalism, and Economic Growth: Essays Presented" to Maurice Dobb ed. C. H. Feinstein (Cambridge: Cambridge University Press, 1967), pp. 158-161. 131 seeking employment. As under decentralized socialism, individual plants and industries would be required to follow the rule of combining the factors of production in such fashion which would minimize their average costs. Similarly, they would be required to follow the rule of expanding production to the point at which the accounting price set for its product would be equal to its marginal cost. These two rules, Lange writes: . . . were formerly consequences of following the preferences of the consumers, now they are consequences of keeping to the preference scale fixed by the Central Planning Board. They are thus rules which make the decisions of the man agers of production and of productive resources consistent with the aims set by the Central Plan ning Board. In other words, they are the rules of internal consistency of the economy. The rule to choose the combination of factors that minimizes average cost secures efficiency in carrying out the plan.2^ As under decentralized socialism, prices would be regarded as parameters, and the Central Planning Board would haveeto adjust them through "trial and error" as necessary to achieve equality between the quantity demanded and supplied of each commodity. Again, where prices were set too low, shortages would develop during the accounting period, and where they were set too high, surpluses would result. On the basis of these shortages and surpluses, a revised set of prices would be established by the Central 2^Oskar Lange, "On the Economic Theory of Socialism," p. 92; 132 Planning Board, and so the system would progress equili brium through this "trial and error" process. Lange's Preference for Decentralized Socialism Lange makes it clear that in demonstrating the possibility of achieving economic efficiency in a system of centralized socialism in which there is neither a free labor market nor a free market for consumer goods, he is not expressing personal approval of such a system. As a socialist, he prefers freedom of consumption and occupation in a socialist system and agrees with Lerner in taking the position that the undemocratic character of centralized socialism is incompatible with "the ideals of the socialist 25 movement." He further makes the point that even in the Soviet Union the early experiments with distributing consumer goods through rationing were abandoned as the supply of these goods increased beyond the initial subsis tence level of output. The Lange Model: A Walrasian-Type Equilibrium Lange's theoretical construction of a decentralized socialist economy provides a microeconomic equilibrium which is quite similar to Walrasian system. This latter system is in equilibrium under three conditions: (1) all 25Ibid., p. 95. 133 ! i households and firms participating in the economic system have attained their respective maximum positions under equilibrium prices and initial quantities of factors owned. This is called the subjective condition. (2) All markets must be in equilibrium, which implies that the supply i curves and the demand curves for every factor and every product must intersect. This is termed the objective condition. Finally, (3) the budget equations or conditions must be fulfilled which imply that the income and outgo of j i every firm and household must be equal throughout. Com- I paring the Walrasian system of general equilibrium with the | Lange model, the following elements of analysis are evident. Households Given freedom of choice in consumption and given their income, "consumers maximize the total utility they derive from their income by spending it so that the marginal utility of the amount obtainable for a unit of income i 26 (expressed in money) is equal for all commodities." In this way, they can freely dispose of their income, buying with it any consumer goods they desire. On the other hand, households can freely dispose of their own labor in any way they desire unless they wish to remain voluntary unemployed. Offering their services in free labor markets, they can enter any occupation for which ; ^Ibid., p. 66. 134 they are qualified and receive as income whatever salary or wage is the going market rate. As under the Walrasian system, households thus maximize their subjective positions Firms Production is carried on in a great variety of firms These producing units are, however, collectively owned by all people. They are administered by socialist enterprise managers who are salaried state-employees. As under the competitive capitalist model illustrated by the Walrasian system, these enterprise or plant managers use the capital and land at their disposal and buy labor services from households. They combine these inputs to produce outputs which they sell to households and firms. Plant managers are to operate under two fundamental rules, while taking the prices of inputs and outputs as given: Rule 1: To produce at lowest possible cost for any given volume of output - by combining the factors of production in such proportions so as to minimize average cost. Rule 2: To select that volume of output where price equals rising marginal cost, that is, where profits are maximized or losses minimized. These two rules exist in Walrasian equilibrium under a purely competitive model, but their operation is automatic and spontaneous in the market. In the Lange model, since the managers are no longer maximizing profit for their own interest, these two rules must be imposed on them by the ; 135 'CPB. Thus, it can be seen that in the Lange model, the i t CPB performs the functions of the market. Lange's model also provides for a group of indus- j trial managers. The manager of each industry is also i j supposed to operate under the rules mentioned. His task is [to regulate the number of firms in such a way that the marginal cost of the industry equals output price. It j means, shortly, that the cost anywhere in the industry of producing another unit of output, whether by expanding i [existing plants or by building new ones, should equal price. i Central Planning Board Many scholars have called the Lange model a "simu lated price system." This is due to the fact that the CPB 'is a substitute for the market as the coordinator of the [activities of the various plants and industries and thus i performs the functions of the market in the context of j ’ public ownership of the means of production, and yet, [according to Lange, efficient allocation of resources results from this operation. Paul Sweezy puts the matter clearly when he writes that "Lange's Board is not a planning agency at all but rather a price-fixing agency; in his j model of production, decisions are left to a myriad of essentially independent units, just as they are under ! 136 i 27 capitalism." The CPB, in the Lange model, has the following functions. i I The CPB determines not only the price for the use of l capital, but it will determine all prices in the economy. i t In so doing, it starts setting all prices at random. Then ! jit observes the consequences in all markets, and acts f t according to the following rule: Rule 3: If demand exceeds supply, raise the price. If supply exceeds demand, lower the price. If demand is equal to supply, leave the price unchanged. In its decisions the price authority is to be quidedtby the infor mation of the changes in the stocks of finished goods.28 Thus, prices are adjusted by "trial and error" until | demand equals supply in all markets for the determination of equilibrium prices. In this process, the CPB is simu lating, in effect, the free market in an attempt to find |the Walrasian kind of equilibrium solution. Only by sheer jaccident, will the CPB pick on the first round a complete jset of equilibrium prices for all interdependent markets i A jwithout giving into the Walrasian tatonnement. !^Paul Sweezy, Socialism (New York: McGraw-Hill Book Co., line., 1949), p. 233. i i 2fl ; Bent Hansen, "A Note on the Rules for Competitive iSocialism," in On Political Economy and Econometrics: j Essays in Honour of Oskar Lange (Warsaw, Poland: Polish Scientific Publishers, 1965), pp. 173-174. | 137 What are the implications of the Lange simulated model of decentralized socialism? They are obvious. The CPB is not setting up equations and feeding them to i |computers to solve for millions of unknown prices and I quantities of the Walrasian equilibrium. Nor, as Sweezy jpoints out, is it trying to guide economic activity by ! elaborately detailed instructions. Rather it sets out to Iguide economic activity through nothing else but prices. j |Beyond this, households are free to do what they like, given certain conditions, and firms have to follow the |simple general rules laid down for their behavior. i i A second function of the CPB is to determine -.the extent of production of social goods, such as for defense, |health, and education, by placing appropriate purchase orders with socialist firms. Such expenditures can be financed from the profits of socialist enterprises or from j their payments into the public treasury of rent and inter- i jest for their use of publicly owned land and capital. If, I however, government demand for social goods is set below i treasury receipts of profits, rents, and interest, the surplus revenue may be paid out to the public-at-large as a "social dividend." This is in addition to the receipt for the labor service performed. As Lange notes, this j second source of income does not exist under competitive capitalism. If, on the other hand, government demand for social goods is higher than income from profits, rents, and interest, the difference may be financed by new money i creation or taxation. | As far as the distribution of "social dividend" is concerned, if the government were to declare a dividend of this type, every citizen would receive equally or "accor ding to age or size of family or any other principle which 29 does not affect the choice of occupation." Thus, in order that such a dividend be consistent with a system of consumer-directed allocation of resources and the optimum distribution of labor services between the different industries and occupations, it would have to be distributed as to have no effect on the wage-directed choice of occupation and allocation of labor. A third function of the CPB is to determine the rate iof accumulation; that is, it draws the dividing line I i between producers' goods and consumers goods production. | iThis is to assure an "adequate" rate of economic growth land thus takes out of the hands of households the decision ! between present consumption and future consumption, as Lange thinks that the households are apt to an irrational degree and for pure utility considerations to sacrifice |for their present betterment. Saying, therefore, that the rate of accumulation is "arbitrary" means only that this decision no longer depends on the willingness of households 29Ibid., p. 108. 139 to save. Accumulation can take several forms: (1) Money learned by the government in form of interest, rent, or profit can be set aside for accumulation, (2) government srevenue from taxation may exceed the cost of current social goods and services, and (3) the creation of new money may cause price inflation and thus decrease the purchasing power in the hands of consumers. From all these sources may flow investment funds which are available ! |for capital goods production. The problem is now the dis4? j itribution of these funds to different industries. In the Lange model, only the size of investment spending, not its composition, is determined by public policy. This policy works as follows: The CPB stands ready j jto hand to any enterprise the cash needed to demand any | capital good. Since resources are scarce and consumption goods must be produced, the amount of capital goods that i can be produced is limited. These, plus the existing capital stock, make up the supply of capital in any period. The demand has to interact with this supply. Therefore, leach enterprise has to pay into the treasury interest on jthe capital (and, incidentally, rent on the land) it uses. A lower interest will, therefore, encourage, and a higher one, discourage, the use of capital goods. The CPB now regulates the interest rate in such a way as to make enterprises, in the aggregate, demand just that quantity of new capital goods the production of which would use up 140 the percentage of resources the CPB has to be devoted to investment. Thu3, investment funds are rationed by an equilibrium interest rate. The Lange Model: A Graphical Illustration Equilibrium Under Static Conditions j The basic Lange argument that socialism can obtain I j a rational price system can be analyzed with the help of a 'graphical illustration adapted from Kohler's book, Welfare I n / * » land Planning: An Analysis of Capitalism versus Socialism. i ' jSuppose that there are two consumer goods industries, A and [ B, with three existing firms in each. Then average and [ marginal cost curves are given in Figure 3-1 for the jshort run: that is, keeping each firm's plant and equipment i jfixed. These curves show the minimum cost attainable for each level of output with the factor prices prevailing; the derivation of these curves, therefore, is assumed to have i occurred in accordance with the first rule given to the l managers of socialist firms. For the sake of ease in i exposition, let us assume that both industries are constant cost industries. This means that the expansion of produc- j ition by all old firms or the entry of the.new firms will not cause a sufficiently large rise in the demand for 3®Heinz Kohler, Welfare and Planning: An Analysis of Capi- i talism versus Socialism (New York: John Wiley and Sons, Inc., 1966), pp. 6?-81. 141 Figure 3-1 (a) Industry A ac c ac a a Firm Aj Firm A2 Firm A Figure 3-1 (b) Industry B me me ac ac i i I Firm B Firm B Firm B Figure 3-2 P $1 Q o - D' resources to raise the prices of the resources used by the industry. Therefore, the expansion of output by the ! industry will not cause the cost curves of all firms to i |shift up. Now, suppose that the price of good A has been set by the CPB at the level of Oa and, following the rules of j |the game, is assumed to be constant by all firms at that l i I level regardless of a firm's actions. Firm A^ will by i i j instruction select the rate of output where marginal cost j (MC) equals price (P) , that is, at the level Ob. Given I jits average cost curve, its AC at this output level will be be, hence a profit of cd per unit is being made. Firm |A2, perhaps working with inferior equipment and land of i 'low quality, has a higher AC at each potential level of i output. Equating MC and P, it will produce o'e and make neither profit nor loss. Finally, Firm A-, is assumed to i have a still higher AC curve. It would produce output o”f j | where MC=P, if it were to follow the rule, thus making a I per unit loss of gh, since AC exceeds P by this amount at ' this level of output. Firm A3, however, would not be allowed to be built, i or if existing already, to remain in the industry. The industrial manager would decide that the additional cost of expanding output beyond A^ and A2 is not justified by the additional revenue obtainable. Let us suppose that A3 is , in fact only a potential firm and the demand for the output I 143 i Iof industxy A at price Oa equals the industry supply of Ob plus o’e. In this case, the CPB has no occasion to change the price and has established an equilibrium price at $1 in Figure 3-2, for example. Turning to industry B, let us suppose that there are i I three firms producing quantities oj, o'k, and o"l, respec- I itively, and that this total also equals the aggregate Iquantity demanded. Hence, Oi is also an equilibrium price. i jSince, in the Lange model, there is nothing to prevent I I I consumers from spending their incomes so as to equate I j ^marginal utility and price ratios, and since all firms I : adjust their output to make marginal costs equal to the I |same prices, a rational price system will be established in the goods market. As a corollary, the other side of the Lange argument, namely, that pure and perfect competi- I jtion can be imitated under decentralized socialism by i . |providing rules of behavior for socialist managers is also I valid if they take prices as given as a further rule. However, the theory of imperfect competition has shown that the case of pure and perfect competition is not too often found under competitive market capitalism. This jmeans that many enterpreneurs know quite well that they can sell more at lower•prices, that the demand curve, as they see it, is not of perfect elasticity, and that the demand and marginal revenue curves are not identical. ! 144 ! |Furthermore, in many cases, the producing units are too i I big and thus prevent a competitive solution. I Lange tried to avoid this effect in his model by jimplicitly assuming that the socialist firm, no matter how big, is to ignore all monopoly or (monopsony) gains, and |is not therefore, allowed to set price. Price is set by ;the CPB for all. Consequently, the socialist firm is ordered to act as if its actions had no influence on price. In this casd, the demand curve facing the socialist firm, like its capitalist counterpart under pure and perfect competition, is perfectly horizontal and it is supposed to act as if it could sell any quantity at the same price, as |if marginal revenue is equal to price. Equilibrium under Changing Conditions i | Now let us test the workings of the system by i |assuming consumers to change their tastes, shifting their i ! purchases away from industry B towards A. In terms of i jFigure 3-2, the demand in A shifts from Dp to D'D', while in B an opposite shift to the left occurs (not shown in i I the diagram.) In this situation, the CPB gets to know the change I in consumer tastes. Statistical reports from industry A I iwill indicate that the quantity demanded at price Oa I |exceeds supply Ob plus O'e. Going back to Figure 3-2, the I j |CPB knows point E on the supply curve and is aware that E' 145 Ion the new demand curve is to the right of it. It will ;therefore, following its own rule of behavior, raise the [price of industry A's product. Similarly, it will lower I the price of industry B's product, since reports will jshow that not all of quantity oj plus O'k plus 0"1 is being I sold. i I Now, the price of goods A is raised to Oa', that of | b lowered to Oi'. Immediately, firm A^ will increase i production to Ob' where MC equals new P. Firm A2 will raise output to O’e' while, let us suppose, the industrial manager authorizes the construction of firm A^ which will immediately produce 0"f'. Profits of A^ have clearly [risen, in A2 profits appear for the first time, and A3 is producing with neither loss nor profit. Industry A's joutput has risen by a total of bb' plus ee* plus 0"f'. I [Existing firms have increased output following the price [change and a new firm has entered. If by sheer accident the new aggregate output now produced by the three firms [equals the quantity demanded at the new price, price will [be maintained at level O'a. Similarly, firm B^ will cut output to oj’ (and its I profits will fall), B2 to o'k' (and it will neither make profit nor loss). Firm B3 should produce o"i' where it would incur losses, but is shut down by the industrial [manager. Industry B's output has fallen by a total of j'j plus k'k plus o"l. Existing firms have decreased output 146 I | following the price change, one has ceased to exist. If ; by sheer accident the new aggregate output now produced by i two firms equals the quantity demanded at the new price, price will remain at oi'. As under competitive market I capitalism, demand has been accommodated. At the new I equilibrium, though different from before, relative prices | will again reflect marginal costs and utilities. In j exactly analogous fashion, price adjustments by the CPB i i j will continue until all factor markets are cleared, and a i | rational price system will also be reached there. Thus, although there is a methodological difference between the | same; both models, according to Lange, lead to a rational | 1 price system or efficient allocation of resources. I i | The Lange Model: Welfare Implications I Lange asserts, as already noted, that a decentral ized socialist economy would assure economic efficiency. | Let us now summarize the implications of the Lange model I of decentralized socialism for efficiency in the alloca- 31 ! tion of resources, using Bergson's marginal conditions ! as described in Chapter II,1 page 68: 1 31 i Marginal conditions have also been summarized by | Kohler, ibid., pp. 7-26. 147 1. Assuming freedom of choice in consumption, in the light of given market price ratios, the condition that the marginal utilities (the mar ginal rate of substitution) for each pair of consumers' goods must be the same for all house holds is satisfied. 2. Given the rule that socialist managers would equate marginal cost with given price, the opti mum specialization in production of goods would be met. This means that in every industry factors would be combined in a technologically optimum manner in such a way th&t it is not possible tech nologically to dispense with any amount of factor without a reduction in output. 3. Given a common ratio of commodity prices for all plants and industries, the application of the rule that marginal cost equals price and thereby the value of marginal product is equal to resource price would simultaneously yield an optimum allo cation of resources among plants in the production of goods. This means that the marginal value productivity of each factor would be the same in every industry. 4. If all commodities are valued according to their marginal productivities and consumers' preferences govern not only as between consumers' goods but also as between jobs, then in the opti mum, there would not be any possibility of shifting a worker from one occupation to another to increase the value of output by more than would be required to compensate the worker for the change. 5. Assuming freedom of occupationalcchoice, the marginal worker is shifted from one job to another, then according to Lange, he must be paid the amount that is necessary to compensate him for the jobs. Consequently, occupational wage differ entials would corresppnd . at one and the same time to differences in marginal value productivity and, for marginal workers, to differences in disutility. 6. If the marginal value productivity of every factor must be the same in every use (condition 3) and if the differences in the wages of dif ferent kinds of labor equal differences in their value productivity (condition 4), it is evident 148 that the social dividend must be determined inde pendently of the workers' earnings so as not to interfere.with their freedom of occupational choice. In effect, the foregoing optimum conditions are sat- ! isfied if plant and industry managers truly take prices as given, and do follow the rules to combine resources in the i ! least costly way and to determine output and input levels iin order to equate marginal cost with the given output j price and value of marginal product with the given input price. If these two rules are obeyed, as in the competi tive capitalist model, profits will be maximized and efficiency will result. Thus, Lange has reached his "opti mum point" in the sense of achieving "optimum welfare i ! conditions" for his model. I The Case for Socialism At this point, the reader may quite convincingly |raise the question: Why bother? Why shift from the I capitalistic system of economic organization to a social ist type if the end results are the same in both systems? ILange himself recognizes and asks the same question when | |he states: But if competition enforces the same rules of allocating resources as would have to be accep ted in a rationally conducted socialist economy, what is the use of bothering about socialism? Why change the whole economic system if the same result can be attained within the present system, i 149 t I if only it could be forced to maintain the competitive standard.32 | i Lange answers this question by arguing that a i i socialist economy is superior in three important ways. It should be noted that these arguments extend Lange's discussion from the relatively restricted and theoretical analysis of how decentralized socialism can work to a broader "case for socialism" as Lange calls it. This latter case involves a number of political and ethical arguments and value judgments. The three basic reasons for desirability of decentralized socialism over competi tive capitalism will now be summarized. In the first place, socialism is superior to capitalism on the basis that the former could reach the right equilibrium prices - those which balance supply and demand - by a much shorter succession of trials than a ^competitive market actually does. The reason for this is i jsimply due to the fact that the CPB would have a much jwider knowledge of what is going on in the economic system jthan any private entrepreneur could possible have under socialism. i ! | With greater knowledge of the economic system as a l whole, the CPB could take into account all the alternatives sacrificed and realized in production. For this reason, j |32oskar Lange, "On the Economic Theory of Socialism," jpp. 98-99. | 150 Lange adds that "an economic system based on private enter prise can take very imperfect amounts of the alternatives I | * jsacrificed and realized in production. Most important |alternatives, like life, security, and health of the workers are sacrificed without being accounted for as a cost of production. A socialist economy could be able to put all the alternatives into its economic accounting. Thus, it would evaluate all the services rendered by production and take into the cost accounts all the alterna tives sacrificed; as a result, it would also be able to ! convert its social overhead costs into prime costs. By j doing so, it would avoid much of the social waste connected 33 with private enterprise.1 1 j Still more important, a socialist economy, as a | |result of taking into account the various alternatives, would not be subject to the fluctuations of business cycles; at least severe depressions and great unemployment would not be likely to occur. Of course, grave mistakes would undoubtedly be made in a socialist economy, such as misdirection of investments and production; but such mistakes would not necessarily involve the whole economic system in a general shrinkage of output and unemployment of factors of production. In short, Lange writes: | i j j33Ibid., p. 104. 151 Mistakes can be localized, a partial overpro duction does not need to turn into a general one .... There is no need to correct losses in one part of the economy, as is done under capitalism, by a procedure that creates in other parts still further losses by the secondary effect of a cumulative shrinkage of demand and. of unemployment of the factors of production.34 The second major basis of desirability of a socialist over capitalist economy is that the former would be in a better position than the latter to attain a variety of other social goals, namely, greater equality and equity in the distribution of income; economic growth; and full employment stability. A complete analysis of this section will be presented in Lange's discussion of the four central economic problems under socialism. The third way in which socialism is preferable to capitalism can be explained in the following manner. The alternatives are not, in fact, socialism and competitive market capitalism, but socialism and the existing economic system, or in Lange's words, the "actual capitalist system .... But, the actual capitalist system is not one of perfect competition; it is one where oligopoly and monopo- 35 listic competition prevail." At this point, Lange looks 34Ibid., p. 106. 35Ibid., p. 108. "The actual capitalist system," Lange says, "is much better described by the analysis of Mrs. Robinson and of Professor Chamberlin than that of Walras and of Marshall." 152 implicitly at the problems created by oligopolistic and monopolistically competitive markets. These problems are ias follows: Misallocation of resources and the resul ting economic inefficiency. Creation of inequalities in income distri bution . Removal of price flexibility that helped to restore full employment-stability in the competitive economics of the nine teenth century. Lowering the rate of innovation and endea vors to maintain the values of past invest ment , thus decreasing the rate of economic growth. asserts that these obstacles are not desirable. To support his assertion, he presents "a brief and sort of Keynesian version of secular stagnation, complicated by monopoloid elements in the economy summarized by Elliott as follows: (1) The continuation of a high level of profi table private investment opportunities in indus trially developed economies depends primarily upon continued technological progress, especially labor-saving innovations. Population growth and natural resources discoveries are, by themselves, insufficient to offset the lack of such technolo gical progress. (2) With increases in the size of business units, barriers to entry of new firms into industries, and the separation of ownership from the entre preneurial function in large-scale corporations, monopolistic arid oligopolistic firms seek to maintain the value of old investments by failure to introduce innovations until 'the old capital 1. 2 . 3. 4. Lang 153 investment is amortized1 or until 'the reduction of cost is so pronounced as to offset the deval uation of the capital already invested . . .' (3) But innovations cannot be held back indefi- nately, especially since the reduction of capital values are often concentrated in the non innovating firms. 'When the pressure of new innovations becomes so strong as to destroy the artificially preserved value of the old invest ments, a frightful economic collapse is the result. The stability of the capitalist system is shaken by the alteration of attempts to stop economic progress in order to protest old invest ments and tremendous collapses when these attempts fail.' (4) To prevent the 'chronic unemployment' resul ting from the slowing down in the rate of techno logical progress and the accompanying lack of sufficient profitable private investment oppor tunities, the state would have to expand its public investments, increasingly replacing pri vate capitalists and thus increasingly socializing the investment function.'36 In conclusion, Lange asks the questions: "Whether the further maintenance of the capitalistic system is 37 compatible with economic progress?" In response, he claims that capitalism is faced with a dilemma: Holding back technical progress leads, through the exhaustion of profitable investment oppor tunities, to a state of chronic unemployment which can be remedied only by a policy of public investments on an ever-increasing scale, while a continuance of technical progress leads to . . . ^Elliott, pp. cit., Chapter 11, pp. 30-43. 37oskar Lange, "On the Economic Theory of Socialism," p. 110. 154 I instability due to the policy of protecting the I value of old investments .. . 38 | i I At this juncture, Lange suggests that there are three ways to remove the tendency to maintain the value of | old investments and thus deal with the problems of monopoly., I |The first and successful way is through the elimination |of private enterprise. The second way would be to return to free competition. For, when there are monopoly elements in the actual system of capitalism, the so-called "para metric" function of prices becomes ineffective. In turn, the monop.d.lisLtic endeavor to maintain the value of past investments by not introducing innovation until "the old |capital invested is amortized." On the other hand, to jreturn to free competition seems impossible for two reasons: (1) on economic grounds, free competition is impossible, because it would be at the expense of economics |of large-scale production, and (2) on political grounds, ;the leaders of large-scale monopolies don't favor the |elimination of monopolies. i ; A third way to overcome the tendency to maintain the |value of old investment is to adopt a system of government j jcontrol and planning of production. This method cannot |work successfully for three reasons: (1) corporations and banks, with their economic power would control the public !38Ibid., p. 116. |planning instead of the government doing so; (2) even if | such government and control were feasible, such control would not be successful because it would force private managers to do things different from those required by the goal of profit maximization, for example, introduce innovations destroying old capital values; and (3) large |corporations and private financial institutions could use | |their power to defy government authorities. i | Thus, if it is impossible to return to free compe- | Itition or to have effective government planning, socialism {will be the only solution. As a result, Lange writes: "Monopoly, restrictionism, and intervetionism can be done away together with private enterprise and private ownership of the means of production, which from being promoters, 39 'have turned into obstacles of economic progress." The important implication of Lange's conclusion is his vision which considers socialism as a prospective successor to capitalism in the economically developed nations of the world. Lange's View of Four Central Economic Problems: A Comparison between Socialism and Capitalism As was mentioned in a previous section of this chapter, Lange indicated that his model can achieve a Walrasian equilibrium. In the following presentation, 39lbid., p. 120. 156 which is based on Elliott's exposition,Lange introduces dynamic and "real-life" comparisons between his model and competitive capitalism as a basis for the alleged superior- | jity of the former over the latter. j i | Allocation of Resources i Both models achieve cost minimization, best levels I of output, and most efficient allocation of resources. i |Lange claims two additional advantages for his model. I First, under the decentralized socialist model, equilibrium I lean be achieved much faster since the CPB can oversee the entire economy and adjust "accounting prices" to their i |equilibrium much faster than the automatic trial-and-error capitalism. In this way, the trial-and-error process under Idecentralized socialism could work "much better" than in jcompetitive, market capitalism. i Secondly, the CPB can take into account social costs and benefits in setting "accounting prices" while under capitalism only private costs and benefits are considered iin setting prices. For this reason, a decentralized i socialist price system would be more comprehensive than I that of a competitive economy. Thus, for example, the cost of setting up a plant in an underdeveloped region could be balanced against the costs of continued welfare payments. ^°Elliott, op. cit., Chapter 11, pp. 33-43. i 157 | I Distribution of Income t According to Lange, a socialist economy is superior :to a capitalist one in the distribution of income. A ] isocialist economy, he maintains, can so distribute incomes i jas to maximize social welfare, while the capitalist economy ican never hope to do so. For, under capitalism, incomes jare distributed according to the ownership of the means of iproduction; these are privately owned by the few, while | the masses own nothing and depend on their labor power for a living. Under such conditions, demand price does not reflect the relative urgency of needs of different people. |On the contrary, it reflects the incomes of many who go I without necessities and the incomes of the few who live in exhorbitant luxury. Thus, a capitalist economy is far from attaining the maximum of social welfare. Lange argues that if incomes are to be distributed so as to maximize social welfare, two conditions must be satisfied'. First, the same demand price offered by j different consumers must represent an equal urgency of need. Second, the services of labor must be distributed among the different occupations so that the value of the |marginal product of labor equals the marginal disutility |involved in performing these occupations. "It may appear," i Lange adds, "that there is a contradiction between the first and second condition: that the first condition requires the distribution of equal incomes and the second unequal ! 158 [ incomes. But, the contradiction is only apparent, he i I argues, because in a free competitive labor market, the unequal incomes under the second condition as the compen- isatory payments for the differences in 'leisure, safety, j 4 1 ;agreeableness, etc."' As Lange puts these things in the jutility scales of the individuals, these unequal incomes | or what might in modern phraseology be called the differ ential incomes, are necessary because there are different |disutilities related to different occupations. i I Thus, wage differentials are largely due to idifferences in the marginal disutilities of the jobs. | Therefore, a higher wage would be accompanied with less leisure, safety, etc. These differences in money wage rates are not only compatible with, but necessary for the attainment of equality in real wage rates or what is called "psychic income." Lange, however, "recognized that this compensatory principle would not explain wage differentials in the cases of (1) the 'natural monopoly' of 'exceptional talents (e.g., |of prominent artists or surgeons)'; and (2) differences in education and training. However, because large portions :of wage income in case (1) would probably constitute an, 'economic rent,' that is, an excess of actual income above the minimum necessary to draw forth and maintain the supply < j ^Elliott, op. cit., Chapter 11, p. 37. j 159 |of the resources in production, 'a socialist society . . . ! I might pay them incomes which are far below the marginal i !product of their services without affecting the supply of those services.' In regard to case (2), a properly I I I organized socialist economy would presumably make educa~ j |tional opportunities and facilities free and equally j available to all."^ Social dividends declared by the CPB would be on some basis so as not to disrupt the "psychic income" equality; for example, it could be distributed on a per |capita basis. In comparing this income equality under I socialism with capitalism, Lange notes that under the latter i i jvery large inequalities of income exist due to the private |ownership of the factors of producation other than labor. Economic Stability Lange contends that errors under socialism can be localized and need not be corrected by general and curaula- ! tive unemployment and loss of output as under capitalism. The major reason for this is that aggregate saving and :investment decisions are made centrally and simultaneously I by the CPB. In this process, Lange notes: The decisions of the CPB being guided not by the aim to secure a maximum profit on each separate investment, but by considerations of making the best use of all the productive j42Ibid. j 160 l I ! resources available in the whole economic sys tem, an amount of investment sufficient to provide full employment for all factors of pro duction would be always maintained. 3 i The implication of Lange's position is that in a !decentralized socialist economy, there can be no divergence i j between saving and investment, since the savers and inves tors are the same people, saving and investing for the same i I reasons, or to put it differently, the CPB only saves in i order to invest. Private savings in Lange's model are I ! considered to be a very small part of the total. By • * \ contrast, in Keynesian model of capitalism, savers and investors are different people, saving and investing for jdifferent reasons, thus generating cumulative fluctuation in output and employment. Consequently, a decentralized : socialist economy is in a better position than competitive I capitalism, even at its best, to maintain full-employment stability and thus to avoid Keynes' "secular stagnation." Economic Growth A decentralized socialist economy is able to pro mote, under given technological conditions, as rapid or ; more rapid rate of growth in potential economic develop ment than a competitive, capitalist economy. There are two points to be considered in this argument. First, the ^Oskar Lange, "On the Economic Theory of Socialism," p. 106. 161 • 1 ;CPB controls the overall savings and investment decisions. !Through the interest rate mechanism, the CPB ensures that : the amount of savings allocated for innovations, plant imodernization, machinery, and so forth, are used up by the plant managers. At this point, Lange states that "assuming consumer sovereignty, a determination of the level of investment and thus the rate of capital accumulation by the ;CPB rather than by the saving^consumption preferences might be said to involve a diminution of consumers' 44 ;welfare." But, this disadvantage, namely, the arbitrary ;rate of interest, is more rational and preferable than the | capitalist crises and unemployment caused by a divergence ! between the savings and investment which is caused by a conflict of interest. To be more specific about the rate of capital accumulation, Lange's position may be summarized as follows: ... we must distinguish between the short period and the long period. In respect to the short period, under both capitalism and social- ism, the amount of interest is determined simply by the condition that the demand for capital is equal to the amount available . . . The main difference, however, between a capi talist and a socialist economy occurs in respect to the long period. Under a socialist economy, the rate is set arbitrarily by the CPB: yet, it is by no means certain that a rate 44 Benjamin E. Lippincott, ed., in On the Economic Theory of Socialism, p. 22. 162 reflecting consumers' preferences is superior. Lange argues that in the present economic order saving is only partly determined by utility considerations; the rate of saving, he affirms, is affected much more by the distribu tion of incomes, which is irrational from the economist's point of view .... Also the public's attempt to save may be frustrated by not being followed by an appropriate rate of investment; and poverty instead of increased wealth may result from the people's desire to save. Thus, under capitalism, too, the actual rate of capital accumlation is divorced from the preferences of the people; and the rate of capital accumulation determined 'corporately' in a socialist society may from the economic point of view prove to be more rational than the actual rate of saving under capitalism.45 Second, following rule (1), that is, to produce at minimum average cost, plant and industry managers would be able to make productive innovations without worrying about their effects on the devaluation and obsolescence of old plant and equipment. On the other hand, it is conceivable that the CPB could institute bonuses to encourage plant managers to innovate. There are two implications which can be drawn from the above discussion. (1) Socialist competition is compatible with decentralized innovations. (2) In addi tion, the CPB can control and promote centralized innova tions by encouraging cost-reducing innovation, regardless of its effects upon the value of past investment. In this process, the CPB must impose rule (1) upon plant and 45Ibid., pp. 22-23. | 163 I I industry managers as it was mentioned above. The result | is that innovations are centrally carried on without any : monopolistic efforts trying to keep the value of old j investment and thus discouraging innovation as it is the : case under competitive capitalism. i ; Summary j ! This chapter has analyzed the prewar Lange model of j decentralized socialism. Since economic systems determine ! the form and specie of economic planning, the Lange model i was classified in accordance with prominent structural I | criteria, giving a sketch of the theoretical model of ! decentralized socialism. Following this classificatory schema, a synopsis of the Lange model was presented in two parts. The first I I part was basically an answer to the Mises-Hayek arguments I that a rational price system can be attained by a CPB | performing the functions of the market, thus demonstrating that an efficient allocation of resources is feasible and practicable in a socialist economy. If socialism begins its economic functioning with free consumer choice in the | selection of both goods and employment, the CPB's arti- ■ ficial price system represents exactly the same sort of I parameters to which producers and consumers would have to j i react under competitive market capitalism. To illustrate his point, Lange argues that central planners can start 164 such a process with a given set of prices chosen at i S random, though in practice the trial and error method i ] iwould be based on historically given prices. All that is i I jrequired is that producers and consumers make their decisions based on these prices. As a result, the i quantities of each commodity supplied and demanded would I be determined. In the event of imbalances between I i ; quantities supplied and demanded,shortages and surpluses | would be alleviated by the CPB through changing the prices i I and equilibrium prices would thus be established through | the method of trial and error. i ! Under such a system, Lange stresses that conditions i ! of pure and perfect competition can be imitated by having j producers follow the instructions of the planning board. ! The only rules that they would have to follow are those ! which require proper combinations of factors of production i so as to minimize costs and proper production of those commodities for which marginal cost is equal to price. In this way, Lange designed a microeconomic model of I decentralized socialism with the purpose of proving to his i ' critics that resource allocation can produce efficient l results under public ownership of the means of production. In the second part, Lange raised the key question that if capitalism and socialism can both produce efficient resource allocation, then why bother to shift from the | former to the latter? In order to show the desirability iof this transformation, Lange, while depending on certain j jpersonal value-judgments and political beliefs, argues that socialism has macroeconomic and other benefits which |capitalism does not. The Lange socialist "case" for jsocialism is essentially threefold. First, it is stressed ! that socialism can allocate resources efficiently and in i accordance with consumer preferences as well as, indeed better than, competitive market capitalism. Second, a socialist would or could be in a better position to i j ; promote greater income equality, full employment-stability, land economic growth than capitalism. Third, capitalism | : in practice is not competitive. CHAPTER IV CENTRALIZED SOCIALISM AND LANGE'S POSTWAR MODEL Introduction In his postwar writings, especially "The Political Economy of Socialism" and "The Role of Planning in Social ist Economy,"^ Lange describes a centralized system of |economic planning which is a function of the imperative necessity of achieving certain goals. The central theme iof his postwar writings, contrary to his prewar prediction, | !is the idea that socialism is likely to emerge first in the economically less developed nations of the world. As a result, rapid industrialization and economic growth will plausibly have priority as far as goals are concerned; and, as a further consequence, socialist economic organization Iis likely to be centralized rather than decentralized, at least in the early stages of the industrialization/develop mental process. In shifting toward a more centralized model of socialist economic organization, Lange, at least to some extent, makes common ground with other centralized social ists, notably such Western neo-Marxists as Maurice Dobb, •'■Oskar Lange, The Political Economy of Socialism (The Hague: Van Keulen, 1£$8). 167 Paul Sweezy, and Paul Baran. The purpose of this chapter is to describe systematically Lange's postwar model of i jsocialists, and to examine briefly the bases for trans- i | formation from centralized to or toward a more decentral ized form of socialist economic organization. Before ! I I turning to an examination of the behavioral principles of |centralized socialism, however, it will be helpful, first, |to identify the structural or organizational features of |such a system? and, second, to note briefly the modific- ! Ition in Lange's view of the materialistic conception of j history required by the shift from a decentralized to a more centralized model of socialism. Organizational Features of Centralized Socialiim Centralized socialism as envisioned by Lange after World War II can be described briefly by utilizing Elliott's schema,2 which would appear as follows: 1. Level of Development Underdeveloped, but developing. 2. Resource Base Landistic, in the process of transformation into capitalistic. 3. Ownership-Control of Dominantly government Instruments of Pro- ownership-control. duction ; 2John E. Elliott, Comparative Econonomic Systems: Theories, Philosophies, Strategies (Unpublished Manuscript), Chapter 12, pp. 5-7. 168 4. Locus of Economic Power 5. Motivational System 6. Organization of Economic Power 7. Social Processes for Making and Coordina ting Economic Deci sions 8. Distribution of Income and Wealth. Government, CPB Government promotion of social goals, coupled with incentive systems to achieve compliance. Dominantly government. Dominantly government hierarchy. Greater equality of income through sharp reduction of property income, coupled with a system of CPB-determined wage differentials. As viewed above, centralized socialism shares with Lange's prewar model of decentralized socialism a few similarities. They are: (1) government ownership and control of capital and natural resources; (2) a central governmental planning body; (3) government hierarchy as a social process for making and coordinating economic deci sions; and (4) greater income equality through reduction of private property, coupled with wage differentials as a source of incentives. On the other hand, centralized socialism diverges from decentralized socialism in four ways. They are: (1) the assumption that socialism will typically emerge in underdeveloped economies with a pre-capitalistic or landistic resource base; (2) the concentration of economic ! 169 j : power in the hands of government and a highly centralized ! governmental planning body, with responsibility for the : formulation of physical economic plans for the promotion i I of governmentally-determined goals; (3) the rejection or i ; sharp restriction of the price system and its correspond- ! ingly heavier reliance upon a hierarchially structured government bureaucracy as the dominant social process for ! I making and coordinating economic decisions; and (4) the I | determination of wage differentials by government planning j | rather than by the process of market bidding. Centralized Socialism's Position in the Conception of History In shifting from a decentralized toward a more centralized model of socialism, Lange has altered his vision of the materialistic conception of history. According to this concept, every social system would presumably evolve into a dialectical process of trans formation, thus moving from feudalism to capitalism, from , capitalism to socialism, and from socialism into communism. Contrary to this Marxian view, Lange maintains that the underdeveloped countries would adopt a system of socialist economic planning at the expense of a competitive market capitalism. The basis for this view, according to Lange is related to the phenomenon of capitalist imperialism which prevents the underdeveloped economies to pursue a 170 capitalistic path of development. In effect, Lange writes: Historical experience has shown that the crises of the capitalist system took place earlier than expected; namely, before capitalism has had the possibility of destroying non-capitalist forms of production, particularly small commo dity production. Owing to the rise of imper ialism, the breakdown of capitalism has occurred first in the less developed countries. Social ism starts to develop first in those countries which imperialism has prevented from developing along raditional capitalist lines . . .3 Lange relates the phenomenon of imperialism to monopoly capitalism and illustrates his point in another passage, saying that "it was precisely the characteristic feature of backward countries like Poland that capitalism was incapable of developing the productive forces because it was not the old, free-competitive type of capitalism which developed in France, England, Germany, and America 4 in the 19th century, but it was monopoly capitalism." While believing that comprehensive planning and detailed control of the economy are justified in order to mobilize the economy to achieve important goals - such as rapid industrialization and economic growth, Lange also contends that as a socialist economy develops and matures, it becomes both possible and necessary to introduce a ^Lange, op. cit., p. 9. 4Ibid., p. 8. large area of decentralized decision making into the I economy. In a framework of centralization and decentral ization, he proposes that the central authorities continue i ito determine the basic proportions and directions of the ieconomy, but give up detailed micro-planning and management iof the economy by administrative allocations and orders. i ; Instead, he envisions the central authorities as achieving |the results they desire by "economic means" - financial i mechanisms and incentives which induce, rather than command managers and households what the plan requires. i Such "economic means" include the introduction of a price Isystem in which market prices equalize supply and demand. In this way, Lange hopes to combine central control of the main features of economic development with a high degree of decentralization of detailed decision making - thus the model of centralized-decentralized socialism. I Behavioral Principles of Centralized Socialism; The Methodology of Economic Planning Calculation without Freedom of Consumer Choice Central versus Marginal Planning, when decentralized jsocialistssuch as Lange (in his prewar model) and Dickinson claim superiority for their order, they do so on a compara tive basis: that their system is planned in comparison with the unplanned market system which is blind, fluctuating 172 iand chaotic. Yet they do not advocate central planning, |because they believe that consumers are supposed to be at full command; and the CPB, after having set rules of [behavior for socialist managers, must limit itself to i [making price adjustments and decisions about capital |accumulation. This type of decentralized socialist planning is indicated by Dickinson's attitude when he says that the Supreme Economic Council or the Central Planning [ Board is: ... a mere statistical board, collecting and publishing data of output, cost, price, capital, and income, calculating demand and supply sched ules, but not exerting any real directive func tions. All that has been done is to set up within the socialist community a sort of simu lacrum of a capitalist economy, purged from the latter's grosser errors, but like it, actuated by the blind choice of millions of uncoordinated consumers and producers. This is now the place to make clear the proper relation of economic planning to the price-process. The two are not opposed, but complementary, principles of econo mic regulation.5 According to Dickinson, planning in decentralized [socialism is only marginal. It supports the pricing process in four different ways. "The first is to give general directives to socialist economy. The second is to make decisions where market indications are lacking. The ^H. D. Dickinson, Economics of Socialism (New York; Oxford :University Press, 1939), pp. 2i9-220. third is to eliminate cyclical fluctuations in economic activity. The fourth is to deal with special emergencies. General directives, according to Dickinson will be ! | necessary when the government has to revive the economic life of society out of the ruins left by revolution. In this stage "the first thing to do would be to ensure a i supply of bare necessities to the people without any consideration for the niceties of an elaborate system of pricing and costing." Later on, however, as a more normal level of productivity is again reached, "the great majority of lines of production would be carried on automatically within the framework of costs and prices so as to supply I goods to consumers according to their preferences as 8 jindicated in the market." Dickinson believes that finally "a stage would be reached in which the economic machine would practically run itself. The planning authority would need only to lay down a few general leading princi ples, and to make definite decisions regarding the allot ment of resources to new capital construction and to 9 communal consumption." The decentralized socialists' attitude is not shared by centralized socialists. Sweezy, for instance, 6Ibid., p. 220. 7Ibid., p. 221. 8Ibid., p. 223. 9Ibid., p. 222. ! 174 idoes not like the type of planning stressed by Dickinson 1 and Lange. According to Sweezy: Lange's Board is not a planning agency at all but rather a price fixing agency; in his model of production, decisions are left to a myriad of essentially independent units, just as they are under capitalism. Such a system is certainly conceivable, but most socialists will probably feel that it reproduces some of the worst fea tures of capitalism and fails to take advantage of constructive possibilities of economic plan- | ning.10 I * Sweezy believes that a socialist economy needs real central jplanning rather than a mere price-fixing agency. He starts from the investment problem, not from consumer preferences ias in decentralized socialism, and gradually comes to the conclusion that planning must become comprehensive: For an unplanned economy - whether capitalist or collectivist - investment decisions are made by many independent units .... It is this circumstance that accounts for the irrational behavior of an unplanned economy: the altera tion of booms and slumps, the existence of gluts and shortages, the paradox of unemployed workers with unsatisfied wants .... It is scarcely conceivable that the socialist state will so decentralize the making of investment decisions as to recreate the blindness and uncertainty of unplanned capitalism. Moreover, it is not hard to see that centralization of investment decisions makes comprehensive economic planning but inevitable. Assume, for example, that the government of a socialist society makes a basic policy decision to invest a certain percentage of the national income over a period of, say, 10Paul Sweezy, Socialism (New York: McGraw-Hill Book Co., Inc., 1949), p. 233. 175 five or ten years and lays down certain general goals such as the building up of heavy industry, the rehousing of a specified proportion of the population, and the development of Hitherto back ward regions. The next step would naturally be to charge the Central Planning Board with the task of drawing up an investment plan for carrying out these decisions. This investment plan will begin by translating the general goals laid down by the government into quantitative ! terms: so many new factories, railroads, power plants, mines, apartment houses, schools, hos pitals, theatres, and so forth. The dates at which these various construction projects are to be started and finished will then be specified* - From these data it will be possible to draw up schedules of the different kinds of materials and labor which will be required. At this point, the investment plan may be said to be complete. But would it be sensible for the Central Plan ning Board to stop here and to rely on price and income controls to ensure that what is needed will be ready at the right time, at the right place, and in the right quantities? The answer is surely that it would not be.H : After the requirements of investment are taken into account: . . . the Central Planning Board will find it necessary to estimate consumer demand for all products which compete for resources with the investment plan and to draw up a second set of schedules showing the different kinds of mater ials and labor which will be required. It should be now possible, by consolidating the investment and consumption schedules and by comparing them with current and prospective supplies, to work out a general plan for the development of the economy over the period in question .... When a consistent and practi cal plan has finally been adopted, it cannot be left to the discretion of individual industry and plant managers whether or not they will con form to it; rather it must be their first duty, •^Ibid., pp. 234, 235. ; 176 | imposed by law, to carry out their part of the plan to the best of their ability - just as, | for example, it is the duty of corporate mana- ! gers under capitalism to make profits for the owners.12 I i Thus, Sweezy has given us a picture of a centrally j ! planned economy: the price system no longer guides the I |plan, consumers no longer decide what is to be produced, land managers no longer behave independently on the basis | |of price-cost relations. The C.PB does not rely on prices i |to ensure the adjustments when they are needed. In short, |the plan controls everything, and prices, if used, are subordinated to the plan. By looking at a centrally planned economy as it is outlined above, Sweezy admits that we have moved away i I from the decentralized socialist models of Lange and iDickinson. In this departure, Sweezy feels obliged to ibring Mises' argument into play by asking whether rational economic calculation, which is possible in the prewar Lange model, is also possible in a comprehensively planned economy. "Is it possible," he writes, "that in going from ; one to the other we have unwittingly fallen into the 13 iclutches of Mises and his followers?" Of course,- he is of the opinion that this is not the case: . . . that rational economic accounting and al location are still possible under comprehensive 12Ibid., p. 236. 12Ibid., p. 238. 177 planning .... As the experience of the Soviet Union proves, there is no conflict between com prehensive planning and money calculation ... The crucial difference between Lange's model and the comprehensively planned economy lies in the location of the authority to make_decisions about production. In the one these decisions are made by many independent units? in the other by the Central Planning Board .... This shift in the location of the authority to make production decisions in no way disturbs the logic of Lange's argument. I It is surprising that Sweezy does not mention that I iLange believes that the "trial and error" method is also |applicable to a comprehensively planned system. Lange, as we saw in Chapter II, feels that rational economic accoun ting is also possible under such a system. He writes: ! i i ; The procedure of trial and error ... is also applicable to a socialist system where freedom of choice in consumption and freedom of choice of occupation are non-existent and where the allocation of resources, instead of being direc ted by the preferences of consumers, is directed | by the aims and valuation of the bureaucracy in charge of the administration of the economic system. In such a system the Central Planning Board decides which commodities are to be pro duced and in what quantities, the consumers' goods produced being distributed to the citizens by rationing and the various occupations being filled by assignment. In such a system also rational accounting is possible, only that the accounting reflects the preferences of the 14Ibid., pp. 238-239. 178 bureaucrats in the Central Planning Board, in stead of those of consumers.15 j In his prewar model, Lange rejects this system |because of its undemocratic character and its "incompati- !bility with the ideals of the socialist movement." Lange i !also discusses a compromise between central planning and i |free choice of consumption. He suggests that free choice of consumption need not imply that production is actually guided by the preferences of consumers: One may imagine a system in which production and allocation of resources are guided by a pre ference scale fixed by the Central Planning Board while the price system is used to distri bute the consumers1 goods produced. In such a system there is freedom of choice in consumption, but the consumers have no influence whatever on the decisions of the managers of production and of the productive resources. There would be two sets of prices of consumers' goods. One would be the market prices at which the goods are sold to the consumers; the other, the accounting prices derived from the preference scale fixed by the Central Planning Board. The latter set of prices would be those on the basis of which the managers of production would make their de cisions. 15 Lange, in his prewar model, does not believe that such a system would be tolerated by the citizens of a socialist | I community. In Lange's postwar writings, there are two jl^Oskar Lange, "On the Economic Theory of Socialism," in l On the Economic Theory of Socialism, ed. Benjamin E. Lippin- jcott (Minneapolis: University of Minnesota Press, 1938), p. 90-91. i 16Ibid., p. 96. 179 positions. First, Lange, as a Marxist, emphasizes the important role of ownership of the means of production in planning an economy. It is in terms of this criteriQn that both the goals and the means of obtaining these goals are determined. Where the means of production are pri vately owned, he speaks of the mode of production as being "antagonistic": In an antagonistic mode of production there are two social classes: one made up of those who own the means of production and the other comprising those who are deprived of the means of production .... As a, result, the means of production are employed in such a way that the process of production does not serve to give the best satisfaction of the needs of society as a whole, but serves first and fore most the satisfaction of the needs of the means of production even to the (detriment of the rest of the society. Hence, the term 'antago nistic. ' 17 He argues that the principle of economic ration ality - the commensurability of ends and means - of a private capitalist enterprise is: . . . confined to private economic rationality and does not mean social economic rationality. The rationality of the activity of a capitalist enterprise consists in the application of econo mic principle in the realization of a private end, for the maximizationi of private profit; it does not serve any real end embracing the whole of the economic activity of society.1® ^Oskar Lange, Political Economy: General Problems, Vol. I, trans. by A. H. Walker (Warsaw, Poland: Polish Scientific Publishers, 1963), p. 21. 18Ibid., p. 173. 180 i Thus social ownership of the means of production is |indispensable for the coordination of the economic activity iof the whole society, and the optimum use of the social I productive forces. t The coordination of the activities of individual jenterprises, "the integration of their aims by a common lend directing the economic activity of society ... is I 19 icalled the planning of the social economy." While the ! jneed for such planning, says Lange, exists under capital- s I ism, plans covering a group of enterprises and state plans have only a limited effect. "The rationality of these plans is distorted by the antagonistic character of | 20 icapitalist relations of production." | On the other hand, in a socialist economy, with social ownership of the means of production, the aims of | ithe individual enterprises are integrated into the common social end which is determined by the social economic plan. While profit is retained in a socialist enterprise it is inot the ultimate end of its activity "and becomes the means 21 of subordination to the general social end of the plan." Whatever the social end of the plan may be, the best i way to define "planning" is to say that "planning" denotes "public actions of a major kind which is in some way or -^Ibid., p. 177.- ^ Ibid., p. 178. i^Ibid., p. 78. 181 Iother aimed at the simultaneous coordination and adaptation 22 of economic development in a number of different fields." Planning defined in this manner is of course the bread and | butter of the socialist economies, but it is not restricted ito them. As Lange says: . . . planning as a method of promoting econo mic development has not remained limited to the socialist countries. It has spread first to the countries which follow what I call the na tional revolutionary pattern of economic devel opment .... More recently the idea of planning is even spreading to the old capitalist countries as a part of the growing pre-occupation with economic d e v e l o p m e n t . 23 ! Second, Lange, as a centralized socialist, advocates 'the necessity of central planning for achieving certain fundamental goals in the underdeveloped countries: (1) rapid industrialization; (2) modernization of agriculture; and ;(3) establishment of economic foundations of a socialist society.2^ These three objectives are interrelated with each other; one cannot be realized without the other two. : 22Kurt W. Rothschild, "Long-Term Planning of New Industrial 'Development," in On Political Economy and Econometrics: jEssays in Honour of Oskar Lange (Warsaw,, Poland: Polish Scientific Publishers, 1965), p. 524. ! p q j Oskar Lange, Economic Development, Planning, and Inter national Cooperation (New York: Monthly Review Press, I?63) , ■ ■ ■- _ 2i*Oskar Lange, Essays on Economic Planning (Calcutta, India: Statistical Publishing Society, 1960), p. 20. 182 Looking upon the historical circumstances of the countries of Eastern Europe, Lange points out that industrialization cannot be achieved by means of private capital in the underdeveloped countries. For, Lange says: Sufficient internal private capital to promote industrialization is lacking in these countries. Past experience shows that foreign capital is ready to come to these countries only as mono poly capital interested in high and quick pro fits. These profits are taken out of the country instead of being reinvested for the purpose of developing the country's productive resources. Furthermore, foreign monopoly capital is inter ested only in such branches of the national economy of underdeveloped countries as would not compete with the industries in the metropolitan areas. In other words, under present historical circumstances foreign capital can be obtained only on colonial or semi-colonial terms, as a means to make the underdeveloped country an agricultural and raw material appendage to the economy of the metropolitan countries: it can not be counted upon as a means of industriali zation of underdeveloped countries.25 Thus, in the given historical circumstances, the industrialization of the countries of Central and Eastern Europe is only possible by means of public investment, i.e., by developing a socialist sector in the national economy. "The socialist sector becomes the foundation of 26 the whole economic development of the country." There are two implications to be drawn from the industrialization process. The first one is the fact that the industriali zation of an underdeveloped country is only possible under 25Ibid., pp. 2-3. 26Ibid., p. 3. 183 | a system of public investment or by developing a national- | ized sector in the economy. The second implication is that i | industrialization leads to the establishment of economic I foundations of a socialist society - as it can be seen from the historical experiences of countries of Central | and Eastern Europe. | ! Industrialization and food production go hand-in- i hand. The former requires a substantial increase in the | latter to feed the increasing non-agricultural population. I ! This requires modernization of the methods of agricultural production. These methods must obviously be provided by j i industry. Hence, industrialization and modernization of | agriculture are indispensable. I Thus, in order to overcome poverty, it is vnecessary | for an underdeveloped country to develop the national ' economy by means of industrialization of the country and i | modernization of agriculture. These two objectives are i ! necessary, Lange notes, for the construction of a socialist | society. In this way, the three objectives of economic i ! planning are mutually interrelated with one another. The Abolition of Consumer Sovereignty. The central- | ized socialists, Dobb, Sweezy, Baran, and Lange, in his | postwar model, stress the necessity of central planning in the underdeveloped countries because of the fact that I i large scale industrialization and economic development lie I at the top of their list of planning goals, and takes 184 priority over other orthodox criteria of economic welfare I such as static allocational efficiency. Such was the main igoal in the prewar Lange model of decentralized socialism. The centralized socialists deny that the success indicator i :of an economic system is the degree of correspondence between production decisions and consumer wants. This idenial rests in part upon the abrogation of consumer i !sovereignty and in part upon the case.of central planning: |that the CPB is generally in a more effective position j ! than consumers to formulate planning goals and targets consistent with the general goal of economic growth. Dobb I gives a critique of consumer sovereignty that on one hand it has little meaning in the competitive market economy, because advertising distorts consumer sovereignty and the iunequality in income leads to "plural voting," and on the other hand, consumer market-behavior is inadequate for providing "collective wants" and dealing with dynamic .problems involved in the industrialization process of the 27 underdeveloped countries. In a capitalist economy consumers are not in fact as sovereign as the orthodox economic theory claims them to be. Consumer preferences are, according to Dobb, con- sierably molded by "the Press magnate" of the producers. 27Maurice Dobb, On Economic Theory and Socialism: Collected Papers (New York: International Publishers, 1955), pp. 34- d ' l . 185 |In this way, producers, in responding to the market- revealed choices of consumers, are in fact producing what i they have pursuaded consumers to want through sales I promotional campaigns rather than what consumers indepen dently desire. This point is also stressed by Barbara iWootton, another socialist writer, who is of the opinion j !that in any complex economic system the choice lies with i the producers rather than the consumer: It is only too easy to exaggerate the degree to which a society that is regulated by the price mechanism waits upon the pleasures of consumers. In every complex economic system the initiative must lie with producers and sellers . . . Prod- duction must anticipate the wishes of consumers, not follow their orders; which means, in effect, that producers must guess at the unpredictable tastes of those consumers; which in turn means that they will sometimes guess wrong. Now it is true that in any unplanned economy it is impos sible, beyond a point, to go on preserving with a wrong guess, pretending that it is right . . . In the planned economy thereiis no such definite limit, since mistakes can be covered up by sub sidizing one article out of the profits of another, or manipulating the purchasing power of consumers, or by similar devices which are only open to those who control virtually the whole economic life of the community and not merely certain industries.28 Further, Dobb points out that equal voting rights ! would be important if consumers were to guide production, jBut this function does not exist in a capitalist economy ! where the "dollar ballots" of the market place provide for i ?Barbara Wootton,plan or No Plan (New York; Farrar and Rinehart, Inc., 1935), p; 173. 18$ a sort of "plural voting." The rich who have more to spend, have a greater impact on the market than consumers in low income brackets. Thus, the inequality of income distribution in itself distorts consumer sovereignty in a capitalist economy. About the adequacy of consumer market behavior, Dobb mentions that it is often irrational in the sense that people "not knowing what is good for them, and in pursuit jof certain ends, adopting means which are ill-adopted to I ; achieving those ends." Consumer irrationality is also I |evident "when it comes to choices extending over time . . . I land exhibits a tendency to myopic underestimation of !future." This is true when consumer confronts decisions |which have to do between present consumption and future i investment. Further, "there is the matter of collective wants which cannot be satisfied by individuals as separate | units and which accordingly are not represented . . . in the demands of individual consumers as expressed on a market." Lastly, consumer choice may also be defective in cases of "external economics and diseconomies in private jconsumption . . . where the satisfaction an individual I derives from a thing is dependent partly or wholly upon the 29 consumption of it (or of other things) by other people." ^^Dobb, op. cit., pp. 71, 72, 73 187 In regard to the underdeveloped countries embarking upon programs for industrialization, consumer sovereignty |in the context of a capitalist economy is an insufficient criterion for the dynamic problems of economic growth and | |development with which these countries are faced. This is j |evident because consumer wants which in the competitive i capitalist model are treated as parameters now becomes 1 variables subject to change in the process of economic development. In such process, the CPB, adopting a planned course of development will undoubtedly affect consumer preferences in such fashion as to hopefully improve them, I since "the setting of new and higher social standards will I undoubtedly be one of the central preoccupations of a i socialist society, and one that is inseparable from the ! 30 I promotion of a higher standard of life." j The Case for Central Planning. The case for central i |planning is, in view of Dobb, based upon the premise that ithe importance of consumer sovereignty has been greatly !stressed in the context of a capitalist economy for direc- !ting production, but this need not be directed by the con- i sumer, and as such, consumer sovereignty can and should be | |abolished. As a centralized socialist, Dobb is an exponent j of an entirely centrally-planned economy where the CPB idetermines the a^^^ategoals of consumption, saving and 3QIbid., p. 79. 188 iinvestment and the level of production of each commodity, the allocation of labor force, and the distribution of output of consumers goods. In this way, his position falls | into category (1) of Johr's definitional framework. As a j Marxist, he adheres to the principle that a change in ; property rights and class relationships changes the form of i !the economic system: "that the fundamental character of i jsocialism consists in its abolition of the class relation j jwhich forms the basis of capitalist production through i the expropriation of the propertied class and socialization 31 of land and capital." In order to explain his position in a greater depth, Dobb sets out "the more obvious ways in which the mode of operation of a planned economy is likely to differ from 32 that of an unplanned capitalist economy." They are as : follows: 1. Investment in a planned economy is determined through government policy decision. This decision is applicable to the total amount or rate of investment, its ! distribution between economic sectors, and the technical forms which it may take. Its decisions affect allocation of resources between capital goods and consumption goods. 31 Maurice Dobb, Political Economy and Capitalism (New York: International Publishers, 1945), p. 270. 32Maurice Dobb, An Essay on Economic Growth and Planning ;(London: Routledge and Kegan Paul, I960), p. 2. i 189 f iThis process would be true of a centrally planned socialist i ! economy. A decentralized socialist economy could have a I mechanism where socialist enterprises made investment j j Iplans according to some profit criterion, either the j profit expected in the future or profit realized in the past. In such a case the demand for and supply of capital goods will be dependent on price relations through the iincome of the enterprises. i 2. In a planned economy there is no need for the |rate of investment to be governed by the time preferences i |of individual saversiiin capitalist countries, this is i jparticularly so, he says, where the rate of investment is I influenced by monetary policy.) This theme is related to the long-run versus short- | irun interests argument. Individual consumers are much I concerned with their own economic interests and short-run ! desires than their future interest and long-run desires. This is especially true, Dobb says, in regard to saving and consumption decisions where "... the individual is 33 notoriously unreliable." In many underdeveloped coun tries , the saving that may be necessary in the short-run in order to achieve the kind of growth which would be ; 3%aurice Dobb, On Economic Theory and Socialism; Collected ; Papers, p. 39. 190 desirable in the long-run to keep a substantially high |living standard is not likely to be voluntarily forth- i coming from the individual market choices. Therefore, the centralized decision to generate and allocate, through government policy decision, an "economic surplus" into |investment projects which are necessary to move the economy i into long-run self-sustained growth. | 3. The technical form of investment does not have i to be determined by what is most profitable. | 4. There is a difference in determining allocation i |of investment between the sectors of an economy which is I crucial to its development. In an unplanned economy, allo cation of investment is governed by consumer sovereignty, and thus is the result of expectations of many independent ! decision makers revised in the long-run by ex-post market j price. "Economic planning essentially consists of an attempt to secure a coordinated set of investment - deci sions ex-ante - in advance of any commitment of resources . 34 |to particular constructional projects or installations." jThis is Dobb's strongest argument for central;.planning. To Dobb, the basic difference between a planned and i an unplanned economic system is the factor of uncertainty. In the latter, the individual producer can anticipate the ^Maurice Dobb, An Essay on Economic Growth and Planning, p. 5. | 191 iactions of others for the near future, and, even the*}, there l is a degree of uncertainty. He must wait, before going further, whether the subsequent price developments justify his actions. The planned economy depends on the same technical interrelation as the unplanned economy. But it makes conscious use of the knowledge of this interrelation i land, in this way, would: ! | .. . substitute ex-ante coordination of the j constituent elements in a scheme of develop ment for the tardy post facto coordinating I tendencies that are operated by the mechanism of price movements on a market in a capitalist world - tendencies, moreover, which in the pre sence of substantial time-lags may merely achieve i extensive fluctuations. In this the essential difference between a planned economy and an | unplanned evidently consists.35 Dobb points out that such ex-ante coordination eliminates much uncertainty and thus permits a given objective to be | jattained more smoothly. But this is not the whole of the difference between a planned economy and an unplanned economy; the structural pattern will affect the rate of growth, as for example, the relation between the capital and consumption goods sector, and the agricultural and ;industrial sectors. Therefore, planning must not only i coordinate decisions but must concern itself with struc tural patterns for development. I | 35Maurice Dobb, Soviet Economic Development Since 1917 (New York: International Publishers, 1948, p. 9. ! 192 | 5. In a planned economy, long-range planning is more important than the question of how a perfect static equilibrium can be reached. But, undoubtedly, as Dobb says: . . . the habit of concentrating attention upon problems of stationary equilibrium has resulted in deficient attention paid to the quintessen tial functions of planning: functions associated with . . . the choice and maintenance of long term path of movement. Analysis of the condi tions of stationary equilibrium is preoccupied with the situation that is finally reached after a given change or displacement has occurred rather than with the path by which it is reached (reached, that is, provided that shifts in interdependent elements of the situation can be shown to be convergent, and not divergent, in their mutual interaction).36 As a result, Dobb argues that the real test of an economic system as a contributor to human welfare, in the context of economic change, is its ability to develop successfully from one situation to another. Central planning can do this job. According to this view, the centrally planned economy is superior because it is concerned with the goals I of large-scale industrialization which are imperative in the underdeveloped countries and not with the free-market notion of an optimum allocation of resources. Implicit in this argument is the assertion that complementarity rather than substitution is dominant in the 36jjaurice Dobb, Welfare Economics and Economics of Socialism: Towards a Commonsense Critique (Cambridge: Cambridge University Press, 1969), p. 122. I 193 jeconomy. The central idea here is that production decisions are interdependent, and there may be substantial advantages or economics in developing a whole series of investment projects together. Again, as in the previous argument, the jsheer magnitude of large-scale, interdependent projects is conducive to centralized decision making. 6. In the foregoing argument, Dobb emphasizes the ;importance of planned development in preference to the achievement of perfect equilibrium at any given point of time in a planned economy. However, the theory of central jplanning cannot discard the concept of economic equilibrium t altogether. Dobb is in agreement with this view and points out that the internal consistency of the plan can be accomplished by "balances," so that equilibrium in the development process can be accomplished. These balances jare physical in the sense of providing "a complex system of equations between the various magnitudes in a plan as the tests of internal consistency or coherence between its 37 various elements." Thus, all quantities of a given material used in all production and consuming units during a given period of time can be added together, and this sum j can then be compared with the forthcoming supply of the material or with the total of each of the various factors of production needed to produce the given material in the 3^Maurice Dobb, Soviet Economic Development Since 1917, p. 331. 194 given quantities. Through this method, Dobb concludes, the I |centrally planned economy would avoid the dangers of any i I |bottlenecks or disproportions which may develop in the economic process. 7. Dobb believes that in a planned economy the |task of the CPB is far less formidable than economic i Sliterature supposes it to be. The planned system, as far | |as the choice of alternative production patterns is i jconcerned, imposes certain historical technological and l 'social factors, thus limiting, in the short run, the I (production choice to manageable proportions. These factors I |are as follows: ; a. At any given time the productive resources are I woven into a given pattern which cannot be changed without high cost. b. Technical considerations impose a minimum scale 'of production. c. There is a high degree of intractability iattaching to productive resources over a short period of ;time. d. Technical coefficients of production require !production processes to be internally consistent and forbid the combination of factors unless all required elements are available in the right quantities. S 195 j e. Expansion of production A without contraction !of production B depends on the existence of reserve pro- i ductive capacity. j |Thus, Dobb argues that the planning board does not have to j I choose anew in every planning period among infinite pos sibilities. Indeed, "instead of an infinitely large number iof ends and limited means to be distributed between them, ! Iwith an indifinitely large number of possible patterns to I ichoose between, essential problems seem to turn upon the i I fact that the ends which it is practicable to choose are jthemselves fairly straightly limited by the means available i |and that the number of possible combinations which can be I i O Q choosen is small rather than large." Analysis of Conditions and Formulation of Plans i According to Sweezy, centralization of investment decisions is the main issue that makes comprehensive i planning inevitable. Considering this, as already noted, the highest priority in the list of goals is growth through irapid industrialization, then the necessity for management |of investment as the key determinent is clear. When the ( CPB formulates the investment plan, it does not on price jand income controls in insuring that "what is needed will i be ready at the right time, at the right place, and in the 38Ibid., p. 4 right equilibrium." It makes sure that the plans are met by extending the scope of the plan to the other sectors of the economy. In this way, a second set of plans are t formulated and both the investment and consumption sched ules are consolidated and reformulated in relation to current and future supplies and a general plan is finally designed for development. After the adoption of the plan, it is the plant i i managers' duty to legally carry out their part of the plan. Hense, the "command" technique is used, though incentives |play a part. In this way, "centralization means, on the i I one hand, that important planning decisions are reserved to the system's directors . . . and on the other, that decisions are communicated to operational units by direct commands or directives. The price system as a social process deals best with continuous, marginal adjustments to changing conditions on j the basis of marginal gain and marginal cost calculation. I On the other hand, the processes used by central planners are best adopted for making "big, discontinuous changes." Elliott points out that there are two limiting cases: at one extreme are "the smooth and perfectly continuous ^Elliott, op. cit., Chapter 12, p. 23. *°Alan A. Brown and Egon Neuberger, "Basic Features of a Centrally Planned Economy," in Comparative Economic Systerns Models and Cases, ed. Morris Bornstein (Homewood, Illinois: Richard D. Irwin, Inc., 1969), p. 100. 197 variations in coefficients and variables!*; at the other extreme is the case of "fixed coefficients of production, constant marginal cost and 'perfect complementarity' in 41 consumer preferences." If the situation lies closer to the former extreme and the number of alternatives are very i great in consumption and production, then the price system i I and marginal calculation is more proper. If the situation lies closer to the other extreme, with a small number of |alternatives, the calculation problem becomes simpler and j the "cruder devices of centralized processes" are more Isuitable. There are varying opinions as to continuity and |discontinuity in economic coefficients and variables. 42 jDobb takes a middle position. I He says one example of discontinuity is the indivisi bility of capital equipment. He asks: What is the criter- i I ion on which to base such an investment decision? If it i i | were that price cover "prime cost" (vaiable cost) and i I i charge for capital equipment, it would be disadvantageous 1 in that such equipment might be socially desirable and not pay, and vice versa. As for complementarity in consumer demand, it exists due to convention and habit. Under socialism, a peculiar demand situation may exist where above a certain price 41Elliott, op. cit., Chapter 12, p. 22. 4^Maurice Dobb, On Economic Theory and Socialism: Collected Papers, pp. 85-8FI 198 there would be no demand, given an equitable distribution of income, and at a certain price level there would be a very great demand - the market demand would have a kink. In planning, the alternative would be not to produce at all ; or on a very large scale. As a final comment, it should be mentioned that ; socialists are not in agreement as to the extent of |continuity versus discontinuity in economic coefficients |and variables, Lange, writing in the late 1930's, accepted ! |the traditional views that constant coefficients and iconstant marginal conditions is a special case rather than ! I a general rule.^ Baran, expressed the view that, in both developed and underdeveloped economies,the problem of the CPB "would not be slow adjustments to small changes . . . but choice among few technological alternatives involving 44 indivisibilities and 'fixed' coefficients." Dobb, as it was seen above, takes an intermediate position on the issues, concluding that "actual situations may be a good ideal nearer to the extreme of rigid proportions that 45 economists have generally assumed." ^Oskar Lange, "On the Economic Theory of Socialism," in On the Economic Theory of Socialism, pp. 94-95. | i^Paul Baran, "National Economic Planning," in Survey of i Contemporary Economics, Vol. II, ed. Bernard F. Haley (Homewood, Illinois: Richard D. Irwin, Inc., 1968), p. 385. 45 Dobb, op. cit., p. 85. 199 j Strategies for Industrialization and Economic j — - - - - - - - - - - - - - - - - - - - - - - - - - ■ ' ' " “ " " " . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . I Development. An underdeveloped economy, according to Lange i j is an economy in which the available stock of capital I goods is not sufficient to employ the total available jlabor force on the basis of modern techniques of produc- |tion. In consequence, two alternatives are open to such i 46 |an economy. One alternative is employment of the available labor force on the basis of a backward, primitive |technique of production. This implies low productivity of | |labor and, thus, low per capital real income. The other j alternative is the adoption of modern techniques of produc- I j ition and higher productivity of labor. This implies, however, unemployment or underemployment of part of the labor force, because the capital goods available do not I suffice to employ the whole labor force on the basis of ! modern technique of production. The failure to utilize fully the laobr force leads to low per capita national jincome. Thus, the essential problem of underdeveloped countries consists in insufficient capital accumulation. Because of the low productivity of labor, the surplus of 1 !the national income over what is needed for the reproduc tion of the labor force, or economic surplus, is small. This, however, Lange says, "is not the most important t ^^Oskar Lange, Essays on Economic Planning, p. 33. j 200 obstacle to capital accumulation. The fundamental jobstacle is the fact that such economic surplus as is | javailable is not utilized for capital accumulation in the i 47 underdeveloped economies." Correspondingly, Baran states that "the principal obstacle to their development is not | shortage of capital . . . the principal obstacle to rapid economic growth in the backward countries is in the way 48 their potential economic surplus is utilized." The i jfailure to actually realize the potential economic surplus I in the form of productive investment is brought about especially by "various forms of excess of consumption of i I the upper class, by increments to hoards at home and i I I abroad, by the maintenance of vast unproductive bureau- cracies and of even more expensive and no less redundant 49 jmilitary establishments." ! For the same reasoning, Dobb also makes the conten tion that "the problem of industrialization is essentially I not a financial one, but a problem of economic organization . . .in particular between an unplanned capitalist ieconomy and a system of socialist planning as forms of iorganization adequate to carry through" the task of i ! 47 Lange, op. cit., p. 35. i 4®Paul Baran, The Political Economy of Growth (New York: Monthly Review Press, 1888), pp. 226, 228. 49Ibid., p. 228. 201 utilizing economic surplus into productive investment.50 Concerning the choice of the two forms of economic organi zations as agencies for development, Dobb makes the following statement: Today it is becoming fairly widely recognized that without measures of planning the develop ment of industry and a faster rate of growth in the underdeveloped countries will not be achieved. But in a capitalist economy, where initiative in investment and development rests with private firms and individuals, with their reliance upon markets and profit margins, the mere existence of a plan on paper means re markably little.51 The implication of Dobb's statement is similar to Lange's position in his postwar model in regard to the path I |of economic development in the underdeveloped countries; ! ithe capitalist way of development is impracticable to solve the problems of the underdeveloped countries due to the phenomenon of capitalist imperialism. Because of the aforementioned arguments, the first step in a strategy of j centralized development is the actual mobilization of the potential economic surplus. The methods of mobilizing potential economic surplus necessary to finance public investment for rapid j 5 0 ; Maurice Dobb, Papers on Capitalism, Development and Planning (New York: International Publishers, 1967), p. 73. 5^Maurice Dobb, Economic Growth and Underdeveloped Coun tries (New York: International Publishers, 196?), p. 2$. ! 202 I I ! industrialization have varied according to different iexisting conditions in the underdeveloped countries. |Historically, there have been three basic sources for ; financing industrialization: (1) Foreign aid - this method is used by many underdeveloped countries which receive foreign aid in order to finance their industrial develop ment. Lange, however, does not refer to this method, but considers the next two sources; (2) Extracting a "surplus" - this method was used in the Soviet Union and Eastern lEuropean countries. In this reagard, Lange writes: i | | . . . the financial resources were furnished by: (i) the profits (including turnover tax) of the nationalized, (ii) contributions of the peasants in the form of their produce delivered to the State at reduced prices .. . these means of financing were supplemented by taxa tion and by State loans subscribed by the popu lation.52 i The implication of Lange's statement is to incor porate collectivization of agriculture in a strategy of t centralized economic development. Baran also agrees with the same strategy when he says that the only way to include agriculture in the general fabric of the national economy I"is by liquidating subsistence farming as the principal |form of agricultural activity and transforming agriculture jinto a speciallizing, labor-dividing, and market-oriented industry in which the structure of output as well as its 52Lange, op. cit., p. 37. 203 distribution between the consumption of those who work in I it and the surplus accruing society as a whole can be ; determined by the planning authority, as in the case of other industries. Under the conditions of socialism this : transformation cannot be accomplished except by means of j productive cooperation of the peasants, through collectiv ization of peasant farming . . . (3) Creating the needed funds out of income - this | method can be subdivided into two parts. One part is | concerned with the British experience in her process of capital formation, resulting from high productivity through the various innovations. For, innovations cut down the ; cost of production and gave use to higher profits which were ploughed back through reinvestment. Another part, to iwhich Lange pays attention, is to provide the resources needed for financing public investments by means of nationalization of foreign-owned natural resources in ! certain underdeveloped countries. Once acutally mobilized, the economic surplus must be utilized efficiently for the direction or allocation of investment. In this connection, Baran points out that there are three strategic questions: (1) "whether economic development should be striven for via industrialization or whether progress should be sought by raising the 53 Baran, op. cit., p. 268. ! 204 t productivity of agriculture . . (2) "whether economic | development should be sought through the expansion of producers' goods (heavy) industries, or through an increase j of consumers' goods (light) industries . . (3) "whether jcapital-intensive methods or labor-intensive methods of ^production should be chosen for the development programs 54 of the underdeveloped countries." | In regard to the first question, centralized i socialists are of the opinion that an exclusive reliance upon raising agricultural productivity is a necessary but i |not a sufficient condition for economic development. Lange, for example, says: ] Industrialization requires a substantial increase in marketable agricultural output in order to feed the increasing non-agricultural population. This requires modernization of the method of agricultural production, agricultural machinery, and implements, tractors, and fertilizers, etc. These must obviously be produced by industry. Hence, industrialization and modernization of agriculture are indispensable. 5 Thus, increased agricultural productivity and jsurpluses are a precondition for industrialization and an exclusive emphasis upon investment in industry is as one sided as an exclusive reliance upon agriculture. This is jdue to the interdependence and complementarity of agri culture and industry, and the way to solve the problem is, 1 I ; I 54Ibid., pp. 271, 288, 285. 55Lange, op. cit., p. 3. 205 according to Lange and Baran, to embark upon a simultan eous development of large-scale investment for industrial ization and industrialization in agriculture. The second question involves the allocation of the economic surplus between investment and consumer goods industries. This question is essentially the same as the more general one of the optimum rate of economic growth. Investment in industries making consumer goods industries increases the productive capacity of those industries only, but investment in the capital goods industries, according i to Lange, increases the capacity of further production, that means building up the industries which produce means of production. Thus, although "a certain amount of jinvestment in industries producing consumer goods for the j population is required, for the standard of living raises ! |with the expansion of industrial employment and output, | . . . it is only through .development of industries which |produce means of production that the production capacity 56 of the economy can be raised." This, Lange says, can be |done either directly through investing in the production of ! means of production, or indirectly through developing jexport industries which make it possible to import in the jfuture the needed means of production. For the same I 56 Oskar Lange, Economic Development, Planning and Inter- 206 t |reasoning, Baran also takes the position that expansion of i producers' goods should be given top priority as a stra- I tegic vehicle to bring about economic development. I ! Within the investment goods sector, Lange adds, i I there are two complementary types of investment which are needed. One is investment in agriculture which is manda tory as a prerequisite for industrialization. Another is I !in the general economic infrastructure of the underdeveloped. j jcountries, such as transport facilities, roads, and also, I isocial services. These two types of investment are needed jto assure "smooth economic development" in contrast to the ! production of producers' goods which is necessary to bring i about "economic development." i The third question has to do with what form the investment should take, or in other words, what methods of production should be used. Very frequently, it is argued that since a large supply of unemployed or underemployed labor power exists in the underdeveloped countries, the most labor intensive should be chosen so as to secure a rapid increase of employment. The reasoning for this argument is two-fold: first, capital is scarce in relation to labor in most underdeveloped countries; hence, low-cost |production in such cases involves economizing in the use of the scarce factor, namely, adopting techniques of produc tion which are labor-using and capital-saving. Second, underdeveloped economies often have large surpluses of 20*7 unemployed labor; therefore, the most efficient means of contributing to the reduction of unemployment and expanding output with little investment would be labor- intensive methods. Baran takes a different view from what is implied in the foregoing arguments. He argues that the opportuni ties for expanding output by transferring the "disquised unemployed to the urban industries is limited due to the expenditures which would be forthcoming. Indeed, he points out that if we consider the expenditures upon hous ing, hospitals, and schools which must accompany the trans- jfer, and the food and clothing which they must be assured jof once they get to the urban areas, "the labor-intensive ]techniques may involve a larger outlay of capital per unit i ' 57 |of output than the capital-intensive alternative." i I I Lange's reaction can be summarized as follows: | Usually the situation is such that there is a distinction between the methods of production I which employ much labor and those which are productive in the sense of contributing more to the increase of net output of the economy, 1 i.e., of national income. Thus there emerges a dilemma in underdeveloped countries whether to use methods which are less labor intensive, provide less employment, but rapidly increase output and national income, or whether to choose methods which are labor intensive but | which lead to a slower rate of increase of j output and national income.5* * t I j 57Baran, op. cit., p. 286. 58Lange, op. cit., p. 20. 208 The decision to be made, Lange says, depends on the planning period. If planning is made only for a short period, then the most labor-intensive method is the best one because it leads most rapidly to the absorption of unemployment or underemployment. But, in the long run, it would be more effective to choose the method which in creases national income more rapidly. This means, in Lange's words, "if a certain proportion of national income, | for instance 20 per cent, is invested, it turns out that i j by choosing the method and allocation of investment which i I increases national income more rapidly, even if it is less labor-intensive, after a number of years national income |will have grown to such an extent that the total amount of investment will become sufficiently large to provide more employment." ^ Finally, Dobb presents a positive argument in deciding on the Utilization of capital-intensive versus labor-intensive techniques. He argues that once the goal i of rapid, large scale economic growth is accepted, then it follows that: . . . the choice between more or less capital- intensive forms of investment has nothing to do with existing factor proportions . . . It depends-, not only on the existing ratio of available in vestment to capital (treated as a stock), but on precisely the same considerations as those I 59Ibid., p. 21. 209 which determine the choice between a high and a low rate of investment . . . namely the importance to be attached to raising consump tion in the immediate future compared with the potential increase of consumption in the more distant future which a particular rate of investment will make possible. In other words, the same grounds which would justify a high rate of investment . . . would justify also a high degree of capital intensity in the choice of investment focus; and vice versa. 0 There is no a priori reason, Dobb adds, to support the contention that underdeveloped economies should have a lower rate of investment than developed economies. Indeed, the converse would be true, because the productivity effects of "a given increase in the (relatively small) stock of capital is likely also to be abnormally large."^ Further, one must take into account, along with Dobb who emphasizes that the factor proportions argument rests upon a static criterion, namely, the ratio of stock of capital to that of labor at a given moment of time. But in the dynamic process of economic development, factor scarcities may also change. Baran aptly explains this conclusion saying that: . . . the abundance and 'cheapness' of currently available labor may well be only a temporarily prevailing condition preceding the realization of any given stretch of the developmental program. Aware of the aggregate demand for labor entailed ^Maurice Dobb, On Economic Theory and Socialism: Collected Papers, p. 149. 61Ibid. 210 by its own plans, the authority has to consider ! therefore that relatively soon, during the life- ! span of the equipment that is to be installed, labor may turn from a relatively ample to a I relatively scarce factor* particularly when this i involves skilled labor. i i I I Scope and Character of Central Planning. Government I I economic planning under centralized socialism - in contrast i | to the type of economic planning currently popular in many of the economically developed nations of the West - does I not consist of the coordination of different public !economic policies and of the various sectors of the economy. It is much broader in scope than this and involves "an active determination of the main lines of development of !the national economy. Otherwise, if planning were mere I coordination, the development of socialist economy would be I elemental; it would not be really directed by the will of i 63 organized society." In short, the CPB has the responsi bility of formulating a "plan" or "plans" for the develop- jment of the whole economic system. j ; The scope of central plan may vary a great deal and i • still meet this general requirement of serving as an ! j"active" agent in the strategy of centralized development. | "The minimum plan, suggests Lange in his postwar analysis, |'must include a least two things: first, the division of 62Baran, op. cit., p. 287. ®^Oskar Lange, The Political Economy of Socialism, p. 20. 211 national income between investment and consumption; second, the distribution of investment among the different branches of the economy. The first determines the general rate of economic growth; the second determines the direction of development.1 In addition, the plan 'may or may not include the targets for the production of certain basic commodities like basic raw materials, basic means of production, and so on.' These, he concludes, are 'technical problems, not fundamental problems.' Beyond targets and plans of physical output, of course, are those of finance and of labor - plans, e.g., for cash, credit, the govern ment's budget, foreign exchange and the balance of payments position; plans for the supply of and demand for labor, targets for eduction and training of labor, for the transfer of labor from agriculture to industry and from 64 over-populated to unsettled regions, etc." In centrally and comprehensively planned economic systems, the CPB has the responsibility of controlling the use of resources and actively guiding the process of economic development through the system of physical plan and allocations. The heart and core of centralized planning and control lies in the physical plan, the overall blueprint which translates the generalized directives of the political leadership into 64Elliott, op. cit., Chapter 12, p. 32. 212 more concrete objectives or targets, expressed in terms of physical quantities of outputs and inputs, of consumption goods and services, of labor, and, especially, of investment in plant and equipment.®5 It should be noted that the sale of consumer goods output, the purchase and sale of labor services, the receipt and expenditure of government funds, the provision of currency and credit, and the sale of intermediate goods among enterprises all involve the use of markets and money. Thus, the "physical plan" must be accompanied by a "financial plan." Nonetheless, the physical plan takes priority over the financial plan. Dobb stresses this point, saying that the "Finanacial Plan will need to be appropriately geared to the Production Plan and the gearing altered to conform with any fundamental alteration in the latter." Consistency and Efficiency in Plan Formulation. From the viewpoint of economic analysis, the formulation of centralized economic plans, rationally designed for achieving certain central goals, involves two fundamental criteria: consistency and efficiency. Consistency, or "coordinative planning," means the internal balance among the different parts of the plan. 65Ibid., p. 32. 66 Maurice Dobb, Soviet Economic Development Since 1917, p. 351. 213 It is an attempt, Lange says, to "make the decisions of the managers of production and of productive resources consistent with the aims set by the Central Planning 67 Board." Defined in this manner, consistency refers to the equality between demand for and supply of labor, between demand for and supply of commodites, and between the demand for and supply of cash. The latter implies, as already noted, that financial planning must accompany physical planning. Efficiency goes beyond efficiency. A centrally planned economy may meet the criterion of internal effi ciency quite well but it may still operate at a very low level of efficiency. Efficiency, as implied from the prewar Lange model, generally involves a maximization- minimization problem: minimizing the input of resources in the production of particular commodities and maximizing output from a given body of inputs. There are a variety of techniques for dealing with the problems of consistency and efficiency in planning. They are as follows: 1. Use of governmental, hierarchial pricing systems- this technique is correspondent with Lange's method of planning on a "trial-and-error" basis with the aid of the 67 Oskar Lange, "On the Economic Theory of Socialism," in On the Economic Theory of Socialism, p. 92. 214 price mechanism. The preference scale of the CPB is given, and communicated to the managers in the form of a system of prices. All prices then become "accounting prices." Consistency might then be achieved by instructing plant managers to produce that level of output where marginal l jcost equals accounting price. This is equivalent to i (Lange's rule two or the maximization of profit. Resources |would be directed only to industries which can account for |the prices fixed by the CPB. Efficiency is promoted by I instructing managers to choose that combination of I |resources which minimizes cost of production. This is |equivalent to Lange's rule one or the minimization of costs. i j 2. Internal consistency can be checked through |national balance sheets which are used for important ispheres of the national economy in the Soviet Union. Lange j calls this technique "the method of social economic bal ance," and elaborates on it in the following fashion: Social economic planning is developed by appro priating the categories and methods of the bookkeeping employed in capitalist enterprise and applying them to the whole social process of production and distribution. The chief metho dological device has become the balance accoun ting . The drawing up of a balance for the whole of the social'process of production and distribu tion was first carried out in the Soviet Union . . . At present a balance of output and utilization of materials (material balances), of the require ment and resources available for the various branches of production and distribution, of indus trial machinery, of foreign trade, of the incomes and expenditure of the population, etc., are 215 drawn up each year. Individual balance sheets are combined to form a general balance sheet for the whole of the national economy, which gives a synthetic picture of the social process of production and distribution showing the production and division of the national income and the direc tion of the appropriate parts for consumption and investment.®® Internal consistency can also be checked by "input- output" analysis. According to Lange, this method uses "balances combined with the mathematical formulation of the conditions necessary for the consistency of the aims of a production plan .... This method arose under direct influence of Marx's analysis of the social process of reproduction and the development of the use of social economic balance sheets in the Soviet Union during the 69 period when the first five-year plan was being prepared." Lange also presents a mathematical formulation of input- output analysis which is beyond the scope of this study. 4. Plans are built upon the past and can be modified from the established patterns of the past. Thus, given the primary objective of rapid industrialization, it is possible to shift resources away from consumer goods industries into the production of investment goods. 5. The scope of centralized planners can be re stricted to a small number of commodities. Decentralized ®80skar Lange, Political Economy: General Problems, pp. 182-183. ®^Ibid., pp. 184-185. 216 plans as to "red versus blue lollypops" can be left to local planners. 6. Data gathering can be decentralized. Even in centralized socialism, the CPB need be responsible, especially at the outset of plan formulation, for only the broadest and most aggregative of plans. The plan can acquire microeconomic content by disaggregation down into regional, industry, and firm plans. Techniques for Plan Realization Plan Revision. Once formulated, the plans as tar gets must be translated into a series of operational plans. Obviously, the Central Planning Board cannot make all the detailed decisions which are necessary to implement a comprehensive central plan. The needed technical knowledge for this purpose rests with the managers of enterprises and industries. Nonetheless, it seems plausible to say that plans must be imposed on managers not as advice but as directives. In this respect, Sweezy's words are very much to the point: "When a consistent and practical plan has finally been adopted, it cannot be left to the discretion of individual industry and plant managers whether or not they will conform to it; rather it must be their first duty, imposed by law, to carry out their part of the plan 70 to the best of their ability." How, then, does 70 /wSweezy, op. ext., p. 236.; 217 centralized socialism propose to combine centralized target planning with the activity of the local managers so that the latter's initiative and special knowledge are used to the best advantage? Dobb argues that plan execution does not mean merely "a post facto audit or inspection to allot praise I I or blame for achieving or falling short of the target;" |instead, it is more proper to suggest the following: .. . the process of putting a plan into oper- j ation is itself part of the process of fitting I it to actual and of testing out its correspon- | dence with reality. Such a process cannot be confined to the stage when the Plan is being put on paper for the first time.71 ! Clearly, as noted earlier, we can add flexibility to 'centralized planning and can contribute to the consistency | and efficiency of plans in practice. However, it raises a problem for plan operation: "If the requirements of the Plan are adhered to with too much rigidity, serious hitches |and dislocations are bound to develop as unforeseen eventu- ! alities crop up - dislocations which are likely to extend the area of their influence and do more damage the longer their repair is delayed. If, on the other hand, in the interests of flexibility, the hand of control is too ^Maurice Dobb, Soviet Economic Development Since 1917, pp. 336, 337. 218 lenient and executive organs are encouraged to treat the programmes allotted to them, not as instructions, but only as advice, then evasions of the Plan are likely to be multiplied for no sufficient reason; and these evasions will themselves introduce new unforeseen elements, with their consequential hitches and maladjustment affecting 72 other parts of the Plan." Dobb's compromise solution is that the CPB must be in a position to judge quickly whether a failure to observe the provisions of the Plan is "justified" by circumstances or whether it is "unjustified." If failures to meet the plan are justified by the course of actual events, then the necessary revisions must be made in such a way as to minimize disturbance to other sectors of the economy. If planning failures are unjustified, it is failures which must be corrected, again with a minimum of interdependent disturbance. In this way, a system of skillful plan revision requires "a developed machinery and technique of observation and of analysis of the current situation at every point, as well as a machinery and technique of control. It will also, of course, be greatly facilitated by the possession of certain reserves (e.g., of key raw materials and mobil equipment) to give elbow room to maneouvre."7^ As a statement of purpose and policy to 72Ibid., pp. 337-338. 73Ibid., p. 338. 219 shape human action, every plan revision also requires a !balance between "political" and "realistic" elements. I I Thus, Dobb concludes that a basic feature of centralized 1 planning "can be said to consist of moving towards a j |successful blend of policy and reality, of subjective j idesign with the objective situations, of directives with I prognosis, by a succession of approximations; but a succes- i ' sion of approximation written, not simply on paper, but in I 74 ;action." Techniques of Social Control. A centrally planned socialist economy is sometimes called a "command economy." !This means that resource allocation, coordination, and income distribution can be accomplished by means of the command technique: "In this instance, the individual !economic units" (though probably only the firms and not the i j households) are ordered what, when, where, and how much ; to produce and consume. If done rationally at all, these i i | commands (directives, orders, targets, "plans") derive !from some sort of conscious attempt ("planning"), as already ! ! noted, "to coordinate the activities of the individual unite i and to direct the economy as a whole toward certain definite i | 75 ! goals." When compared to the actual context of the | i i ! | 74Ibid., p. 339. I ^Gregory Grossman, Economic Systems (Englewood Cliffs, | New Jersey: Prentice-Hall, Inc., 1967), p. 15. 220 economic theory of centralized socialism (as well as the behavior of centrally planned economies in practice), this technique plays only in a technical sense a significant, but limited, role. In the Lange postwar analysis of centralized social ism, active economic planning is not only a question of what activities must go under the control of the planning authority but also a question of the methods of assuring social control in general and securing the realization of the plan in particular. The following are the two major 7 6 methods of such type: 1. One consists of administrative orders and administrative allocation of resources. The various units in the socialist economy are ordered to do certain things - for instance, to produce so much of something. The resources which are necessary for that purpose, both material and financial are allocated in an administrative way. 2. The second method consists in the use of what we call 'economic means' namely, of setting up a system of incentives which induce people to do exactly the things which are required by the plan. At this point, it should be asked: which one of these methods has priority over the other. Elliott's comments are very much to the point: The compulsion of a system of 'administrative orders and allocations' cannot be dispensed ^Oskar Lange, The Political Economy of Socialism, p. 22. 221 with in a centralized socialist economy. The minimum 'fundamental decisions' of the strategy for centrally planned economic development (i.e., the division of national income into investment and consumption, and the allocation of invest ment funds among different sectors of the economy) would seem to require some degree of compulsion - i.e., command and prohibition - to be implemented and executed. Further, 'economic means are rather subtle instruments responding to normal changes in the situation and frequently breaking down when very fundamental or revolutionary changes are needed. In such cases, the use of administra tive means must be accepted.' Thus, in the tran sition to centralized socialism and in the early years of its development, when large-scale and rapid institutional changes are taking place and incentive:: systems are insufficient, unreliable, and slow, great reliance is likely to be placed upon administrative means' and compulsion.^7 Thus, according ot Lange, the first period of planning should be centrally directed for tlie reason of achieving certain goals, i.e., allocation of resources by the revolutionary state, large-scale industrialization in underdeveloped countries, etc.; but as the economy matures, a large area of decentralization should be intro duced by the substitution of economic laws for the cen tralized methods. Preference, "should be given to the use 7 8 of economic means." Lange supports this recommendation by two arguments: first, by using "economic means, planning makes use' of the automatic character of people's responses ^Elliott, op. cit., Chapter 12, pp. 47-48. 78 Lange, op. cit., p. 23. 222 to given incentives. Thus, certain automatic processes in 79 the economy are established." Second, the system of "adminstrative orders" has distinct disadvantages and limi tations which become increasingly apparent as a socialist economy develops. Thus, Lange writes: Methods which are necessary and useful in the period of social revolution and of intensive industrialization become an obstacle to further economic progress when they are perpetuated be yond their historic justification. They become obstacles because they are characterized by lack of flexibility. They are rigid; they lead, therefore, to waste of resources resulting from this inflexibility; they require a wasteful bureaucratic apparatus and make it difficult to adjust production to the needs of the population. However, it seems that the greatest obstacle to further progress results from the lack of proper economic incentives in this bureaucratic central is tic type of management. This hampers proper 'economic utilization of resources, encourages waste, and also hinders technical progress.' 0 It should be emphasized, however, that the conscious, manipulated incentives system of a centralized socialist economy - and the resulting pattern of income distribution accompanying it - is quite different from the more spon taneous controls of the competitive price system. Although central planners may and do make use of "the automatic character of people's responses to given incentives" and thereby establish "certain automatic processes in the economy," these processes should be distinguished from the ^Ibid. , p. 24 . 8QIbid., p. 19. 223 market-determined (Lange calls them "elemental") processes and incentives system of competitive capitalism: These two things should be distinguished. The difference is that in a socialist society, where the automatic processes are part of the method of realization of the plan, the conditions es tablishing incentives are set up by economic policy; whereas in capitalist society, these conditions develop in an elemental way. There is a basic difference; in one case (capitalism), the incentives develop in an elemental way and are not subject to conscious control of society; in the other case (socialism), they are consci ously established by organized society in such a way as to produce desired results.8^ - From Centralized to Decentralized Socialism In an earlier section, we examined some of the major pressures for centralization and decentralization as Lange envisions that they might exist in a socialist economy. In order to understand the movement from centralization to decentralization more analytically, let us now apply Lange's recommendations as well as those of other central ized socialists more systematically. Suppose a centralized socialist economy established by political revolution in an underdeveloped country is successful in establishing and maintaining government ownership of industry, collectivization of agriculture, and a system of comprehensive centralized planning and direc tion of the processes of industrialization and economic 8^Ibid., pp. 24-25. development. Suppose further that such a system has been successful in the industrialization process and has thus achieved a large total output, an expanded capitalistic resource base, an advanced technology, a disciplined labor force, and a skilled and managerial elite. Under these conditions, Dobb says, "The feasible limits on centralized decision-taking becomes more evident, and correspondingly the need to decentralize the taking of economic decisions 82 becomes more pressing." The pressures for and advantages of greater decentralization in a centrally planned economy are as follows: First, the very success of the revolutionary trans formation to a socialist economy terminates the pressures for centralization which came into play as an imperative necessity to maintain a system of government ownership means of production, collectivization of agriculture and to encourage central planning for industrializing rapidly and thus securing some standard of material welfare. At a comparatively early stage of development, the hypothesis suggests that a high degree of centralization will be necessary in planning and administration when large structural changes and a high rate of capital accumulation are on the agenda. But at a later stage of development, ^Maurice Dobb, Welfare Economics and Economics of Social ism: Towards a Commonsense Critique, p. 140. 225 there will be a need for decentralization. This argument, pointed out by Lange and Dobb, confronts us as a practical possibility in the historical experience of Yugoslavia and Czechoslovakia - as we will examine in detail in Chapter VI and VII. Second, argues Lange, are the "dialectics of the 83 processes of construction of socialism." The very success of centralized methods of industrialization generates a working class which "grows in number as well as in cons ciousness and political maturity" and a "new socialist intelligentsia," a new managerial, professional, and administrative class which is sympathetic to changing the highly centralized administrative and bureaucratic methods of management when they create obstacles to further progress. Third, Lange stresses that even within some blend of centralization and decentralization there remains certain minimum requirements which must be the perogatives of the CPB: "division of national income into investment and consumption; allocation of main investments among different branches of the economy;- and physical and financial coordi- 84 nation of the main branches of the economy." But, beyond these minimum fundamental requirements, there is no objective need for enhancing central planning. Even the determination of output targets for various commodities, ®^Lange, op. cit., p. 19. S^Ibid. f p# 23. 226 says Lange, is a "technical" not a "fundamental" problem. In fact, attempting to plan for the microeconomic details of specific products is complex, cumbersome, and confusing, and leads to "bureaucratic" inefficiency. Dobb also supports a similar argument, saying that: An obvious line of demarcation for any horizon tal division of responsibility in decision-making would be between decisions regarding investment in durable plant and equipment and decisions about current output .... If decisions con cerning plant and investment were to be central ized, this would set the long-period framework within which the autonomy of production units (firms or enterprises) would operate; the latter having discretion as to what and how much to produce, choice of inputs and sources of supply, problems of employment and personnel on the basis of given plant and equipment.85 Then, Dobb goes on to say, that centralized control over investment is mandatory, when one considers the question of overall stability of the economy. In an earlier work, he defended this contention by attacking Lange's instructions in his prewar model. In this model, the CPB need decide only the total amount to be invested in any period; the direction and the form of the investment as well as the output of existing plants could be left to the management of the various industries to determine according to the Lange rule of carrying the utilization of resources to the point where marginal cost equals price: in 8^Dobb, op. cit., p. 140. 227 this case, the output of each plant is presumably extended to the point where short-run marginal cost is equal to the value of that output, and new investment in the indus try is undertaken, if the price of the additional output resulting from the investment equals or exceeds its long- run cost, including the current interest charge on the capital involved in the construction of new equipment. Another principle suggested by Lange in his prewar model is that all prices shall be fixed by a process of "trial and error" until an equilibrium price is found at which current supply is equal to the demand. Dobb says that a socialist economy envisioned under these principles are subject to instability, because it is erroneous to think of the "demand for capital" in terms of the marginal productivity of a given stock capital that is responsible for accepting the rate of interest as a mechanism to control the rate of investment and thus to imagine that the "demand for capital" is a sufficiently stable quantity for the supply and demand for capital to be equated by means of an interest rate. Then, Dobb con tinues : As soon, however, as it is realized that the 'demand for capital' is a function .... Of the current rate of investment, and that . . . this demand will vary directly, but not inver sely, with the rate of investment, ceteris puribus, the existence of a powerful destabili- zing influence inherent in this relationship 228 becomes apparent. In other words, the so-called schedule of the marginal efficiency of capital is not independent of the rate of investment. If the investment is increased (or decreased), so will be the inducement to invest; and the situation will be one of unstable equilibrium where a tendency to a Wicksellian cumulative movement, with increased investment 'creating its own draught,' can hardly be controlled effi ciently by a trial and error process of search ing for an equilibrium-price for capital. 6 |Thus, Dobb concludes, because investment fluctuations are the obvious cause of fluctuations in demand and activity, centralized coordination and control of investment is more likely to promote macroeconomic stability than if such | investment is decentralized and controlled only indirectly via the rate of interest. | Fourth, is repetition of a point already noted. In its early, revolutionary stage, a centralized socialist economy will, in most cases, make heavy use of "administra- i !tive orders and administrative allocations' as tools for plan fulfillment. As the economy develops in size and complexity, and as the institutional bases of the new socialist economy becomes established and stabilized, centralized administrative orders and allocations become gradually cumbersome and ineffectual. Indeed, Lange notes, "the greatest obstacle to further progress results from the lack of proper economic incentives in the bureaucratic p£ Maurice Dobb, On Economic Theory and Socialism; Collected Papers, p. 43. 229 centralistic type of management. This hampers proper economic utilization of resources, encourages waste, and 87 also hinders technical progress." A good indicator that the economy is maturing is when it starts to overcome the centralized administrative orders and commands, and turns to greater reliance upon the decentralized systems for economic incentives. It is important to realize that the decentralized process in this case concerns both the preparation of the plan and the content of the plan itself. The former has to do with collection, verification, and analysis of information by the CPB. This process is not accomplished once and for all. According to Lange, the CPB lays down accounting prices and then manipulates them in such a way as to maintain equilibrium between supply and demand for each product at the current accounting price. There fore there must be a continuous information flow from the various quarters of the economy to the planning authority indicating changes in demand and supply. On the basis of this information manipulations of accounting prices are undertaken until the equilibrium situation is reached. This type of decentralization, in reducing waste and increasing efficiency, is purely administrative as distin guished from decentralization in an economic sense which has to do with the content of the plan. 87 Lange, op. cit., p. 19. 230 Decentralization in the economic sense goes beyond the administrative aspect of planning. "It is not concerned with raising the standard of administrative efficiency of the planning organization through better flow of information, but with the much more profound and substantial problem of multiplying or at least differen- 8 8 tiating the sources of decision making." This has been advocated on the ground that only in this way is it pos sible to let a larger number of people participate in shaping the development of the economy and also to facilitate the manifestations of the creative abilities of the members of society. In order to accomplish this result, Lange proposes to substitute a decentralized model to the centralistic one corresponding strictly to a system with the following features: (a) one-level-decision-making? (b) strictly hierarchial structure and predominance of the vertical links between central level and enterprise; and (c) com munications from the top to the bottom in the form of orders. The decentralized model rests essentially on the following features: (a) the basic feature concerns the QO Francesco Vito, "Decentralization in A Collectivist Planned Economy," in Comparative Economic Systems, ed. Jan S. Prybyla (New York: Meredith Corporation, 1969), pp. 59-60. 231 fact that the power of decision-making is dispersed between different agencies. In the Lange model, there are basic ally two such agencies: the level of the central authority and the level of enterprise. To the first, as already noted, belong decisions which determine the general direction of the economic development, the rate of increase of national income, the shares of investment and consump tion, the allocation of investment outlays between branches, the distribution of the "social dividend," and so forth. To the second, as already noted, too, belong decisions on the following matters: the size and the structure of outputs of a given branch or production unit; the sources of supplies and direction of sales; the form and methods of remunerations, and so forth, (b) plans on different levels are independently formulated: the central plan on the basis of the aims of the headquarters, the plans of the enter prises on the basis of their rules of the game. Plan formulation, insists Lange, can and must be decentralized as socialism develops: "Economic planning should be decen tralized so far as it is possible to set up economic incentives such that the decisions of the decentralized units are the same, as the decisions which would be made centrally. Second, economic planning must be decentralized in all cases where the central decision responds to a situation too late, because in such cases, unless there is 232 89 decentralization, central planning becomes fictitious." (c) the links between different levels are achieved not by orders but by indirect means, i.e., the determination of market magnitudes which serves as parameters of deci sions taken by the enterprises. By implication, it is essential, as Lange argues, that "the plan be based on correct economic accounting. Correct accounting of economic costs and economic benefits, and consequently a 90 correct price system, are indispensable." Fifth, decentralization in an economic sense gradually opens the way for political decentralization. The reason is that decentralization of economic functions within the context of a socialist economy tends to con tribute to the dispersion of power which might conceivably tend to strengthen the bases of political and personal freedom. For those who make the decisions, such decentral ization tends to make their work more satisfying, heightens their sense of responsibility and independence and promotes initiative and resourcefulness. These are realized in a decentralized socialist economy with a high degree of freedom of consumer and occupational choice and oppor tunity. Sixth, in our present electronic age, it is possible to overcome the criticism raised against decentralized ®9Lange, op. cit., pp. 24-25. ^ Ibid., p. 26. 233 socialism by Hayek and Robbins on the practical difficulty of calculating millions of equations in order to arrive at the accounting prices. Given the supply of goods, the state of technology and the scale of preferences, it now becomes easier, by means of modern mathematical techniques, to reach to solutions corresponding to the most appropriate allocation of resources. In this connection, Lange writes: Planning of long-term economic development as a rule is based on overall considerations of econo mic policy rather than upon calculations based on current prices .... Actual market equili brium prices do not suffice here, knowledge of the programmed future shadow prices is needed. Mathematical programming turns out to be an essen tial instrument of optimal long-term economic planning . . . here the electronic computer does not replace the market. It fulfills a function which the market never was able to perform.9-1- In this case, what is being decentralized does not refer to the very process of planning decisions, i.e., the economic content of the plan, but simply to the planning technique. It is a decentralization in a purely technical sense. Summary This chapter presented Lange's position in his post- I j war writings, along with the contributions of other Western! Q 1 ' Oskar Lange, "The Computer and the Market," in Socialism, , Capitalism, and Economic Growth: Essays Presented to i Maurice Dobb', ed. C. H. Feinstein (Cambridge: Cambridge University Press, 1967), pp. 160-161. ; 234 neo-Marxists in regard to the model of centralized social ism. This model was also classified in accordance with relevant structural criteria, thus giving an overview of the organizational features of centralized socialism. The focus of the Western neo-Marxist theories of decentralized socialism is upon the methodology of central and comprehensive economic planning. This has had three major dimensions: first, a critique of consumer sovereignty and a defense of central planning by government authori ties; second, a substitution of centralized development strategies emphasizing the "mobilization and allocation of the economic surplus" for static allocational efficiency in the analysis of conditions and formulation of plans; third, an emphasis upon government hierarchy and manipula tion as the major techniques for the execution of economic plans and the implementation of social controls. Drawing inspiration from the experiences of Com munist countries, Western neo-Marxists have regarded centralized socialism as essentially a process for the industrialization and economic development of underdevel oped countries. Lange goes along with this view at least in the first stage of socialist economic development; in a later stage when the important goals of centralized socialist planning have been achieved - rapid industriali zation and establishment of a socialist sector which controls the "commanding outposts" of economic life - then 235 a socialist economy should and can become, in large part, decentralized. While planning of economic development and detailed microeconomic decision-making through administra tive measures were a historical necessity in the first stage of centralized planning, in Lange's opinion, these become fetters to further development as the economy becomes more mature and complex. They lead to waste of resources due to inflexibility and require a wasteful bureaucracy and make it difficult to adjust production to consumption and the needs of the people. Additionally, the incentives of moral and political exhortations to workers by appealing to their patriotism and "socialist consciousness" need to be replaced by economic incentives. This approach is considered to be "a classical example of the dialectical character of the development of socialist society," or the 92 laws of motion of socialism. While economic incentives operated to some extent in the centralized phase, in this second phase administrative measures become secondary and the use of economic means, 93 i.e., the operation of economic laws," become primary. However, says Lange, under capitalism the incentives are not subject to the "conscious control of society," while under socialism incentives are established to produce the ^^oskar Lange, The Political Economy of Socialism, p. 24. 93Ibid., p. 27. 236 desired results of the overall plan. In other words, economic planning should be decentralized and incentives established so that the decentralized decisions are the same as if the decisions were made centrally. Also, econo mic; planning must be decentralized to obtain flexibility, inasmuch as central planning in some situations responds too late. For example, enterprises must have the power to use funds for unforeseen breakdowns, or to buy machines to increase output quickly or make technical improvements. Such investments - as contrasted to long-run investments, building new plants or substantial enlargements of existing scale of plant - would not appear in the central economic plan. However, since the enterprise would borrow from the bank for the short run there would still be indirect influence as the bank could refuse to extend credit if the objectives are not consistent with general economic policy. As far as the scope of the plan is concerned, it should include the planned rate of investment: division of national income between investment and consumption; and the basic distribution of investment. Additionally, the plan may include targets for production of basic materials. More specifically, the output of certain basic commodities like steel, some capital goods, and so forth, would be in the central economic plan. The output "in terms of total net value" of other products would be assigned by the plan, | 237 but the decision as to the details as to assortment of 94 goods, would be up to the enterprises. Lange then quickly suggests that this is a problem of technique and not of principle, and the solutions may change. However, the problem of a correct price system is a matter of principle and not a matter of technique. Prices in a socialist economy, Lange notes, have two purposes: (1) as a means of distribution, involving market prices, where prices equilibriate supply and demand; and (2) as a means of economic accounting, which "reflect the social 95 cost of production of the various products." There may be a divergence between the two kinds of prices. Lange proposes the calculation of initial or normal prices, which is the cost of production plus a profit, to cover accumulation and collective consmption. The positive or negative differences between the market prices and the normal prices would then serve as an indicator for economic planning. 94Ibid., p. 28. 9^Ibid., p. 29. CHAPTER V DECENTRALIZED AND CENTRALIZED SOCIALISM: AN APPRAISAL Introduction The models of decentralized and centralized socialism have been subjected to critical evaluation. In this chapter, attention is focused separately on the theoretic studies of the economic problems facing each model. In the case of the Lange model of decentralized socialism, we are primarily concerned with the welfare implications of the CPB's task - to rationalize the planning system by performing the functions of the market. Our chief aim here is to appraise in summary fashion the probability of achieving this task. To do this, critical evaluation will be organized around a number of central issues: Is the Lange model really socialism? Could it work? Would it work? How well would it work? In the case of Lange's postwar model, our interest is in centalized socialism as an alternative planning scheme to achieve certain priority goals in underdeveloped countries. Assuming that such a possibility is feasible, i the question arises as to how smoothly it can function and whether it can be compatible with certain non-economic i goals. To answer this question, discussion will be 239 organized around a number of central topics - problems in plan formulation, problems of plan realization, and centralized socialism versus freedom. Decentralized Socialism Assuming that socialist economic systems are administered in accord with the general principles outlined by Lange in his prewar model, to what extent might an optimum allocation of resources be approximated? In forming a judgment on this central question, the following considerations should be taken into account. Is the Lange Model Really Socialism? Lange has been criticized from both the left and the right. Hayek, a neo-liberal critic, states that the Lange model "appears not to involve much more planning than a construction of rational legal framework for capitalism: and therefore "much of the original claim for the superiority of planning over competition is abandoned if the planned society is now to rely for the direction of the industries to a large extent on competition."^ Centralized socialists consider the Lange model as a useful logical exercise and a refutation of the kinds of ^•Friedrich A. von Hayek, Individualism and Economic Order (Chicago: The University of Chicago Press, 1963), pp. 161, 186. 240 criticisms raised by Mises and Hayek. But they clearly regard it as a "bourgeois" deviation from how a real socialist economy should be run. Thus, Dobb argues that the Lange argument: . . . can be said to have had importance as a refutation of the a priori impossibility of socialism. But since the argument had adopted common ground with this school in admitting the need for a competitive market, it refuted the a priori argument only to replace it by a modi fied one of its own: namely, the categorical imperative for a socialist economy to make use of this particular mechanism. . .. At the same time there is no valid reason to maintain that it must necessarily be the solution adopted - to deduce it, Mises-like, from the 'nature of the economic problem1 as the imperative solution. Sweezy, another socialist critic, states: ". . . such a system is certainly conceivable, but most socialists will probably feel that it reproduces some of the worst features of capitalism and fails to take advantage of the construc- tive possibilities of economic planning." Baran, in a similar fashion, argues that "not too much useful purpose is served by considering planning in a socialist society as directed towards the attainment of 'optima' the contents of which are borrowed from the individualistic value system Maurice Dobb, On Economic Theory and Socialism: Collected Papers (New York: International Publishers, Id55)", pp. 241, 243. 3 Paul Sweezy, Socialism (New York: McGraw-Hill Book Company, Inc., 1949), p. 253. 241 of the capitalist world or from some personal predictions 4 of the writers." In spite of these criticisms, the Lange model certainly falls within Johr's definitional framework and is compatible with category (3), namely, a centrally-directed economy with free consumer's choice and free occupational and sovereignty of the individual economic agents over the | CPB. On the other hand, there is conformity between the |Lange model and the classical definition of socialism; | |namely, one which socializes production. Elliott states that whatever preferences there may i |be about the terminology, the following is certainly true: ... decentralized socialism is definitely a 'mixed' economic system, sharing certain features traditionally and historically associated with the theory and practice of market capitalism, j The Lange model provides the useful tour de force | of distinguishing clearly between ownership of i the means of production and social processes for | coordinating economic decisions as criteria for identifying, classifying, and comparing economic ! system. Just as recent students of capitalism I have argued that it should be possible to combine j private ownership with social and government: con trol and coordination, the model of decentralized j socialism posits the possibility of an admixture | of public ownership and coordination and control by the institutions and/or rules of the competi tive price system.5 *Paul Baran, "National Economic Planning," in A Survey of Contemporary Economics, Vol. II, Ed. Bernard F. Haley (Homewood, Illinois: Richard D. Irwin, Inc., 1968), p. 3,84. I !^John E. Elliott, Comparative Economic Systems: Theories, I Philosophies, Strategies (Unpublished Manuscript), Chapter Could the Lange Model Work? In order to answer this question, it is necessary to mention that Lange developed his model as a response to Mises' criticism that a rational allocation of resources requires a competitive price system and thus it is impos sible in a socialist economy. As a counter-criticism, Lange maintains that Mises' contention is based on a con fusion concerning the nature of prices. For this reason, Lange, like Wicksteed, distinguishes between two types of prices: the first kind is price in the ordinary sense, i.e., the exchange ratio of two commodities on the market; the second kind is in the generalized sense, i.e., "the terms on which alternatives are offered." It is only the latter sense which is fundamentally important for the problems of rational economic calculation and allocation of resources. Keeping this distinction in mind, Lange has essen tially designed a model wherein private ownership is not regarded as a logically necessary requisite for the existence of a pricing system as a social process for economic calculation. Starting from the basis of the theory of market equilibrium, Lange argues persuasively ; that under socialism prices are not arbitrary but are based on the quantity of production outlays, and that they are an important instrument in economic calculation. It is possible to fix prices (so-called "accounting prices") j using a method similar to the free market, i.e., by a method of successive "trial and error." In the decentral ized model of socialist economy, a quasi-market or a central planning board accomplishes this. Thus, Lange shows that a type of socialist economy in which there is free choice in consumption and occupation, and which is directed by a scale of preferences defined by consumers as free economic agents, is a consistent system capable of functioning. Joseph Schumpeter, while supporting Lange's thesis, states that both capitalism and socialism borrow from "the perfectly general logic of choice" and thus show 6 an "essential sameness .. . of logic ..." The economic theory of decentralized socialism appears, therefore, to meet the test of logical consistency. The neo-liberal critics of socialism are in agreement with this conclusion; yet, they point out that rational alloca tion of production factors is unrealizable in practice under socialism. Hayek, for example, praises Lange for his "courageous attempts to face some of the real difficulties and completely to remodel socialist doctrine in order to meet them ..." but point out: "whether the solution offered will appear particularly practicable, even to the 7 socialists, may perhaps be doubted." ^Joseph A. Schumpeter, Capitalism, Socialism, and Democracy (New York: Harper and Row Publishers, 195Q), p. 182’ . ^Hayek, op. cit., p. 208. 244 Would the Lange Model Work? The neo-liberal critics' answer is in the negative. They point out that though rational allocation of produc tion factors is theoretically possible, it is impractical because economic calculations would require the solution of thousands or hundreds of thousands of equations. In response, Lange argues that practical difficulties can be overcome by a "trial and error" process. In this connec tion, he writes: . . . the CPB . . . would not need to have as Hayek seems to think, complete lists of the different quantities of all commodities which would be bought at any possible combination of prices of the different commodities which might be available. Neither would the CPB have to solve hundreds of thousands of equations. The only equations which have to be solved would be those of consumers and managers of produc tion. These are exactly the same equations which are solved in the present economic sys tem and the persons who do this solving are the same also.8 Consumers solve them by spending their incomes so as to maximize total utility and the managers of production can solve them by finding the combination of factors that minimizes average cost and the scale of output that equal izes marginal cost and the price of the product. ^Benjamin E. Lippincott (ed.) On the Economic Theory of Socialism (Minneapolis: University of Minnesota Press, 1938), p. 15. 245 To establish the accounting prices which serve as parameters for the persons solving the related equations, Lange continues, no mathematics is needed, nor is there a need for any knowledge of the demand and supply functions. "The right prices are simply found out by " the CPB through "watching the quantities demanded and the quantities supplied and by raising the price of a commodity or service whenever there is an excess of demand over supply and lowering it whenever the reverse is the case, until, by trial and error, the price is found at which demand and 9 supply are in balance." There are, however, according to Elliott, three difficulties which emerge in the path of reaching a valid answer to the question posed at the beginning of this section. First, the theory of decentralized, socialism as presented by Lange is a theory of a prospective, not an actual, economic system. Therefore, its practicability cannot be verified by testing the extent of its correspon dence to some actual, existing economic system. In a similar vein, "the Polish economist Jan Drewnowski argues that a Theory of socialism should start from an analysis of the existing socialist system . . . Lange's theory was a considerable intellectual achievement, but it did not 9Ibid., p. 16. 246 explain any reality because its premises were never based in existing conditions. Second, if we abstract from the notion that decen tralized socialism might survive, i.e., that it would not degenerate into economic anarchy, then we are inclined to agree with Schumpeter in stressing the following words: The Lange-type model of socialism is eminently operational; that is to say, it not only estab lishes a logical possibility, but in doing so, also shows the steps by which this possibility can be realized in practice.^ Third, if a socialist price system is to work, decentralized managers must be induced to follow the rules as set by the CPB, and in doing so they must regard accoun ting prices as given and beyond their control. This brings us to the fundamental question of how the success of the managers of production is to be tested. Lange did not explicitly deal with this question, perhaps because he did not really foresee the practical difficulties inherent in his two rules for managers of production. Dickinson refers to it briefly. He examines the responsibility of the managers and clearly sees that "responsibility means in practice financial responsibility" and that unless the manager "bears responsibility for ■^Cited in Elliott, op. cit., Chapter 11, p. 48. •^Schumpeter, op. cit., p. 185. 247 losses as well as for profits he will be tempted to embark upon all sorts of risky experiments on the bare chance 12 that one of them will turn out successful." The obvious test, therefore, is profits. But, as Dickinson recognizes, this is not an altogether satisfactory criterion as it is a difficult problem with managers who have no property of their own. Dickinson hopes to solve it by a system of bonuses. Criticizing Dickinson, Hayek argues: This may indeed be sufficient to prevent mana gers from taking too great risks. But is not the real problem the opposite one - that mana gers will be afraid of taking risks if, when the venture does not come off, it will be some body else who will afterward decide whether ._ they have been justified in embarking on it? Dickinson also refers to this problem when he says that, "although the making of profits is not necessarily'a sign 14 of success, the making of losses is a sign of failure." On the other hand, Lange assumes that managers ignore all monopoly and monopsony gains, thus behaving as if prices were given and beyond their control. This would establish conditions of pure competition under decentral ized socialism. But this assumption is highly dubious, it is doubtful that managers can be induced to follow rules 12 H. D. Dickinson, Economics of Socialism (New York: Oxford University Press, 1939), p. 214. ■^Hayek, op. cit., p. 199. ■^Dickinson, op. cit., p. 219. 248 of behavior which every entrepreneurial impulse must urge them to violate. Such behavior is aptly described by Hayek in the following words: The manager's task is ... to order production in such a way that his marginal costs are as low as possible and equal to price .... He has to take price as given. This turns him into ... a pure 'quantity adjuster,' i.e., his decision is confined to the quantities of fac tors of production and the combination in which he uses them. But, as he has no means of inducing his suppliers to offer more (or to induce his purchasers to buy more) than they want to at the prescribed price,nthe only way for him, for ex ample, to expand production so as to make his cost equal to price, would be to use inferior substitutes or to employ other uneconomic methods; and, when he cannot sell at the prescribed price and until the price is lowered by decree, he will have to stop production, where under true competi tion he would have lowered his prices.-1 -5 Furthermore, in the case where the size of the producing unit is large relative to the market served, managers would be tempted to violate the rules, too. "In order to make a large profit," Bergson says, "they might try to take into account the effects of their actions on the 16 Board's decisions on prices." in this way, they might restrict the output in the same fashion as monopolists do in a capitalist economy. Hence, Lange's solution might not. be as competitive as it is supposed to be. 15 Hayek, op. cit., p. 197. ■^Abram Bergson, "Socialist Economics," in A Survey of Contemporary Economics, Vol. I, ed. Howard Ellis, (Homewood, Illinois: Richard D. Irwin, Inc., 1968), p. 435. 249 In such cases, there might be no alternative for the CPB except to audit the cost records of the individual production units, as suggested by Dickinson.^ However, if carried to any length, this would be in conflict with the aim of Lange's solution - to decentralize decision making - because it would involve the CPB in more administrative calculation. Indeed, Hayek argues that the CPB would have to look into the cost records of individual firms in any and all circumstances: "this will not be a perfunctory auditing, directed to find out whether" the manager's costs "have actually been what he says they have been . . . This means that the control will have to consider not only what he actually did but also what he might have done and 18 ought to have done." Thus, Hayek concludes that the CPB will have to make a full-fledged study to check whether the managers have operated as efficiently as possible. At this point, it is appropriate to consider a few other problems arising out of the relation between the socialist managers of production and the CPB upon following Lange's rules and Dickinson's profit criterion. The following will, in turn, summarize these problems. Decreasing Cost Conditions: Case of Indivisibili ties . For one thing is the case of decreasing costs caused by large indivisibilities in production. In ■^Dickinson, op. cit., p. 217. "^Hayek, op. cit., p. 198. applying Lange's instructions, it is obvious that accordfhg to rule (1) production would stop when average cost equals price for the industry. In rule (2) production is con tinued until marginal cost is equal to the price of the product. Since marginal cost is now lower than average cost - as price is below average cost - losses would be made, and managers would be disinclined to continue pro duction even though it might be socially desirable. "For this reason," Bergson says, "it might be especially difficult to establish a suitable managerial success criterion to assure conformity to Ruler.2 . . ." or, in other words, it might be difficult to reconcile Lange's second rule with Dickinson's profit criterion.1^ The case of decreasing cost, therefore, constitutes an exception to the Lange-Dickinson suggestion that under the established rules the socialist, like the competitive firm, maximizes profit. Dickinson suggests that the negative rents or accounting losses incurred under the application of rule (2) to decreasing cost industries should be covered by permanent subsidies. These subsidies could be taken from "a marginal cost equilization fund" into which would be all positive rents arising in increasing cost industries •^Abram Bergson, "Market Socialism Revisited," Journal of Political Economy, LXXV, (October, 1967), p. 659. ^®Dickinson, op. cit., p. 108. 251 Decreasing Cost Conditions: Case of Externalities. Decreasing cost conditions may be caused by externalities. While indicating that the trial-and-error method or the competitive solution supposedly facilitates dealing with them generally/ Lange feels it is especially advantageous regarding external economies and diseconomies that are internal to the industry. In a socialist economy," Lange says, "the social benefits and costs due to external econo mies and diseconomies are taken care of automatically by the rule that each industry produce just enough to equalize the marginal cost incurred by the industry in producing the 21 amount with the price of the product." These externalities, as already indicated, may give rise to decreasing costs for the industry, and, as Bergson reminds us, profit maximization is inappropriate in this case. Now, assuming that the manager of an industry could be counted on to observe Rule (2), it evidently might be difficult, as Bent Hansen notes, to approach equilibrium through a "trial-and-error" process. What may make this process "impotent , in this case is the practical circum stance that short-run decreasing costs are usually to be met in transport, i.e., in production of services where 21 Oskar Lange, "On the Economic Theory of Socialism," in On the Economic Theory of Socialism, ed. Benjamin E. Lippincott (Minneapolis: University of Minnesota Press, 1938), p. 105. 252 there are no stocks which can reveal excess demands and 9 9 supplies." Thus, since there are no stocks, it is a great problem whether Lange's rules are really the appro priate ones under these circumstances. Hansen refers to this problem graphically. P PI PO MC <Jl dl a2 ^2 Figure 5-1 In Figure 5-1, MC is the falling marginal cost curve of the industry (denoting decreasing, cost conditions) and d-d the demand curve. PQ‘ and qQ are the optimum price and quantity, respectively. Assume now that the CPB has fixed the price too high, at p-^. If the enterprise follows Lange's Rule (2) , the production will be q-^; but the demand is d^ and, since there are no stocks, the result will be unsatisfied demand equal to d^-q-^ with all the inconvenience which this implies. If, on the other hand, 22 Bent Hansen, "A Note on the Rules for Competitive Socialism," in On Political Economy and Econometricsr.Essaysl in Honour of Oskar Lange (Warsaw, Pbiarid: Polish Scientific j Publishers, 1965), p. 177. 252 there are no stocks which can reveal excess demands and 22 supplies." Thus, since there are no stocks, it is a great problem whether Lange's rules are really the appro priate ones under these circumstances. Hansen refers to this problem graphically. P PI PO ---1 MC ql dl % d 2 “ 12 Figure 5-1 In Figure 5-1, MC is the falling marginal cost curve of the industry (denoting decreasing cost conditions) and d-d the demand curve. P0- and qQ are the optimum price and quantity, respectively. Assume now that the CPB has fixed the price too high, at pp If the enterprise follows Lange's Rule (2) , the production will be q-^; but the demand is d^ and, since there are no stocks, the result will be unsatisfied demand equal to with all the inconvenience which this implies. If, on the other hand, 22 . . Bent Hansen, "A Note on the Rules for Competitive Socialism," in On Political Economy and Econometrics:. Essays! in Honour of Oskar Lange (Warsaw, Pbdartd: Polish Scientific ; Publishers, 1965), p. 177. ! 253 the price is fixed too low at production will exceed demand and there will be unutilized services which represent a clear waste. Consequently, there arises a troublesome question: "What is optimal when we are outside the opti- 23 mum?" Under these circumstances, Hansen concludes that Lange's competitive socialism loses some of its attractive ness and it may be thus better to drop Lange's rules and let the enterprise follow the rule; satisfy the demand at the given price. Constant Cost Conditions; Lange's Rules versus the Trial-and-Error Method. Hansen also stressed that even in the case of constant cost, the manager, upon seeking to conform to the rules would be in doubt how to behave. This is due to an inconsistency between Lange's Rule (2) and his method of "trial-and-error," to reach an equilibrium price. Hansen proves his point diagrammetically: M.C P A.V.C. q q Figure 5-2 23Ibid., p. 178. 254 The cost structure o£ a single plant, producing one commodity, is shown in Figure 5-2, where M.C. depicts marginal costs and A.V.C. the average variable costs. Both are supposed to be constant until a production equal to q - called normal capacity - is reached; for larger productions the costs are rising. This means that below normal capacity the marginal and the average variable costs curves are horizontal and coincide. The demand curve is d-d. Hansen assumes that it cuts the cost curves to the left of q, which means that there is some idle capacity in the plant. In equilibrium where the optimum is reached, the price will be pQ and the quantity produced will be qQ. Assume now that the CPB has actually succeeded in fixing the price at pQ. Now, upon instructing the enter prise to follow Rule (2) , the situation is indeterminate: any production between zero and q fulfills the requirement that price and marginal costs shall be equal. To make the situation determinate, Hansen notes, the enterprise must have another rule to follow: satisfy the demand at the given price. This solves the problem if the CPB has actually fixed the price at pQ. But how does this new rule work if the CPB has fixed a wrong price. According to Lange, the mode of correction is simple: if, for instance, the price has been fixed at p^, then, upon following Rule (2), 255 the enterprise will produce the amount q»j. Since the result is an excess supply equal to < 22~3i ~ as demand is only q^ the CPB must lower the price and in this way the optimum price pQ should eventually be reached. However, Hansen adds, with our new rule for production - satisfy demand - the enterprise will produce the quantity q^. With this rule supply will always be equal to demand and Lange's method of "trial-and-error" will cease to work. Thus, we end up in a troublesome dilemma: "under constant cost, Rule (2) leaves the quantity produced indeterminate. And with the new rule - satisfy demand - the price will be indeterminate because the market will always be in a neutral equilibrium where any price (higher than pQ) will clear the market."2^ How Well Would the Lange Model Work? There are several observations which should be noted in answering this question. In the following we try to provide a brief summary of the important ones which are relevant to the question. The Need for an Interest Rate Under Socialism. First, it is important to consider a fundamental question in regard to managers' behavior in relation to their own decisions on investment. Is there a need for an interest rate under decentralized socialism? In the Lange model, a 24Ibid., p. 176. 256 "trial-and-error" setting of the interest rate would have to be followed in order to equate the total demand for investment funds with the quantity of such funds that the CPB has decided to make available in attempting to realize the rate of investment which has been in turn set by the CPB as a goal for the economy. Dobb is extremely critical of this process. He starts his criticism by considering the behavior of managers under perfect competition, and gradually argues that a need for centrally planned invest ment becomes all-inclusive. The capitalist entrepreneur, Dobb says, while taking prices as given, makes his decisions on investments on the basis of expectations as to future market conditions. Since these expectations are merely personal guesses, mistakes and errors in forecasting develop, thus causing fluctuations in introducing investments. Similarly, the socialist manager would have to estimate his prospective behavior by forming estimates of future market conditions in deciding on investments. This guessing-game cannot be remedied, Dobb argues, by a manipulation of the accounting- price of capital according to the period of investment, since the CPB, in fixing a long-term rate, would be tempted to do so on the basis of a guess regarding the reaction of industrial managers to this long-term rate and to current short-term rates. Indeed, Dobb says: 257 . . . it is difficult to see how Dr. Lange's accounting price for capital, if it is to be a long-term rate, can be a 'trial and error' rate in any significant sense of the term, since the process of 'trial and error' that is to test it and adjust it necessarily lies in the future, and is itself being influenced by current happenings which, under a regime of decentralized investment decisions, are out- side the planning authority's immense control. b Errors in forecasts based on guesswork presumably would be the greater the more dynamic the economy, thus causing more fluctuations in investment. This would lead to a high degree of instability and large-scale unemploy ment of resources. The way this process of cyclical fluctuation is created is simple: Dobb points out that a reduction in the rate of interest by the managers of firms as a basis for encouraging investment leads to a cycle of expansion or contraction - as the investments take place, there is an expansion in purchasing power, and, assuming that the economy is at full-employraent production, the prices for consumers' goods rise, and there will be a secondary increase in the demand for capital, and so on. Any attempt to put an end to this process by increasing the rate of interest will steer the economy into the same Wicksellian cumulative movement, but in the opposite direction, resulting in unemployment. Dobb recognizes, however, that the CPB would be able to control the volume ^Dobb, op. cit., p. 54. of purchasing power through its policy on taxes and divi dends to assure that the volume of purchasing power in the hands of consumers is just sufficient to buy at prices covering marginal costs of production, thus enforcing the operation of Lange's Rule (2). The Problem of Equilibrium Under Decentralized Socialism. Second, Lange considers that convergence toward an equilibrium price would take place rapidly under decen tralized socialism. The functioning of such process is simple: the CPB, in watching the market, adjusts the accounting prices in accord with the conditions of demand and supply. If the initial accounting prices are consis tent with an equality between demand and supply, they remain unchanged. Otherwise, they should be increased if demand exceeds supply or decreased with an excess supply in the market. In this manner the Competitive Solution proceeds through a "trial-and-error" process toward equilibrium prices. Hayek argues that on the contrary the task of fixing prices by the CPB for an entire economy is a hard one. For one thing, the Board would find it difficult to respond quickly to continually occurring changes in supply and demand. Prices will be adjusted only periodically or from time to time. The reason, Hayek says, is as follows: "While with real competition price changes occur when the parties immediately concerned know that conditions have 259 changed, the CPB will be able to act only after the parties have reported . . . and the new prices will become effec tive only after all the parties concerned have been noti- 26 fied ..." This obviously takes time, and it is possible for the CPB not to correctly measure the values of alternatives foregone. The CPB would also be unable to fix in detail prices for all the infinite varieties of goods produced in a modern industrial economy. Inevitably, there will be a tendency for the CPB to fix prices only for broad categories of goods, with the result that in this case also the prices will not provide an accurate measure of alternatives fore gone in different circumstances. Both these deficiencies stem from the limitation on the amount of detailed "knowledge of particular circum stances of time and place" which can be placed at its disposal. Hayek is concerned with this limitation and explains that: . . . the sort of knowledge with which I have been concerned is knowledge of the kind which by its nature cannot enter into statistics and therefore cannot be conveyed to any central authority in statistical form. The statistics which such a central authority would have to use would have to be arrived at precisely by abstracting from minor differences between the things, by lumping together, as resources of one kind, items which differ as regards location, 26 Hayek, op. cit., p. 192. 260 quality and other particulars, in a way which may be very significant for the specific de cision. 27 The Pattern of Income Distribution. Third, as already indicated in Chapter III, Lange contends that his scheme would not be only efficient generally, but quite equitable in the pattern of income distribution. He bases his claim on the ground that in systems characterized by private ownership of productive assets, the distribution of income is a function of the distribution of such assests. The ownership distribution of productive assets, in turn, he considers to be a result of historical develop ment which is not necessarily related to the maximizing of social welfare. As a Marxist, he argues that the develop ment of capitalism has concentrated ownership in the hands of a relatively small proportion of the population, while the vast majority of people have only their labor power to offer in the market.28 The income allocation stemming from these circumstances, he says, tends to be very inequitable. In a decentralized socialist economy in which there is an absence of private ownership of productive assets, 27Ibid., p. 83. 280skar Lange, Political Economy: General Problems, Vol, I, trans. by A. H. Walker (Warsaw, Poland: Polish Scientific Publishers, 1963), pp. 15-45. 261 a more quitable distribution of income would result than in a capitalist system. As in the former, the distribution of income is based on the (tacit) assumption that everyone has an identical marginal utility of income curve and there is no private income from ownership of private assets, which is a major source of inequity under capitalism. Also, given freedom of choice in occupation, wage differen tials would tend simply to correspond to differences in disutility, and hence would not be really inequitable. With regard to distribution of a "social dividend," it might be distributed according to some equitable criterion, such as personal variations in need due to differences in well-being. Putting aside these exceptional cases, if the distribution of the dividend were equal for all households, they all would be well off. As far as the social services such as education and training are concerned, Lange says, they would be free for all. Lange,recognizes, however, that there would be an exception in the sense that persons with rare talents would receive rents which, on the basis of value productivity, are considered as differences in income being out of pro portion to differences in disutility.' He hopes that these rents could be extracted without adverse effect on the supply of services produced by these people. At first glance, looking at Lange's position in Marxist terms, the income distribution argument seems 262 rather impressive. On a more careful analysis, however, his case loses much of its force, as he recognizes, too, from the point of view of a decentralized socialist. First of all, it should be remembered that there are significant differences in natural ability, and that great ability is in relatively scarce supply. Also, people who are endowed with more ability and natural talent, thus being able to make greater contributions to society, are not willing to provide their services for the same rewards that are extended to people with less ability and talent. Lange recognizes these premises in his model, stressing that wage differentials are necessary if labor is to be allo cated without compulsion to the production of commodities that consumers demand or the state decides to produce. T. J. B. Hoff has pointed out that Lange is really contradicting himself when "he starts by requiring differentiated income, but arrives at the conclusion that 29 the incomes are in reality the same ..." This is evident, Hoff says, because it is important for Lange to have both free choice of occupation and goods and a distribution of income which will maximize "the total welfare of the community." This can only be achieved 2Q T. J. B. Hoff, Economic Calculation in the Socialist Society (London: William Hodge and Co., Ltd., Id49), pp. 71-74. 263 under Lange's two conditions:(1) the distribution is such that the same demand-price offered by the different consumers represents an equal urgency of need, as is obtained if the marginal utility of income is the same for all consumers, and (2) the distribution leads to such apportionment of services of labor between the different occupations as to make the difference of the value of the marginal product of labor in the different occupations equal to the differences in the marginal disutility involved in their pursuit. In Lange's opinion, the first condition is satis fied when all consumers have the same income, "assuming the marginal utility curves of income to be the same for all individuals." In the meantime, he admits that the premise that the optimal distribution of labor requires differential income, as implied by the second condition, is in contradiction with the first condition. This contradiction is only apparent, Lange says, because he believes that these wage differentials would be negligible in view of the fact that "the choice of an occupation offering a lower income, but also a smaller disutility, may be interpreted as the purchase of leisure, agreeableness of work, etc., at a price equal to the difference between 30 Oskar Lange, "On the Economic Theory of Socialism," in On the Economic Theory of Socialism, p. 101. 264 the money earned in that particular occupation and in others."3^ Thus, by putting these nonpecuniary advantages into the utility scales of the individuals, he concludes that "the disutility of any occupation can be represented 32 as opportunity cost." But are income differences in the decentralized socialist economy really "only apparent"? George Halm's answer is negative to this question: In such cases a lower income may be offset by nonpecuniary advantages, such as leisure, in many cases, however, jobs that are disagreeable are also badly paid. The cause of low wages in spite of great 'disutility' is, of course, a relatively large supply of certain kinds of labor; and as far as this large supply is caused by more modest requirements in terms of the laborer's natural endowments, the (decentralized) socialist economy will not be able to equalize incomes, even in the meaning of Lange's broader interpretation.33 Thus given freedom of choice of occupation, the departure from equalitarian principles might be much greater than Lange envisages. Bureaucracy and Mangerial Efficiency. Fourth, how well decentralized socialism would work in practice depends on political, sociological, and psychological factors. We have already commented on an important gap in the Lange 3^Ibid. pp. 101-102. 33Ibid., p. 101. ^^George N. Halm, Economic Systems: A Comparative Analysis (New York: Holt, Rinehart and Winston, Inc., 1$68), pp. 220-221. model: the lack of a managerial incentive system which would otherwise persuade the managers to accept psychologi cally the profit maximization criteria. Still, as Lange notes, "the real danger of socialism is that of a bureau cratization of economic life and not the impossibility of 34 coping with the problem of allocation of resources." To Schumpeter, the problem of bureaucratic management, or as he phrased it, the "rational exploitation of the bourgeois 35 stock," is a difficult one and one which Lange ignores, on the unsatisfying ground that it belongs to the field of sociology rather than economic theory. In his "Case for Socialism," Lange makes certain political value judgments to demonstrate the preference of socialism over "actual" capitalism by insisting that in the latter the power of capitalists and large-scale corporate enterprise would prevent effective programs of government anti-monopoly policy. Yet, it is surprising that he fails to recognize the possibility of political and administrative problems in his model of socialist economy. Thus, Kenneth Boulding suggests: "Any realistic theory of the socialist . . . economy must operate in terms of an equilibrium of politi cal and administrative processes," and there is "no reason 34 Lange, op. cit., p. 109. 35 Schumpeter, op. cit., p. 205. 266 to suppose that these pressures will be any more perfect 36 in a socialist than in a market economy." When Lange says that the problem of bureaucracy is a greater danger to socialism than the problem of alloca tion, he is making a concession to the critics of social ism, because he believes that a similar or even greater »' 1#V danger would prevail under monopolistic capitalism. On balance he concludes that the socialist officials, who, as he put it, would be subject to democratic control than private corporate executives "who are responsible to nobody."37 Lange's argument can be accepted where private monopolies are guilty of exploitation, inefficiency, add misdirection of economic progress. Where a sufficient degree of competition exists, as in the case of contempo rary capitalism in the United States, it is not defensible to attribute, as Lange does, a greater bureaucratic 4 inefficiency to mature capitalism, than to socialism. In this connection, Halm writes: "True, the private corporation is responsible to nobody except for the fulfillment of 36 Kenneth E. Boulding, Principles of Economic Policy (Englewood Cliffs, New Jersey: Prentxce-Hall, P- 26. 37Lange, op. cit., p. 110. 267 contracts freely entered Into. But this independence promotes efficiency and initiative rather than bureaucratic slowness. In his critique of socialism, Lange also separates the problem of bureaucracy from allocation. This separation, Halm says, will bring a contradiction between Lange's method of "trial and error" and decentralization of economic decisions. This is evident, because the former is necessary to decentralize the system in order to avoid too much bureaucracy, thus giving to consumers and to labor the greatest possible amount of freedom. If decentralization does not work, because the "trial and error" process gives way to a heavy reliance upon the planned character of the economy, then the bureaucratic apparatus must grow; and decentralized socialism may change into centralized social ism. Thus, Halm concludes that "the problems of bureau- 39 cracY and allocation are very closely related." Transition Problems. Fifth, Lange seems to argue that his scheme would work not only in an established society but in the period of transition. Lange bases his claim on three conditions: (1) the private sector of the economy must be small; (2) competition must reign in it; and (3) small-scale production must not in the long-run be more expensive than large-scale production. Although Lange j S^Halm, op. cit., p. 224. ^ Ibid., p. 225. hints that political factors might raise special problems for planning in this period, he points out that the transi tion to socialism cannot come by a process of "economic graduation," and "a socialist government really intent upon socialism has to decide to carry out its socialization at one stroke or to give it up altogether, and the one economic policy which (an economist) can commend to aosocial ist government as likely to lead to success" is "a policy 40 of revolutionary courage." Schumpeter argues that transition from capitalism to socialism will always raise political problems. These problems would be more or less difficult according to whether the capitalist society from which socialism emerges is in an early or late stage of development. Thus, in a late stage of development or in a "state of maturity" resistance is likely to be weak and the revolution might be 41 accomplished in an orderly manner. By contrast, Bergson argues, drawing on the Soviet experience, "that a most favorable moment for the socialist revolution is at an early stage of capitalist development, when the middle class is still weak and the proletariat has not yet tasted the 42 fruits of capitalism." ^Lange, op. cit., pp. 121-128. ^Schumpeter, op. cit., pp. 219, 220. ^Abram Bergson, "Socialist Economics," in A Survey of Contemporary Economics, p. 440. 269 After the transition is complete, there would be certain pressing economic problems such as rapid industrial ization and high economic development. In such situations, the model of decentralized socialism becomes inadequate and there would be a need for central planning. Lange conceived of this necessity in his postwar model. Decentralized Socialism and International Trade. Sixth, if the Competitive Solution, as envisaged by Lange, is going to be a substitute for perfect competition, it must also offer theoretical tools for handling problems of international trade. Lange does not discuss this issue. Other decentralized socialists admit the advantages of international trade and suggest that fullest use be made of these advantages. Dickinson, in his Economics of Socialism, discusses briefly how socialist communities should trade with "other communities." At the same time, he seems not to worry about the trade between the socialist countries. He expresses this view in a footnote which goes as follows: These other ccnnmunities are assumed to be non socialist. It is improbable that a number of independent socialist commonwealths would isolate themselves, each in its own distinct economic system, when self-interest and social ist principle alike would impel them to adopt an integrated system of economic planning and costing.4^ 4^Dickinson, op. cit., p. 173. This passage seems to say that there is no-need to worry about intra-socialist trade because there will be no nationalistic bias against socialism. There will be either central pl&hning by a central body of comprehensive author ity or there will be competitive pricing. In the latter case, which is rOlatdd to our issue for discussion, all that woiild be necessary is to instruct the managers of plants and industries in each country to disregard national boundaries and to refrain from "discrimination." The rules of marginal pricing and costing would apply universally without regard to national economies. Thus, looking at trade on a multilateral and nondiscriminatory basis among the socialist economies, Dickinson assumes that the supreme economic council (the CPB) would compute prices, compare them with foreign prices on the basis of a given exchange rate, and determine, accordingly, which commodities should be imported and which exported. Similarly, R. L. Hall, another decentrali zed socialist, suggests that "a list of products may be drawn up in order of advantage, those with the greatest comparative advantage at the top and those with the least 44 at the bottom," and that international trade equilibrium will be established through the rate of exchange at which exports pay for imports. ^R. L. Hall, The Economic System in a Socialist State (London: Macmillan and. Co., Ldt., 1937), p. 220. 271 The state may not wither away. Dickinson admits that state-trading by large national monopolies leads to bilateral monopoly "in which it is probably that there is no determinate stable position of equilibrium but in which either party has an incentive to get the better of the 45 other by the use of fraud and of force." This implies that the instability of prices could be greater under state trading than under competitive basis considered on a multilateral basis. Nonetheless, Dickinson points out that the governments in trading on a bilateral basis would refuse to use their power to the detriment of the consumer or other countries and that "within the 'glass walls' of socialist economy it would be difficult to maintain 46 unreasonable discrimination for long." Halm, in criticizing Dickinson, states that it is not obvious that the "glasswalls" of the decentralized socialist economy will clearly reveal the cost-and-price structure of the nationalized industries. This is due to the dangers of monopoly: The monopolistic concentration of power is by definition much greater in a socialist than a private enterprise economy. The (decentrali zed) socialist argument rests on the weak assumption that public managers will play at competition while they are, at the same time, responsible to the CPB. But even if we assume that the managers will behave as if they were ^5Dickinson, op. cit., p. 177. 272 acting competitively, it is not obvious that they would act in a non-discriminatory fashion in their relations with other countries.47 Conclusion The discussion in preceding sections, it is hoped, has provided a preliminary framework for judgment'on the central question posed at the beginning of this chapter: to what extent might an optimum allocation of resources be approximated from the Lange model? A direct answer to | this question is a hard task to make. However, the fol- | lowing comments are pertinent to the issue in helping the reader to formulate an answer. First, in order to reach a commonsense opinion in i i I regard to the central question, it is necessary to agree on the test of efficiency, i.e., on the ends according to which the optimum allocation of resources is to be defined. It is important to realize that the comparison of the total market value of the consumers1 goods produced in the rival systems, such as Schumpeter proposes, implies only one possible criterion on ends, namely, consumer sovereignty, ! to judge efficiency.48 It is also necessary to decide whether an equitable distribution of income and whether consumers are to be sovereign in respect to investment are considered to be other criteria for .judging the efficiency 47Halm, op. cit., p. 382. 48Schumpeter, op. cit., pp. 188-189. 273 of the system on the basis of ends. Applying the Lange model to this framework, it is evident that Lange proves to be more of a hero in the case of consumer sovereignty than in the latter criteria. Second, keeping in mind that the question "how well would the Lange model work" is not an empirical one due to the fact that decentralized socialism is a prospective rather than an actual system,one must distinguish between blueprints of economic systems operating in hypothetical worlds and rival economic systems in the real world. There seems to be very little point in comparison of "the Competitive Solution in an established socialist state where there is a unanimity on encls, on the one hand, and monopolistic and unstable capitalism in the United S t a t e s . "50 on this account, the Lange model is subject to a sound criticism, as he compares the ideal theoretical system of decentralized socialism with the practical and operational model of capitalism. Ignoring this criticism, Lange's model of decentralized socialism, as already noted, is definitely a "mixed" system in which there is a distinc tion between public ownership of the means of production and the social process for making and coordinating economic decisions. As such, the socialist economy is capable of ^Elliott, op. cit., Chapter 11, p. 64. 5®Bergson, op. cit., p. 448. 274 producing the result of competitive market capitalism via the CPB performing the functions of the market. Finally, it is important to remember that, looking at the real world in terms of a socio-politico-economic entity, the question of efficiency cannot be separated altogether from questions of political and social nature. In this respect it is necessary to tackle the existing problems in accord with existing circumstances. Centralized Socialism Centralized socialists begin with the underlying premise that rapid and large-scale industrialization and economic development is more important for human welfare than the immediate satisfaction of consumer desires. Under their scheme, the operations of individual production units and households are to be integrated directly by the CPB. The managers are supposed to fulfill the targets set by the CPB. The result is a planned economy at the expense of consumer sovereignty. A planning scheme of this sort is suggested by Dickinson, who presents it as a possibly practical alterna- 51 tive to the decentralized model. Lange advocates it in his postwar analysis as a necessity in the underdeveloped countries in the early stage of development for at least 5^Dickinson, op. cit., pp. 104-105. 275 52 two major reasons: First, reasoning from Communist experience, the revolutionary liquidation of the pre- socialist system and the revolutionary establishment of socialism "requires centralized disposal of resources by the new revolutionary state, and consequently, centralized management and planning" as a basis for maintaining and defending the revolution. Second, centralization in the planning and use of resources is required: by the goal of rapid, large-scale industrialization. Dobb prefers the Centralist Scheme to the Competitive Solution on the account that "a socialist economy must necessarily be a planned economy, in the sense that major economic decisions (such as would be entrepreneurial decisions in a capitalist economy) cure taken by some central governmental body, and embodied in a general complex of decision, or conspectus, coordinated ex-ante for a defined 53 planning period." Then Dobb presents a series of argu ments to defend the case of central planning at the expense of consumer sovereignty. (These arguments were summarized in Chapter III.) Similarly, Sweezy argues that a socialist economy needs real central planning, because the "crux of ^Oskar Lange, Political Economy of Socialism (The Hague: Van Kuelep, 1958), p. 17. 5^Maurice Dobb, Welfare Economics and the Economics of Socialism: Towards a Commonsense Critique (Cambridge: Cambridge University Press, 1969), p. 126. the whole problem" for underdeveloped countries is "the management of investment." Starting from this problem, and. not from consumers' preferences, he consistently reaches the conclusion that in a socialist economy planning must become all-inclusive. The centralized solution is also facilitated in the special case of "fixed coefficients," where, for technical reasons, resources must be employed in amounts that must bear a constant relationship to each other. "Fixed coeffi cients" is itself a special case of the genus "limitational factors." Lange distinguishes between two types of the latter: one according to whether the amount of limitational I I factor that must be employed is a function of output and in the other of the amount of another factor employed.^ In these cases, Lange says that "no prices and no ; cost accounting whatever are needed in allocating re- ! sources." The problem is simply a technical one, and "efficiency in production is maintained merely by tech nological considerations of avoiding waste of materials." This is true only if, as Lange assumes, the demand for consumers' goods is in the form of fixed quotas. If the quotas of consumer goods to be produced are given, all further problems of planning i i i | 5^Oskar Lange, "On the Economic Theory of Socialism," in j On the Economic Theory of Socialism, p. 96. 277 production are purely technological and no price system and cost accounting is needed.55 Bergson has contended that the competitive solution has an allied adverse feature: If the coefficients are fixed, marginal and average costs are constant. The administra tive rules established by Lange no longer provide a definite basis for managerial de cisions. If prices were above marginal costs, for example, the managers would know that they should expand, but would be quite in the dark as to how much. The possibility is still open that by the manipulation of prices the Board could assure that the total output of the industry was brought in line with demand; there might be a 'neutral' equilibrium such as it is supposed might be attained under capital ist perfect competition in the case of con stant cost.5*5 Thus, Bergson concludes that there would be no satisfactory basis for moving toward equilibrium by successive approxi mation. As a result, a centralized solution may be the only feasible alternative. Suppose that centralized socialism, as perceived by Lange, Dobb, Sweezy, and Baran, is adopted as an alternative | planning scheme to deal with problems of underdeveloped \ countries. The question now arises as to how smoothly it can function and whether it can be compatible with certain non-economic goals. The following development will focus on some problems of such nature. 55Ibid., p. 94-95. ^Bergson, op. cit., p. 441. 278 Problems in Plan Formulation In the context of an underdeveloped economy, a centralized, collectivist analysis of economic conditions and formulation of plans, as already noted, can be a powerful vehicle to generate economic development. Given the case for central planning at the expense of consumer soverignty and the goal of large-scale industrialization, the centralized socialist strategy for mobilizing the allo cating economic surplus acquires a rational content which it would lack in a more complex, economically developed and consumer-oriented society. Also granting the existence of : some of the indivisibilities in production as stressed by centralized socialists, the task of achieving consistency and efficiency in economic calculation and plan formulation would be indeed much simpler than what their critics envisage it to be. Assuming that a dynamic sequence of development over the passage of time is more important as a measurement of success than static allocational efficiency at any given moment of time, the choice between the cen tralized socialism and the decentralized model would revolve about the nature of ends sought and the stage of social and ! economic development that has been reached. As a centrally planned economy develops, however, it becomes more complex, the number of alternatives in pro ductions and consumption increase, the earlier macroeconomic strategies of industrailization become gradually less 279 efficient, and thus the need for decentralization in micro areas of the economy becomes more pressing. So far as these considerations are concerned, a strict model of centralized socialism as endorsed by its advocates "is admirably suited for providing a simplified rationale for the Soviet industrialization process of the 1920's and 1930's? it is less effectively equipped for providing guidelines to understanding and appraising the considerably more complex, more industrialized, and more sophisticated 57 Soviet economy of the 197O's." ^ In addition to the difficulties of maintaining integration as the economic system increases in size and complexity, the major limitation of centralized socialism in plan formulation would seem to be the wide and embar- rasing gap between theory and practice. A prominent Yugoslav economist, Rudolf Bicanic, has put the severity of its shortcomings in this way: To those who have lived under a system of cen tralized bureaucratic, normative planning, its expense in human and economic terms and the damage which it can do at all levels of economy are obvious. Sometimes people . . . are led astray by the bias for rationalization to the superficial assumption and greater speed. The balancing of supply and demand in a centrally planned economy occurs in offices where a few people, unaware of the real effects of their authoritarian plans, become the supreme judges 57 Elliott, op. cit., Chapter 12, p. 41. 280 of the destinies of all producers and con sumers through their bureaucratic machine.58 Correct economic accounting of this limitation would open the way for greater decentralization. As Such, Bicanic's comments on central planning stand in marked contrast to those of such theoretical advocates as Sweezy and Baran. it is a pity that they do not favor the conver gence of central planning with decentralization; this is perhaps due to their rigid Marxist inclinations. On the contrary, Dobb and Lange consider this issue, perhaps because of their more liberal socialist outlook. Thus, success in plan formulation requires more than maintaining internal consistency through the "Method of Physical Balances," more than avoiding bottlenecks and excess capacity in production - which, in itself, would presumably become more complex and, ceteris paribus, more difficult in the process of economic development. It also requires an institutional mechanism to rationally calcu late alternatives by taking into account consumer prefer ences as well as the relative scarcities of factors of production. Dobb and Lange recognize this problem. Dobb, in an earlier work, accepted the rationality of a retail 58 Rudolf Bicanic, "Economic Growth under Centralized and Decentralized Planning: Yugoslavia a Case Study," Economic i Development and Cultural Change, VI,(October, 1957}, p. 66. 281 market as a process for communicating consumer preferences and also included a money wage system as a vehicle for 59 registering workers' preferences. In a later work, he incorporates, in varying degrees, price systems as social processes for economic calculations: It would look as though any unique system of 'ideal prices,' whether accounting-pnices, shadow prices, or actual prices, is unlikely to prove successful in reconciling and per forming simultaneously the multiform functions or else some combination of different kinds of price (such as accounting prices for certain types of calculation or certain categories of planning decisions combined with actual prices as the basis for incentives and as governors of decentralized decision at lower levels). 0 Lange, on the other hand, goes on to propose a comprehensive system of accounting prices and for the calculation and use of marginal costs as contrasted with average costs, in planning decisions. Even within this framework, Elliott states that the successful incorporation of price systems in centrally 61 planned economies faces two major difficulties: First, the doctrinal and ideological biases of centralized social- i ists (particularly those of Baran dnd Sweezy and to some ^Maurice Dobb, "Introductory Note," in Aims and Methods of Soviet Planning, Mikhail Bor (New York: International Publishers, 1967), p. 14. **°Maurice Dobb, Welfare Economics and the Economics of Socialism: Towards a Commonsense Critique, p. 138. ^Elliott, op. cit., Chapter 12, p. 43. 282 extent Dobb and Lange) work as obstacles to the use of comprehensive price systems, especially in regard to land and capital. Second, the institutional structure and behavioral principles of centralized socialism, as des cribed by Dobb and others would seem to make the efficient incorporation of price systems difficult. For example, unless the CPB accepts Lange's suggestions made in his prewar model, prices will retain a large element of bureaucratic guesswork. Problems of Plan Realization Although centrally planned economies have logically and empirically been powerful agents for channeling human, capital, and natural resources into development projects for industrialization, there are important shortcomings of centralized systems of plan realization. According to 62 Elliott, these are as follows: First is the inevitable conflict between the "political" and "realistic" elements of planning targets. The input-output figures in central plans may be a confu sing mixture between political goals and realistic statis tical data. As such, planning targets may be mere hopeful anticipations, and production managers will soon find out that these targets are not realizable in reality. In this 62Ibid., pp. 50-52. 283 situation, each manager will have to use his own discretion as to the extent he should attempt to adhere to planning targets. Thus, the concept of ex-ante coordination of planning targets, so important to centralized socialists, loses its validity in contrast to a pricing system which does not raise any issue of conflict because, in this case, no physical targets are to be met. Second is the problem of plan simulation. This begins with the formulation of plan itself. Taking advan tage of their knowledge of particular conditions, managers may be tempted to understate the fulfillment of output targets and overstate requirements so as to require a margin of safety for unforeseen contingencies. The managers use this device more often, the more convinced they become that their own monetary and non-monetary rewards (after being established by the CPB) will be best maximized by attaining planning targets. Third, a centrally planned economy lacks a single criterion of success equivalent to profit maximization in a capitalist economy or to Lange's triple-rule system in decentralized socialism. A central plan consists of a large variety of targets and expectations in regard to output and input levels, product assortments, and so forth. No plan is met perfectly and in this case, in the view of Robert Campbell, central planners "must establish some set 284 of priorities for relating underfulfillment of one goal to overfulfillment of another." Then, he continues: . . . once the managers have learned what the set of priorities is, they will take these pri orities into account in making their decisions .... Whenever controllers give high priority to one particular goal in their evaluation of plan fulfillment, and make that priority effec tive through bonuses, enterprise managers will violate other parts of the plan in order to fulfill the high priority indicator.63 An illustration of this is the sacrifice of quality for quantity when quantitative targets have not been met. Fourth, centrally planned economies have established incentive systems for managers and industrial workers. But, they have tended to ignore the position of the peasantry. Collectivization provides a solution of a sort to the problem of the social control of the peasantry, but a solution which causes extreme difficulties. On the one hand, the traditional peasant hunger for land ownership makes collectivization a burdensome task. On the other" hand, economies of large-scale production are less in agriculture than in manufacturing, and there is no guaran tee that the most efficient sized production unit will coincide with the size deemed by political leaders as necessary for effective political control. C O Robert W. Campbell, Soviet Economic Power (Boston: Houghton Mifflin, 1965), pp. 123, 12$, 130. 285 Centralized Socialism Versus Freedom In addition to the purely economic points so far described, there is one mixed economic and non-economic consideration which is widely raised in discussions of centralized socialism. This is the question of individual freedom. The following arguments will be useful in indicating the nature of arguments that have been developed on the subject of freedom under centralized socialism as compared to capitalism. Hayek and other critics of socialism question the genuineness of the socialists' attachment to the ideal of freedom. They claim that though socialist systems wish to promote "the common good," they cannot do so because the means that they adopt, i.e., economic planning, must lead to the opposite to what they want. The reasoning behind this claim is simple: an economic plan cannot be directed toward a goal so vaguely defined as "the general welfare" or "the common good." Its objectives must be described in specific terms in order to determine a particular course of action. In this connection, Hayek writes: The welfare of a people cannot be adequately expressed as a single end, but only as a hierarchy of ends, a comprehensive scale of values in which every need of every person is given its place. To direct all of our activi“. ic ties according to a single plan presupposes that every one of our needs is ranked in an 286 order of values which must be complete enough to make it possible to decide between all the different courses between which the planner has to choose.64 Since no one is in a position to know "everyone of our needs" it follows that the planners themselves must "impose their scale of preferences on the community for which they 65 plan." This scale of preferences naturally supersedes the actual preferences of individuals; people must then take what is planned for them, not what they would like to choose for themselves. Thus, Hayek concludes that freedom of consumers' choice, as embodied in consumer sovereignty, and planning cure incompatible. In addition to deciding what consumer goods will be produced in what quantities, the planners will correspondingly have to decide where and how long individual workers should work, thus restricting freedom of occupational choice. The socialist answer is that planners can effectively direct production in line with free consumer demand. Barbara Wootton states that "the weakness of the thorough going critics of conscious determination of economic priorities is that they constantly compare an ideal, theoretical consumer sovereignty (in which demand corres ponds precisely to desire and all production is competitive) CA °*Friedrich A. von Hayek, The Road to Serfdom (Chicago: University of Chicago Press, 1^45), pp. 42-43. 65Ibid., p. 48. with the actualities of planning in a world of flesh and 66 blood and imperfect human institution.1 1 If the planners have good data concerning population, total consumer income and the pattern of income distribution, and the typical expenditure pattern of consumers in each income grouping, they will be able to estimate with a high degree of accuracy the demand for the various consumer goods to be produced. In regard to criticisms concerning the restrictions on freedom of occupational choice under centralized social ism, Wootton contends that this would not be a serious problem. Indeed, she says that "free choice of employment will never be a reality without planning, since legal freedom of choice is a mockery if economic pressure compels 67 the chooser to accept the first available job." The right of effective choice of employment is thus provided by planning where the number of persons needed in each occupation are indicated, and considerable leeway could be given to individual occupational choices within the global employment requirements. The argument concerning freedom under socialism and capitalism has also included the matter of such basic Barbara Wootton, Freedom Under Planning (Chapel Hill: The University of North Carolina Press, 1945), p. 66. 67Ibid., p. 159. 288 civil liberties as freedom of assembly, freedom of speech, freedom of press, and freedom of arbitrary arrest. For example, it is asserted by Hayek that if the economic life of the individual is to be controlled, it will be necessary 6 8 to control every other aspect of his life. Against this argument, socialist writers claim that there is nothing in socialism that makes it inevitable that personal freedoms must.be limited. While admitting that these freedoms have been severely restricted under Soviet communism, they reject the contention that this one experience justifies 69 the generalization to all communist or socialist systems. The socialist counter-argument is misleading in the view of the writer of this study, because a democratic capitalist country tends to start from a higher plateau of personal freedom than does a socialist system which from the begin ning inevitably involves a higher degree of centralized control. In practice, the gap in personal freedoms between such countries as Russia and the United States is so great that one wonders whether any real convergence in this area between the two countries is likely to emerge. ®®Hayek, op. cit., p. 68. 69por example, see Sweezy, op. cit., pp. 250-251. 289 A Concluding Note This lengthy appraisal brings us to a final ques tion: "Can socialism work?" Schumpeter says in response: 70 "Of course it can." No doubt, numerous problems emerge in the path of centralized socialism in the underdeveloped countries. But when the time is ripe, these problems, as already noted in Chapter III, make the transition to decentralized socialism possible. This new system will inherit certain desirable and undesirable legacies from the previous system. The degree and the impact of these legacies upon the operational working of the new system will depend on the nature of political leadership in these countries. Just as Marx and Schumpeter discuss the transi tion from capitalism to "centralized" socialism, Professor Egon Neuberger discusses the transition from centralized socialism to decentralized socialism via the introduction of the "legacy problem." In this connection, he writes: Marx, Schumpeter, and others have discussed the transition from capitalism to socialism and the legacies that socialism inherits from capitalism. I suggest that now is the time to begin a similar discussion from Soviet-type socialism to a new system, and of the desirable and undesibrable legacies that this system will inherit.71 ^Schuijtpeter, op. cit., p. 167. 71Egon Neuberger, "Central Planning and Its Legacies: Implications for Foreign Trade," in International Trade and Central Planning, ed. Alan A. Brown and Egon Neuberger (Berkeley and Los Angeles: University of California Press, 1968), p. 349. 290 If Lange were to comment on Neuberger*s view, he would simply say "precisely!" Summary Of the central questions by which the Lange model of decentralized socialism were evaluated in this chapter, the major ones were as follows: could and/or would it work? And, if so, how well would it work? As for the first question, there is little doubt that the system is logically consistent and economically operational. The major problems are still motivational and administrative: How are the socialist managers to be enticed to follow the rules? How is the CPB to be trusted not to exceed its functions as described by the model? As for the second question, the Lange model of decentralized socialism has been criticized by centralized socialists, who argue that his model fails to take advantage of the merits of central planning, and suggest that the tendencies toward economic instability in capitalist economies might be found in decentralized socialism as well. In regard to centralized socialism and Lange's postwar model, it would seem clear that it could and would "work." It is "operational" in the Schumpeterian sense of showing not only a logical possibility but also in identifying the techniques whereby this possibility could be actually realized. No doubt, numerous problems 291 would emerge in the path of its development. This is true of all systems and in no way leads to the liquidation of centralized socialism as a vehicle for achieving certain priority goals in the underdeveloped countries. 292 CHAPTER VI THE APPLICABILITY AND RELEVANCE OF THE LANGE MODELS OF CENTRALIZED AND DECENTRALIZED SOCIALISM: THE CASE OF YUGOSLAVIA Introduction Yugoslavia is a country undergoing continuous change in its institutions and economy. Yugoslav economic planning has changed and continues to change as the criteria of its socioeconomic system change. Many changes have occurred in Yugoslavia's politi cal, social, and economic organizations since World War II. With the abandonment of the rigid Soviet type of economic planning or what the Yugoslavs call "administrative socialism," the development of the country proceeded to a "separate path to socialism" or to what has been called "Titoism." This separate path has been constructed by means of decentralization and popular participation at all levels in the affairs of the country. George W. Hoffman and Fred W. Neal aptly summarize these developments when they write that "the Yugoslavs dipped into not only the experience of the French Revolution and the early days of the Bolshevik Revolution, but also American theory and practice. They came up with a system that, as a whole, 293 was new and original including certain institutions held to be 'unique in the annals of practical and economic organization."^ Changes which took place in the Yugoslav economy during 1951 and 1952 created a new institutional setting for economic planning and had to be accompanied by changes in the system and methodology of planning. The law on the planning system, passed in 1951, was the first step in this direction. As a result of this reorganization of the state apparatus for economic management and the introduc tion of workers' self-management in enterprises, the hierarchial system of administering enterprises was abol ished. Political-territorial units, - namely, the commune, the republic, and the federation - became the basic forms of social organization. Among these, the self-governed commune represented the starting poihtt This led to decentralization of management and decision making within the political institutions. In this way, Yugoslavia became a federated socialist republic with a one-party government headed by Communist leaders. The Constitutional Law of 1953, which only modified the 1946 constitution, created forther institutional changes of some magnitude, combining socialism with elements of democracy. Although by no means purporting to establish a ■^George W. Hoffman and Fred W. Neal, Yugoslavia and the New Communism (New York: Twentieth Century Fund, 1962), p. 2l2. 294 political democracy in the Western sense," it did give "legal recognition to the continued process of the 'with- 2 ering away of the state' in Yugoslavia." While Yugoslavia was being decentralized, it was also being industrialized. The overall rate of economic expansion during the years 1952-65 was 9 per cent. The per capita rise in real income was 7.8 per cent. In 1939 some 77 per cent of the population was rural; in 1966 less than 50 per cent. Another remarkable transformation which has taken place in Yugoslavia since World War II is the change in exports from predominantly unprocessed agricul tural products to the highly diversified export pattern of 1966, when 36 per cent of the value of exports consisted of manufactures. After giving the foregoing information, Joel Dirlam claims that "the Yugoslav economy has . .. unquestionably moved out of the 'underdeveloped' class to the developed and is heir to the difficulties that afflict 3 the second, as compared with the first." With the decentralization measures introduced in 1951-52, the process of economic development removed obstacles in the material structure of production which blRcked the further development of market relations. 2Ibid., p. 213. 3 Joel Dirlam, "Problems of Market Power and Public Policy in Yugoslavia," in Comparative Economic Systems; Models and Cases, ed. Morris Bornstein (Homewood, Illinois: Richard D. Irwin, Inc., 1969), p. 237. However, the imbalance created by economic development caused difficulties for the performance of normal market functions. To avoid negative, social, and economic effects, it was felt to be necessary for the state to intervene occasionally. In some periods, imbalances in key sectors led to inflationary pressures, general in creases in prices, and economic instability, which required continuous state intervention. This process continued until, in July, 1965, Yugoslavia introduced an economic reform designed to stabilize its overextended inflationary condition. This reform was essentially formulated in the new constitution of 1963, which was adopted to confirm the principles and enlarge the legal framework of self- government, further decentralize the country along federal lines, and enhance democracy within the socialist system. Action came in the form of various measures designed, as already noted, to stabilize the economy, to check infla tion, to correct the unfavorable balance of trade, to get idle capacity in industry going, to reduce unemployment, to raise standards of living, and to find a form of govern ment able to give the country a consistenteeconomic policy. These short-term objectives were also linked to some longer term measures of structural change in the economy such as: to overhaul the whole price system, to revise growth and investment policies, to make Yugoslav products competitive in international markets, and to liberalize 296 foreign trade in order to remove a continual deficit. The policy of liberation in foreign trade included the intro duction of a new exchange rate for the dinar and conditions to make possible the convertibility of national currency. All quantitative restrictions are to be removed; custom duties are to be reduced; and a reserve fund or foreign currency is to be gradually built. These developments, according to Rudolf Bicanic, a prominent Yugoslav economist, have led to the obsolescence of the economic system intro duced in 1954 and to the adoption of the new constitution of 1963 which "laid down new principles for the economic and political system, the main aim of which could be described as to base the whole economy and society on 4 workers' management." Today, Yugoslavia is the only true example of a decentralized socialist economy which combines public ownership with decentralized resource allocation through markets and prices. As a result, the organization, operation, and performance of the Yugoslav economy are of great interest not only to economic theorists and students of comparative economic systems, but also to policy makers both inside and outside the Communist orbit. The Yugoslav experience has been followed closely in many economically 4 Rudolf Bicanic, "Economics of Socialism in a Developed Country," in Comparative Economic Systems: Models and Cases, ! p. 224. 297 underdeveloped countries committed to government ownership and entrepreneurship but aware of the enormous difficulties of comprehensive economic planning. For these reasons, it is interesting to compare and contrast the postwar Lange model of centralized and decentralized socialism with the Yugoslav economic practice. In this chapter, it will be suggested that Yugo slavia has devised its. own answers to the problems, such as imperfect competition and managerial incentives, raised by the critics of the prewar Lange model of decentralized socialism. Yugoslavia has also had to deal with problems of foreign trade and agricultural organization not consid ered by Lange's prewar model. One can perhaps posit that the Yugoslav economy offers a unique and original example of decentralized socialism, adapted to Yugoslavia's parti cular economic, political, and cultural conditions. The purpose of this chapter is to analyze specifi cally the main features of the contemporary Yugoslav economic systems, to assess the relevance of Lange's writings (prewar and postwar) to the development of the Yugoslav economic practice, and to appraise critically some of the major economic problems which have historically emerged in Yugoslavia. Before turning to an examination of the specific features of the Yugoslav economic system, however, it will be helpful to give an overview of the evolution of the Yugoslav economic system. 298 Evolution of the Yugoslav Economic System; An Analysis of Policy Interactions The Planning Methods In the development of the economic structure of Yugoslavia, three stages of economic planning can be sharply distinguished: first, from the end of World War II to 1950; second, from 1950 to 1965; and third, from 1965 until today. 1945 to 1950. In the first period, Yugoslavia utilized centralized socialist planning. In this period of 5 development, the following steps were undertaken: 1. Confiscation of foreign holdings, national ization of important industries, and emer gence of state ownership of the means of production. 2. Collectivization of agriculture. 3. Centralization of planning: regulation of prices, output, wages, distribution of in come, profits and investment. From Lange's point of view, we can say, by inference, that this process was a necessity, because Yugoslavia was an underdeveloped country, and therefore, the high priority gdals of large-scale industrialization and economic develop ment required centralized planning. Before the war, with an annual income of $120 per capita, Yugoslavia was at the bottom of the European scale. The distribution of the fsavka Dabcevic-Kucar, "Decentralized Socialist Planning: Yugoslavia," in Planning Economic Development, ed. Everett E. Hagen (Homewood, Illinois: Richard D. Irwin, Inc., 1963), p. 189. 299 labor force and the share of industry and agriculture in the national income were typical of a state of economic underdevelopment.6 In this way, centralized planning was adopted due to the perceived imperative necessity of achieving certain priority goals; and in this process, the state was the "only factor which was capable of organizing economic life, particularly actions and measures designed to speed up development and rapidly change the country's 7 economic and social structure." To achieve these priority goals, the centralized system had just one objective: to maximize investment while fixing an order of priority for the means of production over consumption, heavy over light, industry over agriculture. In short, the first period of economic planning was the period of centralistic and administrative management of the economy. But, as the economy developed, the deficiencies of centralized planning became more evident. In general, these problems came in two forms. First, centralized planning became gradually less able to correct discrepan cies or utilize advantages which the central plan could not foresee. Second, there began a problem of insufficient 6Ibid., pp. 185-186. ^Borivoje Jelic, "Characteristics of the Yugoslav Economic Planning System," Socialist Thought and Practice (Beograd, Yugoslavia: Jugoslavija, i~96l)7p* 3. 300 initiative as central planning continued. Also, central planning led to bureaucracy which appeared as an obstacle in handling administrative procedures. In svim, the Yugoslav planners considered that sufficient industrialization had been achieved to experi ment with methods of decentralization. Economic and political leaders decided that Yugoslavia could develop a "true socialist democracy" and was thus ready for the "withering away of the state." This was, of course, contrary to the Marxist-Leninist dogma which holds that "withering away" could only take place after all classes were abolished and socialism was established. Consequently, the effort of democratization of the Yugoslav socioeconomic system began in 1950 through the passage of a law, giving the workers the right to manage their enterprises through the elected Workers' Councils and Management Board and thus "social ownership" was established. 1950 to 1965 In this way, the second period of planning began in 1950, in which a shift occurred to a new and more flexible economic system based on the conception that social and economic progress is to be promoted by "social management" rather than governmental management and by emphasis on economic incentives rather than on administrative instru ments. In this new system, the workers of each enterprise biennially elect a workers' council which has the 301 responsibility for operating the enterprise. The manager of the enterprise is selected in a public competition by the workers' council, with approval of the legislative body of the commune. A management board selected by the council from among its members assists him. These changes have had important implications for the planning system. Experience has shown that the planning system need not aim at an exhaustive prescription | of every detail of economic expansion. This is due to the ! fact that at a higher state of development, namely, a stage which is characterized by high rates of economic growlji and a large total output, there is a need for consumer | sovereignty to play its role in regard to demand. This view is not only advocated by Lange in his postwar model, I but also by Yugoslav theoreticians. Thus Stanovink states that the "maximum increase in national income is not achieved by mere increase in quantity of production but by g the actual satisfaction of demand." The decentralized stage gave greater attention to consumption, while the priority to growth continued. The order of priorities, however, changed. After 1955, priority was mainly given to light and consumer goods 0 Janez Stanovink, "Planning Through the Market: The Jugoslav Experiment," Foreign Affairs, An American ! Quarterly Review, XL (January, 1962), p. 3. industries. These industries were counted on to provide 9 the greatest savings in the shortest time." So far, what we have established in this chapter is an impression that there is a conformity between Lange's postwar analysis concerning the transition from centralized planning to decentralized decision making and the Yugoslav historical experience of economic development which was based on complete centralization before 1950 in order to break the vicious circle of underdevelopment and a gradual decentralization of planning in the 1950's, and the country moved into a higher stage of socialist development. In the following development, the focus of attention will be placed on a third stage of development. 1965 and After The third period of planning began in 1965 with the economic-political reform to strengthen the economy and fight government bureaucracy. "The aim now was to depoli- ticize decision making in business management, not only in regard to current operations but also in the field of investment and with regard to branch size, location, and financing."^0 The dominant theme of the reform was an emphasis on further decentralization of economic controls, and a further exposure of industrial enterprises to Q Bicanic, op. cit., p. 228. 10Ibid., p. 225. 303 competitive domestic market forces in order to increase efficiency and thereby cut production costs. These moves have naturally brought the Yugoslav system closer to the Lange model of decentralized socialism.^ More specifi cally, the reform called for the following changes: 1. Devaluing the dinar to a new parity of 12.5 to the dollar and extending partial conver tibility between the dinar and the dollar until the expected attainment of full conver tibility in 1970. 2. Cutting by more than 50 per cent the average rate of customs duties on imports, revising the system of tariffs differentials, and gradually eliminating most import and export restrictions. 3. Curtailing governmental controls of invest ment and giving the banking system greater authority over investment. 4. Changing the tax laws to fit the increased emphasis upon market-oriented controls, abolishing the heavy local taxes on enter prises ' earnings, reducing interest rates from above 6 to about 4 per cent, and re placing a general turnover tax with a sales tax on consumer goods purchases. 5. Suspending subsidies in the form of controls, led prices for all but a few commodities. These measures, as implied from Bicanic's dis- cussion, are to fuse enterprise, in a Western sense of the j term, with Yugoslavia's brand of socialism, in the hope •^Certain reservations still remain to be explored at the end of this chapter upon comparing Lange's theoretical writings with Yugoslav economic practice. 304 that a progressive economy might rest basically on free- market forces. They sure also to link the level of living to that of productivity, and to raise both through the principle of selective growth. Property Relations In the centralized system, public ownership of the means of production was in existence. Everything became a state property except small-scale handicrafts. A drive to nationalize and collectivize agriculture took place rapidly. In the decentralized system, as already noted, all nationalized property remained, but its character changed from state to "social" property. This led to the transfer ence of management from the hands of the state administra tion over to the Workers' Council, whose power gradually increased. In 1953, the forcible collectivization of peasant property was discontinued. This is in sharp contrast to the Lange position in his postwar analysis, as he failed to discuss the form of ownership in agriculture in the decentralized stage of socialist economic develop ment . The recent reform faced the following situation: the departure of labor from rural to urban areas had increased more quickly than the effective demand for labor in the socialized sector. This led to three undesirable 305 results: considerable unemployment, a reduction in labor productivity, and an increase in the cost accompanying urbanization. Also, a gradual increase in imports of food for the growing industrial population and for millions of tourists caused the demand for agricultural products to outrun what the socialist agricultural sector and existing independent peasant production could produce, thus leading to an increase in prices of agricultural products. In effect, a change came in the policy toward the unused capacity of peasant holdings. "The growing tourist business argued in favor of further use of the private sector in the catering trade. The Position of Enterprise Under the centralized system, enterprises were totally controlled by state administration. Under this framework, all materials were supplied to them, prices and costs were determined by ministries, sales were turned into orders for allocation, and finally, all profits were paid into the state budget and all deficits were in turn covered by this budget. In decentralized systems, the enterprises became autonomous units with freedom to operate their own activities according to their own decisions and risk. 1 2 Bicanic, op. cit., p. 226. 306 This provided a market for Yugoslav firms in the following senses: they sold their products on the market, bought raw materials, decided on the employment of labor, and made their own plans for borrowing for the purpose of expanding their operation. Gradually, the worker-managers in Yugoslav firms started to operate the country's socialized enterprises in their own material interests. These inter ests are best served by the so-called "income-maximizing behavior" of individual worker-managers. For such behavior, they had to cover costs by proceeds from the sales in the market. If successful, they shared the benefits with the social community (federation, republic, and commune). As to the forms of this sharing, Bicanic states that they "underwent several changes: from profit sharing to income sharing, until finally the wage system was abolished and instead the workers' councils were given the right to dispose of part of the income of the enterprise allocated to its funds, while another part of the income was allocated 13 to the workers as their personal income." What remained centralized were the macroeconomic decisions about invest ment resources and the founding of new enterprises. What are some of the implications of the income- maximizing behavior of the Yugoslav firms? Benjamin Ward has some reservations about this behavior: 13TK., Ibid. 307 At first glance the fact that Yugoslav firms operate in a market would seem to be the most important fact determining their behavior. However, this need not be the case; in fact I think it is easy to exaggerate the necessary causal impact of the market environment on firms in general.I4 Herbert Grubel, in a discussion on Ward's thesis, states that Ward is in essence relating his argument to the problem of decision making in the Yugoslav firm for factor allocation. In view of Grufcjel, the decision making process in the Yugoslav firms has become a confusing one because of a basic dilemma: "the institution of workers' councils and the public ownership of the means of capital is incompatible with the objectives of efficient allocation 15 and economic growth." In defense of this proposition, he compares the operations of the capitalist firm as envisioned by the classical model with that of the Yugoslav firm. The former operates in competitive markets under certainty, thus yielding one optimizing solution, because production function and price parameters are known. In a dynamic world with unknown constraints, however, someone has to take a chance on the outcome of future events. This role 14 Benjamin Ward, "The Nationalized Firm in Yugoslavia," American Economic Review, I)V (May, 1965), pp. 65-66. 15Ibid., p. 77. 308 is assumed by the owner of the firm's equity. It should be noted that while conditions are uncertain in the future, the enterpreneur in the capitalist model nevertheless bases his decision on prices given to him as parameters, i.e., they are beyond his control, including the price of capital. By contrast, the Yugoslav firm was organized in line with a capitalist firm in order to derive the benefits which decentralized decision making and scarcity prices have on the efficiency of resource allocation and maximi zation of consumer demand. The important difference is, however, the public ownership of the means of production. Grubel's argument is basically two-sided. Theoreti cally speaking, he sees no contradiction between the static allocation of resources and public ownership of the means of production in Yugoslavia. In this regard, he writes: Thej-.power to make input and output decisions must ultimately be tied up with the ability and willingness to accept the consequences of a wrong decision in a meaningful way. If we assume that prices of factors and products are competitively determined, then it follows that the capital invested in the enterprise carries this burden, just as in the capital ist firm. Therefore, the firm's decision making authority should be invested in the hands of a government representative, whose pay (and social status,etc.) should be based on his ability to make the proper allocative decisions and maximize the value of the enterj-r prise for the government. It is quite clear i : i that such an institutional arrangement leads to statically efficient allocation.16 16Ibid., p. 78. 309 Ideologically speaking, however, Yugoslav firms are not supposed to be run by state-appointed managers. Instead, workers' councils are in a position to make basic input-output decisions. Since they have the power to do so, they are faced with the insoluable conflict between looking after their own interests and looking after those of the state. These two levels of interest, Grubel says, "do not coincide; therefore, efficient opera tion of the firms requires a social conscience on the part of the workers as decision-makers which, the record 17 shows, they do not possess." As far as the recent reform is concerned, it can be described as an attempt to withdraw somewhat the tutelage to which enterprises had been subjected and to give more play to market forces. More specifically, under this reform, a bigger share of national income was allocated to the enterprise - i.e., 70 per cent for investment and 18 workers' personal income. Also, fiscal burden on the enterprises was diminished by certain tax reforms such as the abolition of the income tax on enterprises and reduc tion in capital tax. Capital Market; Policy Reforms In the system of centralized socialism, saving and investment decisions were done by top political 1 " 7 18 i/Ibid. Bicanic, pp. cit., p. 226. leaders in the hierarchy. All savings were incorporated into the state budget. In the decentralized system, a novel system of investment allocation emerged: first, investment funds were separated from the state budget, i.e., the bulk of investment savings was collected into a general investment fund by the central Investment Bank; second, an attempt was made to isolate the macroeconomic decisions of inter sectoral allocation by plan from microeconomic decisions regarding the intrasectoral allocation by a market mechanism. In regard to the former, the decisions in regard to total investment and the allocation of invest ment funds among sectors of the economy were made by the central authorities. Needless to say, the important role played by the general investment fund in the implementation of the planned volume and composition of investment is indicated by the fact that projects of national importance ejs well as those needed to speed up the economic develop ment of the country's underdeveloped areas are financed 19 exclusively out of this fund. As far as the latter decisions are concerned, i.e., those which have to do with the microeconomic allocation of investment funds among forms within a sector, the system operated as follows: in 19 Branko Kubovic and Vidosa Trichovic, National and Regional Economic Planning in Yugoslavia (Belgrade: Federal Planning Bureau, 1961), p. 16. 311 order to obtain investment funds for new projects, firms must apply to the Investment Bank for a substantial part of such funds. These funds are marked for the various sectors of the economy on the basis of sector projections contained in the intermediate economic plan. The Invest ment Bank, in accord with the social plans, announces auctions for accepting bids from the firms for the marked funds in order to achieve special goals of the plan. Obviously, these funds cannot simply be given to those enterprises that are willing to pay the highest rate of interest.2® Instead, the Investment Bank grants these funds to applicants with projects which are based on such economic criteria as the profitability of the project, the amount of money needed per unit of capacity, the length of borrowing period, and the balance-of-payment effects of the project. 20 Yet, "it was believed in Yugoslavia from December, 1953, until sometime in 1955 that the competitive rate of interest was the best possible device for the allocation of investment funds from the general investment fund ... Yugoslav economists believed that higher interest rates offered should indicate higher prospective rates of return ; on investment . . . The high expectations of the system in which the competitive rate of interest was the alloca tion of funds among competing users within the industry . . . turned to bitter disappointment. In order to get loans Enterprises tended to offer higher rates than they could reasonably afford, so that their applications had a better chance to be intramarginal . . . Since this behavior: was more or less common to all enterprises the result was that the marginal rate of interest rose too high relative to the expected net returns." Svatozar Pejovich, The Market-Planned Economy of Yugoslavia (Minneapolis: Univer sity of Minnesota Press, 1966), pp. 19-20. 312 Such operation, Egon Neuberger believes, is £ar from achieving a great deal of success. The basic reason for this lack of success is the absence in the Yugoslav situ ation of two necessary conditions for the action system: "a price system with a high degree of rationality and full confidence in the judgment and integrity of managers of 21 enterprises on the part of the central authorities." Nonetheless, he contends that the new system of investment auction is an improvement over the allocation which took place under the previous centralized system. The recent reform gave more autonomy to enterprises in regard to their investment decisions. The banks are to provide funds and credits on the basis of business princi ples. Consequently, the general investment fund was discontinued in 1965 and its function was taken over by the investment banks. Foreign Trade From a complete state monopoly of foreign trade, Yugoslavia moved to an open economy in three stages. The centralized system was a system of autarky^ or self-sufficiency. It looked upon foreign trade as a necessary evil which had to be accepted until everything was produced at heme. "This original tendency to autarky 2^Egon Neuberger, "The Yugoslav Investment Auctions," Quarterly Journal of Economics, X (February, 1959), p. 114. was probably strengthened by the blockades during the 22 revolutionary war and by the size of the Soviet Union." Later, when planning was introduced, self-sufficiency was even more desirable because the Yugoslav leaders were ambivalent about the desirability of introducing market elements into the foreign trade and the exchange system - as it was difficult for them to handle foreign trade. The decentralized system introduced commerical inde pendence of enterprises on foreign markets and led Yugo slavia to turn toward the nations of Western Europe and the United States for trade and economic aid, which were vital to the continuation of her economic growth. While the volume of foreign trade began to increase rapidly, "the balance of payment problem, the need to meet obligations under bilateral clearing agreements, and the desire to keep some of the crucial levers of control at the central level all militated against complete abandonment of the command economy . . . elements in foreign trade and foreign ' .r exchange."23 Thus, while imports increased, not balanced by adequate exports, multiple rates of exchange were introduced to cover the gap. 22Ljubo Sire, Economic Devolution in Eastern Europe (New York: Fredrick A. Praeger, Inc., Publishers, ld6d), p. 104. 23 Egon Neuberger, "Central Planning and Its Legacies: Implications for Foreign Trade," in International Trade and Central Planning, ed. Alan A. Brown and Egon Neuberger (Berkeley and Los Angeles: University of California Press, 1968) , p. 373. 314 The reform of 1965, while providing some necessary changes (devaluation, establishment of a uniform exchange rate, a policy of deflation, and price adjustment), did not result in an immediate transition toward a free foreign 24 trade and exchange system. The hope is, however, the acceptance of a policy of long-term structural integration of the Yugoslav economy into the world division of labor, in place of short-term commercial operations. An Analysis of Specific Features of the Yugoslav Economic System In order to be more systematic in our approach, we may now examine the specific features of the Yugoslav economic system in terms of the criteria used in explaining the prewar and the postwar Lange models. Level of Economic Development Yugoslavia is now a developed country with a per capita income of $500 as of 1966.25 Resource Base The resource base used to be landistic, but has rapidly developed into a capitalistic one. Before World War II, 75 per cent of the country's population or 11,600,000 people were engaged in agriculture. At present, ^ Ibid. 2^Bicanic, op. cit., p. 233. 315 less than half of total employment is engaged into agri culture.26 Ownership and Control of the Means of Production Ownership. Private ownership is held in agriculture and handicrafts. In agriculture, some 90 per cent of the land under systematic cultivation is owned by independent peasant proprietors, who number over 2.6 million. The remaining 10 per cent of the land is under public owner ship.2^ Private enterprise is limited to small-scale production where the number of workers hired may not be more than five and to agriculture where ten hectares or 28 twenty-five acres is the maximum that one owner can hold. The role of the agricultural cooperatives is inter esting and important. They enable individual peasants who privately own their land to utilize socially owned mech anized farm equipment and modern facilities. In the socialized sector, which consists of industry, i construction, and partly agriculture, "social ownership" of the means of production exist. "Social ownership ... 26 1 George Macesich, Yugoslavia; The Theory and Practice of j Development Planning (Charlottesville: The University of Virginia Press, 1964), pp. 163-164. i 2^J. M. Fleming and Viktor R. Sertic, "The Yugoslav Econo- mic System," Comparative Economic Systems: Models and Cases, p. 234. 28Ibid., p. 232. 316 refers not to state owned and operated enterprises but to enterprises whose management is entrusted to working collectives of the producers (the workers) themselves as 29 trustees for society." Enterprises don't own "resources." This is evident by the fact that these enterprises can dispose of their share of capital resources by investing them in other enterprises, but cannot sell their capital and use the funds to increase the personal income of the workers. Also, sales and transfers must take place within the socialized sector. Additionally, enterprises cannot dispose of their total income or earnings. If they could, it would be equivalent to a "collective private ownership of the means of production by the working collective," 30 states Leon Gerskovic. Branko Horvat discusses "Social Capital" in which the difference between collective or private ownership by the 31 enterprise and social ownership is elaborated. After the necessary capital is provided by the bank (if the required criteria have been fulfilled) and the; factory is built, it is handed over to the collective. 29 Dabcevic-Kucar, op. cit., p. 183. Leon Gerskovic, Social and Economic System in Yugoslavia ! (Beograd, Yugoslavia: Jugoslavia, no date), p. 27. 31 Branko Horvat, Towards a Theory of Planned Economy (Beograd: Yugoslav Institute of Economic Research, 1964), pp. 219-224. 317 The capital loan is not repaid in the traditional way, as in private enterprise or if the workers' council owns the enterprise. In the traditional sense, the debt would be gradually repaid with interest and if the fixed capital has not become obsolescent, it is owned by the enterprise. For the case of "social ownership" the enterprise per*-, mantently pays interest on the fixed capital measured by • t its productive capacity, "and pays rent if interest (due to diminishing marginal productivity of investment) does 32 not exhaust net revenue." In those cases where enterprise internal funds are used to finance an investment the firm must pay the bank interest on the capital invested at the given rate. In buying and selling fixed assets, the following procedure is adopted: upon selling a piece of equipment by the enterprise, the proceeds are paid into the depreciation : account being equal to all depreciation quotas which are as yet unpaid. The positive or negative difference is-made up out of the wage and reserve funds. The enterprise buying the equipment continues paying depreciation to the selling enterprise and interest to the bank until the machine is scrapped. In other words, the bank merely registers the transaction rather than intervening directly, • and transfers the capital debt from the seller to the buyer. 32Ibid., p. 221. 318 "Social ownership" differs from state ownership in that the enterprise may appear against the state as a party in court. While the state, through appropriate government bodies, provides some investment funds, it does not own the capital resources nor does the surplus or profit belong to the state. The enterprise, after meeting legal financial obligations to the community as a return to the "socially owned" means of production, determines the allocation of surplus which belongs to the enterprise. Control. As far as the private sector is concerned, control is exercised by the owners. With regard to the cooperative sector/ Hoffman and 33 Neal mention that there are three types of cooperatives. 1. Cooperatives to supply services and technical assistance to individual farmers at special prices, usually on credit. If the cooperative buys the whole crop, the farmer must follow cooperative instructions on how to till his land. Cooperative services include the supplying of fertilizers, selected seeds, and so forth. 2. Cooperatives may participate either fully or j partly in various production processes and in return receive a fixed share in kind of the individual peasant's profit. 33 Hoffman and Neal, op. cit., p. 284. 319 3. Cooperatives may produce jointly with the private peasant, with profits shared in proportion to the contribution made by each partner. With regard to the socialized sector, it should be mentioned that the role of social ownership is of crucial importance in Yugoslavia. "Once an enterprise is estab lished and its working force recruited, it is put under the control of a Workers' Council representing all its workers. An Executive Board (elected by the Council) and a Director, the legal representative of the enterprise (appointed by agreement between the Workers' Council and the Commune), are responsible for the implementation of the Council's 34 decisions and for day-to-day management." While the Workers' Council controls output, prices, and some part of distribution of income of the enterprise, there is also social control over the enterprise. Such control can be seen through regulations related to the enterprise income, public control of bookkeeping, control over patent supervision, and monopoly. Socialized banking controls investment decisions in agreement with the Social Plan. Locus of Economic Power On the production side of the economy, the locus of economic power is dispersed in (a) the workers, 34 Fleming and Settic, op. cit., p. 232. 320 (b) government bodies, and (c) small-scale owners in crafts and farms. On the consumption side, consumer sovereignty prevails, and in this way, consumers take part in the decision-making process. Motivational System In recent years, there has been a tendency for the motivational system to become substantially more market oriented. Such orientation has also been modified by the introduction of a "merit" criterion, namely, the beginnings of stimulus from work as a creative process, and the promotion of a relationship between individuals and collective interest. In the socialist sector, each worker seeks to maximize his income through increasing his own efficiency. Since income is determined neither by private ownership nor by state ownership, it should be obvious that the worker is inclined to develop his creative abilities. On the other hand, the relationship between individual and collective interest is established through the mechanism of workers' self-government. In the private sector, profits are maximized. The agricultural sector, on the other hand, is motivated, through the services of the cooperatives, to increase productivity and to increase its own profits. 321 Organization of Economic Power; Centralization versus Decentralization The organization of economic power is a combination of consumers' and planners' sovereignty. 35 Decentralization exists in the following cases: (a) Consumers and workers have freedom of choice in consumption and occupation. (b) Prices of consumer goods, with some exceptions, are determined by market forces. (c) Workers' Councils of socially owned plants can make decisions concerning prices, output, quality, and investment within the limits given by governmental bodies. Freedom for similar decisions is also given to the private managers of privately owned enterprises and farms. (d) The enterprise establishes its own scale of wages based on the prospective profits of the enterprise and on the desired allocation of these profits of the enterprise between personal incomes and the funds of the enterprise. However, there are minimum wages which are set by the State. 3 6 Centralization exists in the following cases:'’0 i (a) The type of planning method socially conditioned by the level of consciousness, cultural development, and efficiency of the working class in Yugoslavia is called 36 Ibid., pp. 232-239. Macesich, op. cit., pp. 50-68. j 322 global planning. This method of planning refers to determination of aggregate macroeconomic variables such as employment, investment, consumption, and government expenditures rather than the detailed microeconomic proportions of such variables. As such, this centralized planned system exists for development for the federation, the republics, the districts, and the communes. (b) In order to fulfill the aims of the economic plans, there are at least two types of calculations to be considered. Economic Calculation. According to this criterion, it is decided by the Federal Planning Bureau in cases of the Federation or by any other similar agency in the other levels of government that the formulated economic plan is destined to stimulate different groups in the economy. Financial Calculation. According to this criterion, plans are formulated within the limits set by financial sources such as taxation of the firms and individual incomes. Social Processes for Economic Coordination At present, Yugoslavia is one of the few countries that can claim relative success in having carried out its development programs via a synthesis of economic planning and price system. More specifically, there are four 323 processes for economic coordination in the Yugoslav planned market economy. Price Systems This system includes the following four markets: (1) The price system performs its functions in the consumer goods market. It determines the volume, quality 37 of output, and prices. (2) The market for capital goods is determined lay allocation of investment funds. But, these investment funds are not rationed by an equilibrium interest rate. Rather, "the usual technique for distributing investment funds is for the Investment Bank to publish statements at intervals regarding the purposes for which loans will be available, and to invite bids from investors, i.e., from local authorities so far as the setting up of new enterwr..-.^ prises is concerned. Bids are then scrutinized, and an allocation of funds is made .... In inviting bids and in deciding how much is to be allocated to different branches of the economy, the Investment Bank is guided by the central investment program outlined in the Social 38 Plan." ^Price ceilings are applied to materials in short supply. They are also set locally for house rents and for utili ties, such as public transport. •^Fleming and Sertic, op. cit., p. 244. 324 (3) With regard to land and other natural resources; market forces are weak. (4) In the labor market, each enterprise estab lishes its own scale of wages based on work performed, productive efficiency and a piece-rate system. These wages and salaries are paid to the workers as a compensa tion for their work in the firm, representing costs to the enterprise and excluding profit sharing of the workers. But, "the wage bill is an independent variable not proportional to the turnover of the firms in goods and services, because the recruitment of the personnel and especially their dismissal is not so elastic as to keep 39 up with changes in turnover." The implication of this statement confirms the idea that the workers' compensation is not a "wage," because they are not formally hired by managers or owners of means of production and are them selves managers. Therefore, what they earn is an income or a residual which is distributed according to the criterion "to each according to his labor." Bureaucratic or Hierarchial System. Prices in Yugoslavia, for the most part, are freely determined by i 39Rudolf Bicanic, "Interaction of Macro- and MicrosEconomici Decision in Yugoslavia, 1954-57," in Value and Plan* Economic Calculation and Organization in Eastern Europe, ed. Gregory Grossman (Berkeley and Los Angeles: University | of California Press, 1960), p. 351. 325 demand and supply on the domestic market, but the supplies and prices are very much influenced not only by domestic turnover and sales taxes but also by instruments of foreign trade policy, such as custom duties, export subsidies, export restrictions and Other similar types of control. These restrictions are imposed by authorities at each level of government in an attempt to correct the prevailing price distortions. As a result, it would be correct to argue that both consumers' and planners' sovereignty exist. While the autonomy of individual firms is maintained, plans are coordinated cooperatively with socio-political authorities in the commune up through the districts, republics, to the Federation. Democracy or Polyarchy. Many changes have occurred in Yugoslavia's political and social organization since 1950. These changes reflect the development of the country's "separate path to socialism" or what has come to be called "Titoism." This separate path is constructed by means of "decentralization and popular participation" at all levels in the affairs of the country. The Yugoslavs believe that it is only by such means that a country can develop "true socialist democracy." This refers to the country's unique system of workers' management which was put into effect with the passage of the Basic Law in the 326 Management of Enterprises by the Working Collectives on June 27, 1950, by the People's Assembly of Yugoslavia.^ This law transferred the operation and management of all factories and of all economic enterprises in general to the persons employed in such enterprises. The law, with its subsequent amendments, is based on the principle that, although an economic enterprise is public property, it is managed on behalf of the community by the firm's employees. Bargaining System. This model is based on the idea that trade unions exist in the Yugoslav economy not for the purpose of protecting the economic interests of the workers, but for the purpose of supplementing the general system of workers' self-government. According to law, the trade union in an enterprise is empowered to propose candidates to the workers' councils, to carry out decisions reached by the director, the workers' management, and other exec utive bodies, to propose dismissal of inactive or irresponsible members in any of the workers' management bodies, and to propose the convocation of the workers' council. Moreover, the trade union has considerable influence on the pay policy of the enterprise and on actions taken to ensure the health, education, and safety of employees.^1 Thus, the role of the League of Communists, a local trade organization, in an enterprise is essentially educational 40 4i Macesich, op. cit., p. 69. • Ibid., p. 76. 327 and persuasive in coordinating the individual interests with the general interest. Distribution of Income and Wealth There is a greater equality of income based on the fact that income is not correspondent with property since private ownership does not prevail. On the other hand, greater equality of income is obtained in the Yugoslav economy due to the existence of the unique system of workers' self-government. However, distribution of income i according to the principle "from each according to his ability; to each according to his work" would result in the inequalities in skills, education, et cetera. Milentije Popovic argues that the principle of "distribu tion according to "need" or "principle of mutual help" in the sphere of community or social services be added to the foregoing principle.42 Lange and Yugoslav Economic Practice Although, according to some Yugoslav economists, the Yugoslav planning system is "self-generated," i.e., breated on the basis of the specific Yugoslav conditions, its development confirms some general ideas and solutions j . . . 42Milentije Popovic, "Standard of Living and Distribution of Income According to Work,",Yugoslav Life (May-June, 1964), p. 5. ' 328 to which Lange gives a substantial amount of emphasis in his analysis of the relationship between plan and market in socialism, and which is valuable from the viewpoint of the empirical verification in the Yugoslav economic prac tice. One Yugoslav economist expressed this view by saying that "the Yugoslav planning system which was applied after the introductionnof workers' self-management, according to some of its characteristics went consequently along these solutions (as well as faults) which were met by some authors of the so-called 'competitive solution' some ten to twenty , , 4 3 years ago." The notion, that Lange called "the minimum condition of palnning" has been accepted by the majority of Yugoslav economists both in theory and practice. Any' Yugoslav study on problems of planning start from the same platform, thus stressing that the "national economic plan" must include two things at least: (a) the distribution of national income between accumulation and consumption, and (b) the distribution of investments between different sectors of economy. For (a) determines the general rate of economic growth, and (b) determines the direction of growth. Besides, Yugoslav economists introduce another important proportion into the "minimum conditions" of planning, i.e., ^3Broivoje Jelic, "The Planning System in the Yugoslav Economy," Socialist Thought and Practice (Beograd, Yugo slavia: Jagoslavija, 1962), p. 42. 329 the relationship between the national economy and world 44 market, which Lange did not include. The other aspect of planning, where a greater simi larity between Lange's ideas and Yugoslav planning doctrine exists, is that of the concepts of planning as an evolu tionary process whose methods and instruments gradually develop and change according to the degree of the develop ment of the material, organizational, and subjective factors. Thus, as can be seen from the Yugoslav experience, the first period of.planning from the end of World War II to 1950 was based on centralistic and administrative procedures in an attempt to bring about a high level of economic development. As the economy gradually moved into this level, decentralized planning methods were adopted in the second period of planning which began in 1950 and has continued until today. As a result, it is possible to say that at an early stage of socialist economic development, a high degree of centralization is needed in order to achieve certain priority goals such as large-scale indus trialization and rapid economic development; but at a later stage, there will be a need for decentralization to attain economic efficiency. i So far, what we have established is a conformity that exists between Lange's position on the methods of 44Ibid., p. 146. 330 centralized planning and that of the Yugoslav planning practice. Meanwhile, contemporary Yugoslav economy resembles the postwar Lange model of centralized and decentralized socialism in at least two respects. The first similarity is concerned with the public ownership of the means of production. Lange's identifi cation of the type of socialist economy he had in mind is an important assumption in his model of decentralized socialism. According to this assumption, a socialist economy is one which is characterized by public ownership of the means of production. Although Lange did not specify the form of this ownership, i.e., state, collective, or social, it is apparent from carefully reading his analysis that by public ownership of the means of production, he meant most likely a state ownership. As far as a type of owner ship other than private is concerned, there is obviously a similarity between Lange's model and the Yugoslav economy. But, since in 1950, a shift occurred from the previous centralized system to a new and more flexible economic system in which "social ownership" was established, it is possible to say that Lange's criterion of state ownership of means of production does not correspond closely to the present situation in Yugoslavia. In the "socialized sector," which consists of indus try, construction, and partly agriculture, "social 331 ownership" of the means of production exist. This refers not to state owned and operated enterprises but to enterprises whose management is entrusted to working collectives of the producers (the workers) themselves as trustees for society. There is, however, private owner ship in small scale production in agriculture and handi crafts. The second similarity is connected with the organi zation of economic power in the Yugoslav economy. The fact is that there is a combination of consumers* and planners' sovereignty - as was previously mentioned in discussing the specific features of the Yugoslav economic system. Decentralization exists in certain cases; while centralization works in other cases. There is, indeed, conformity in these criteria and the Lange model of centralized and decentralized socialism, with some reserva tions which will be discussed in a later section. At this juncture, it may be said that the Lange model corresponds with the following methods practiced by the Yugoslav economy in its synthesis of price system with economic planning. (1) Decentralization exists in the following cases: (a) Consumers and workers have freedom of choice in consumption and occupation. (b) Prices of consumer goods are mostly determined by market forces. 332 (c) The enterprise establishes its own scale of wages based on the prospective profit of the enterprise and on the demand allocation of these profits of the enterprise between personal incomes and the funds of the enterprise. (2) Centralization exists in the following cases: (a) On a macroeconomic level, there is global planning in Yugoslavia. This method refers to determination of fundamental proportions of such aggregate variables as Investment and Consumption, etc. Also distribution of Investment within the different branches of the economy is determined by this method. (b) A financial plan is also designed in order to allocate the financial resources needed for different investment projects. Besides the very important concepts and ideas about centralized and decentralized planning with which there is agreement between the Lange model and the Yugoslav economic system, there are at least four differences between his thoughts and those of the Yugoslav practice. First, the Yugoslav economic system gives greater emphasis to the worker councils which play a major role in enterprise management. In doing so, the Yugoslav doctrine gives a great deal of importance to the significance of the workers' self-management, and, thus, to the system of planning based on more decentralized decisions. Lange considers the problem of decentralization more restrictive- ly as being a purely economic-technical one. He says that "economic planning can be decentralized if it is possible, 333 to offer more economic stimulus which can ensure that decisions in decentralized units are equal to those which would be centrally made. Secondly, economic planning must be decentralized in all cases in which the decisions centrally made are late in reacting to the actual situa tion."45 In the above criteria, Lange can be criticized on two grounds. First, Lange ignores the political side of decentralization. It is only by such means, argue the Yugoslavs, that a country can develop "true socialist democracy," which can be promoted by decentralization and participation at all levels. This refers, in the economic sphere, to the workers' self-management in the firm through Workers' Councils and Management Boards, mainly in the communes. Within the socioeconomic system as a whole, emphasis is on self-government in the local communes with the economic enterprise. Workers' Councils of socially owned plants can make decisions concerning prices, output, quality, modernization, and investment within the regula tions determined by the sociopolitical bodies. Second, Lange is criticized even by the Yugoslav economists on economic grounds in two respects. For one thing, Lange identfies the centralistic decisions with the 450skar Lange, Political Economy of Socialism (The Hague: Van Keulen* 1958), p. 16. 334 only rational decisions in the planning domain; thus he allows the application of a different methodology and principles only if the same degree of rationality is achieved in the lower instances. In this regard, Jelic writes: The way to distinguish the two regions - cen tralized and decentralized - could not be by indentifying criteria but by being aware of their differences. Therefore, the domain of decentralized decisions is where their decen tralization is based on criteria which can guarantee them a greater rationality than those made in the centralized way.^6 For another, the fact that Lange sees the need for decentralization in the light of time problem of trans*- ferring the decisions from the higher levels to the lower ones seems to be logically thin, because, according to Ivan Maksimovic, "The improvement of the communication system can completely remove this difficulty of trans ferring decisions and the need for the decentralized decision can still remain." Furthermore, he says: Even if all information is available for the central decision makers, so that the central plan can always react to it, the fact remains ^Jelic, op. cit., pp. 211-212. 335 that the quality of decisions on the lower level is different - it is a different kind of rationality. 7 From these two critical comments we can say that the main difference in concepts between Lange's thinking and the present Yugoslav planning doctrine in the domain of rationality. The Yugoslav model of planning starts from the idea of two autonomous criteria of rationality: "the first is the social, macroeconomic one, which goes roughly along the line of production and the global determination of proportions of economic structure of the national economy; the second is a microeconomic one, on the level of enterprises, which goes along the line of simple produc tion and takes into account the part of autonomous invest- 48 ment." The problem, now, xs the attempt to solve the problem of the interaction of macroeconomic and micro- economic decisions. The Yugoslav economy offers a unique solution, i.e., one which is entrusted to the banking system, as a kind of intermediary institution. Such solution is, according to Svetozar Pejovich, a definite contribution to the static economic theory of socialism. The way it works is as follows: 47Ivan M. Maksimovic, "Professor Oskar Lange on Economic Theory of Socialism and Yugoslav Economic Thinking/" in On Political Economy and Econometrics: Essays in Honour of Oskar Lange (Warsaw: Polish Scientific Publishers, ld£5), p ' . i%r .— 48Ibid., pp. 357-358. 336 The Federal Government orders the basic distri bution of scarce resources and expects the banks to make the most of it. While the Federal Gov ernment retains its power to decide, administra tively, the size of funds available for, say, the shoe industry and for the production of steel, it asks the banks to see that these administra tively allocated funds ax;e then distributed with in each industry strictly in accordance with market principles of profitability.49 In other words, the Federal Government is not con cerned with the allocation of funds within the shoe industry, as long as it controls the percentages of the general investment fund going into various industries and is assured that within each industry the funds are used as effectively as possible. The result has been, Pejovich concludes, the growing importance of monetary and fiscal I ! policies in Yugoslavia. i The second difference between Lange's thoughts and those of the Yugoslav practice is connected with the fact that in Yugoslavia enterprises do not follow the Lange rules for choosing outputs and inputs but, instead, attempt to maximize profits. The aim of Lange was to formulate conditions under which a welfare-optimum (defined in some Pareto-sense) could be realized under socialism, and where in particular those obstacles to a welfare-optimum known to exist in modern capitalist economies are removed. In order to achieve this aim, Lange maintained that decentralized 49Pejovich, op. cit., p. 120. 337 managers must obey the rules of keeping total costs at minimum and choosing the level of output which satisfies the equality between marginal cost and price. As such, Lange did not really recognize the practical difficulties inherent in his two rules for plant and industry managers. Under capitalism entrepreneurs are only required to act as if they equate marginal cost and price while their social ist counterparts are required to actually do this. One very good reason for the inapplicability of the directives given by Lange for the operation of his two rules in Yugoslavia can be indicated by the case of a firm whose worker-managers are asked to act in a way that does not exactly coincide with their motivations. Theoretically, at leastv the Yugoslav system is superior to the other type in which it avoids the pitfalls of marginal cost pricing inherent in Lange's 'socialism by price guidance.' Lange's method of pricing dictates that every firm sells as much as it produces and at a price equal to marginal cost. But, what happens in the case of a firm whose average costs decrease as its production increases? According to the standard average, marginal relations when aver age costs are falling, marginal cost is less than average cost. Consequently, if the firm sells at a unit price equal to marginal cost, the price must be less than average cost. In effect,-unit costs exceed unit returns and the firm loses money on each and every unit it sells. What is more, the managers of such a firm, no matter how efficient they are, can do nothing to make any profit so long as they stick to the rule of a marginal cost price.50 50 Macesich, op. cit., p. 88 338 By and large, the bulk o£ the worker-managers in Yugoslav socialist firms are interested in the goal of maximizing their individual incomes. And since 1950 their incomes have depended in part on the firm's profits. Also the directors of these firms in the socialist sector may be interested in maximizing the firm's monetary profits because they are representatives of the local commune which receives a part of its income from a tax on the firm's profits. On the other hand, these directors may be interested in maximizing the firm's total revenue or the money value of its sales, subject to a provision that profits should not fall below a certain acceptable level. The pursuit of such a goal can be rationalized on the ground that the directors of socialist firms wish not only to maintain their firms' competitive positions, which are dependent on the size of the enterprise, but to overwhelm competitive firms in the private sector and so promote socialism. The third difference between Lange's thoughts and those of the Yugoslav economic practice is related to the capital market. In the Yugoslav economy, the market for capital goods is determined by allocation of investment funds (within enterprises and social-economic plans). But,: these investment funds, contrary to Lange's observation, are not rationed by an equilibrium interest rate. The interest rate is not decisive in the allocation of investment as it is not an important factor cost. Federal plans allocate investment funds to the various sectors and investment loans are subsidized at 2 per cent for electrification, eit■certera. Interest rates are not 51 determined competitively. The Yugoslav Investment Bank, in accordance with the social plans, announces auctions for the purpose of achieving specific goals of the plan. The last difference between Lange's version of a socialist economy and that of the Yugoslav practice is based on the determination of prices. In Lange's "social ism by price guidance" there are two rules of behavior. As was mentioned before, Lange envisaged a society where the i ownership of the means of production belongs to the state, but where the decisions about current production are decentralized and left to the management of the state enterprises. In its decisions about current production, the management of the state enterprise has, according to Lange, to obey the following rules: Rule 1 The management must keep the total costs for the output chosen at a minimum. c1 Albert Waterston, Planning in Yugoslavia (Baltimore: The Johns Hopkins Press, 1^62), pp. 50-87. 340 Rule 2 Production must be pushed to the point where marginal costs are equal to the priceoof the product. The fixing of prices must, at the same time, be done by the CPB, and in its price fixing this authority must obey the following rule: Rule 3 If demand exceeds supply at the existing price, raise the price. If the supply exceeds demand, lower the price. If demand and supply are equal, leave the price unchanged. In its decisions the price authority is supposed to be guided by information of the changes in the stocks of finished goods. Therefore, it is possible to fix these prices (so-called accounting prices) using a method similar to that of the free market, i.e., a method of successive trial and error. As a result, Lange has designed a model of a "simulated" market economy in which the CPB performs the functions of the market, and the prices are set centrally at first, but the divergences which may arise are eliminated by the CPB through watching the market - thus reaching a quasi-equilibrium. In Yugoslavia, contrary to Lange's analysis, prices are determined by market forces. For example, the price j system performs its functions in the consumer goods market and labor market. The capital market is, however, an 341 exception to which a great deal of attention was paid before. With regard to land and other natural resources, market forces are weak. General Appraisal In a general appraisal of the Yugoslav system as either, a pursuant of Lange's scheme or a prototype of its own kind of decentralized socialism, several observations should be considered. They are briefly as follows: Worker Self-Management No doubt exists that Workers' Council play a crucial role in both the economic and sociopolitical aspect of the Yugoslav economy. The role of this institution may be assessed from a dynamic as well as static aspect. From the economic viewpoint, the Workers' Council is in a position to act as a force to push for higher wages, thus forcing the director to strive for higher profits. The director's search for higher profits leads to an increasing flow of innovations. On this static account, the allocation of resources tends to conform to consumer preferences, subject to certain constraints such as distribution of income, tax structure and the basic macroeconomic propositions of the Social Plan. Yet, the dynamic role of Workers' Council cannot be ignored. On this point one can agree with John Dunlop who says that 342 "the full impact of the institution of the Workers' Council on economic development in Yugoslavia can be properly understood only when the role of the Workers' 52 Council is observed in its dynamic context." For Dunlop, the relation between director and Workers' Council means that the former can be neither a dictator nor a paternal istic supervisor. Upon selling his ideas, he has to convince the Workers' Council that they are sound. Therefore, the director will undoubtedly try to make his proposals constructive, with the result of an improvement in the allocation of resources with respect to consumer preferences. From the socio-political aspect, the Workers' Council seems to be the only important institution within the framework of the Yugoslav socioeconomic system which is not necessarily controlled by the party from inside - because of the system of rotation. As long as the scale o- of wages depend on the size of the profit of the enterprise, Pejovich notes that the Workers' Council, striving for high er wages, will push the economic system toward more freedom for the enterprises from the government. Then, he continues: 52John T. Dunlop, Industrial Relations Systems (New York: Hold, Rinehart, and Winston, 1959), p. 295. The firm acceptance of this institutionj.by the workers and its dynamic potentialities may eventually force the bureaucracy to choose be tween further decentralization of the economic system and a retreat to the old system of admin istrative control. But 'as time goes by, it may become increasingly difficult for those who . . . favor . . . bureaucratic control . . a to effectuate the return to rigid centralism.'53 Monopoly Distortions In discussing the problem of monopoly within the framework of the Yugoslav economy, it is important to recall Lange's thoughts on this matter. He wants the socialist industrial managers to take prices as given and play the rules of the game. In his model, the CPB is to set prices with the aim of moving them in order to equate demand with supply. But, it is important that the CPB definitely fixes these prices rather than leaving them to be negotiated directly between buyers and sellers. The result would be the same as under a market regime of competition, but for cases where there are few enough firms to imply some monopoly or oligopoly power, there would be a problem. Lange assumes away this problem by making prices parametric for managers of these firms, i.e., that they ignore monopoly (or monopsony) gains by taking these prices as given and thereby make their own 53 Pejovich, op. cit., p. 92. 344 decisions as to output and employment levels. In practice, the Yugoslav economy does not work this way. The Yugoslav version of socialism, as already noted, seems to have market-negotiated prices rather than adminis tered prices. The main reason is probably that the Lange conception is not really feasible. In this respect, Dr. Sire states that "obviously many present reform proposals have been inspired by Lange's writings, but flexible fixing of prices is proving administratively 54 difficult." For this reason the slow and cumbersome process of price fixing by a CPB has been replaced by the forces of real markets in determining the prices. This transfer unfortunately leaves the economy with the danger of monopoly distortions. Problems of Macroeconomic Balance: Inflation and Price In Yugoslavia today, planning is no more Soviet- style central planning. Detailed planning from the center is rejected as dangerously bureaucratic. Nonetheless, Yugoslavia wants to retain a planned economy. Planning is to be supported by the pricing process so that a substan tial degree of decentralization, both in operational planning and in the management of the enterprises, can be achieved. S^Sirc, op. cit., p. 78. 345 The plan on the Federal Government level or the macroeconomic plan does not hand down more or less detailed figures through administrative channels. The enterprises at the lower level do not have to fulfill set quotas nor do they receive allotments in resources, but, instead, are free to formulate their own operational plans within the general framework of the macroeconomic plan, under consideration of prices and profit expectations. A These prices are guidelines for production decisions of the district governments. The latter are responsible for creation of new enterprises. Having entrusted the Yugoslav microeconomic operation to a considerable reliance upon markets and the profit motive, it is therefore possible to argue on a priori grounds that a decentralized socialist economy based on the "Yugoslav experiment" is subject to problems of macroeconomic balance, such as inflation and unemployment. Price inflation often results from the enterprises having every reason for increasing prices at every oppor tunity, when output demanded does not fall proportionately. i These higher prices can give the opportunity for the Workers' Council of the enterprise to pay out higher wages. Thus, there is some reason to believe that a tendency to inflation may be inherent in the wage-price policies of the Workers" Council, and not really a temporary phenomenon. 346 Once this inflationary process has begun in the economy, stabilizing monetary policies can be applied only at the cost of unemployment. Furthermore, as was noted, Yugoslavia, being exposed to a few large firms, is inevitably faced with a large number of monopoly producers. The result of the strong wage position and the monopoly structure of the industry has been a chronic tendency toward price inflation. In 1964, Ivan Lavrac argued that Yugoslav markets were too limited to permit competition, that either monopoly or monopolistic competition was inevitable, and that society should therefore exercise efficacious control. In this respect, he wrote: . . . Yugoslavia has not yet attained a social ly useful level of concentration in production, nor, on the whole, in wholesale trade. This means that it is illusory to aspire to perfect competition where it is, by the nature of things, impossible and irrational because of the advan tage of concentration. Instead of generally striving for competition, as is sometimes the case, one should rather try to find out . . . what results we actually want to achieve in indi vidual fields, and then establish the appropriate form of the market according to circumstances, i.e., monopolist competition or monoply, and take care to exercise efficacious control.55 ^Ivan Lavrac, "Competition and Incentive in the Yugoslav System," in Yugoslav Economists on the Problems of a Socialist Economy, ed. Radmila Stojanovic (New York: International Arts and Sciences Press, 1964), p. 152. 347 Efficacious control has come into play, as Yugoslavia has passed an anti-monopoly law against combinations in restraint of trade or conspiracies to raise prices. In addition, the natural reaction of a central government with a planning tradition like Yugoslavia has been the imposition of a large number of price controls. "Controls are presently exercised under a law passed in 1967 which, while laying down the principle that direct control of prices must be regarded as an exception to reliance on monetary and fiscal policy, establishes pro cedures for fixing ceilings, pricing new products, and 56 raising controlled prices." As a result, firms either may set prices only within certain limits, or they must get agency approval for any price change. These develop ments have brought the Yugoslav system closer to the Lange stage of price-setting but via the back door, though the enterprises are still the formal sources of all prices. In the Lange system, needless to say, the prices are i centrally set, but enterprises may set their output. Evaluation of the Recent Reform The full effects of the 1965 reform will not be known for some time, but in the words of Bicanic, "Its aim is not less than to build a model of a socialist systemj 5^Dirlam, op. cit., p. 245. for a developed country, one which will be able to stand the competition of other developed countries and progress on its own merits/ without the constant tutelage of govern- 57 ment machinery." The process has begun with a new methodology for the preparation of social plans. They start with the plans of the enterprise as the base. In this fashion/ the principle of building from the bottom up has been accepted in the planning system. This means that plans have two new characters: they are no longer centralistic and directive; they coordinate decisions reached at lower levels and thus leave autonomy in decision making in the decentralized units. An active role of the Federal plan is limited to "those sectors in which the market mechanism cannot assure balanced development, either because of their special significance (infrastructure, education) or because of the low level of economic develop ment (underdeveloped regions and underdeveloped industrial sectors).1,58 Within the introduction of polycentrism in economic decision-making, the Yugoslav economy has shown the merit S^Rudolf Bicanic, "Economics of Socialism in a Developed Economy," in Comparative Economic Systems: Models and Cases, p. 231. ^®Milos Samardzija, "The Market and Social Planning in the Yugoslav Economy," in Comparative Economic Systems, ed. Jan S. Prybyla (New York: Appleton-Century-Crofts, 1969), pp. 348-349. of being a "mixed" or "market-planned" system in which the administered macro-measures and the market-induced micro decisions of the social plans are integrated together with the help of the banking system. As such the Yugoslav economy has been considered to be a decentralized socialist economy which is approximated to prove the feasibility of the Lange blueprint with certain differences which were already noted. However, the evaluation of a new planning methodology coming from the recent reform in Yugoslavia is not the last word. Only with time can the efficiency of the new system be confirmed. Summary Many changes have occurred in Yugoslavia's political and social organization since World War II. In the development of the economic structure of Yugoslavia, three periods of economic planning can be distinguished. In the first period of planning, which lasted from the end of World War II to 1950, Yugoslavia utilized centralized planning. In the second period of planning, which began in 1950 and continued until 1965, a shift occurred to a new and flexible economic system based on the conception that social and economic progress is to be promoted by "social management" rather than governmental management and by emphasis on economic incentives rather than on administra tive instruments. The third period of planning, which 350 began with the economic and social reform introduced in 1965, has brought about further improvements in the methods of management and planning which should contribute to an increase in productivity and economic efficiency within the individual enterprises. Within such a framework, Yugoslavia has moved away from a centrally-planned economy toward a "market-planned" economy, thereby facing the problems that afflict the latter instead of the former. As such, the Yugoslav economy has been considered to be a market socialist economy which combines public ownership with decentralized resource allocation through markets and prices. The contemporary Yugoslav economy both resembles and differs from the theoretical Lange model of socialism (centralized and decentralized). Its similarities include: (1) "The minimum condition of planning" stressing that the "national economic plan" must at least include two things: (a) the distribution of national income between accumula tion and consumption, and (b) the distribution of invest ments between different sectors of the economy; (2) Public ownership of the means of production; (3) A combination of consumers' and planners' sovereignty; and (4) Decentralized decision making by enterprises in response to market forces, instead of detailed planning and administrative orders by the central authorities. At the same time, the Yugoslav economy differs from the Lange model of market 351 socialism in several important respects: (1) Prices, with some exceptions, are determined by market forces, rather than set centrally; (2) Enterprises don't follow the Lange rules for choosing outputs and inputs but, instead, attempt to maximize profits; (3) Investment funds are not rationed by an equilibrium interest rate: and (4) Workers' Councils play a major role in enterprise management. 352 CHAPTER VII THE APPLICABILITY AND RELEVANCE OP THE LANGE MODELS OF CENTRALIZED AND DECENTRALIZED SOCIALISM: THE CASE OF CZECHOSLOVAKIA Introduction Like Yugoslavia, Czechoslovakia, after the end of World War II, patterned her economic system after that of Stalin's model for the Soviet Union. As such, her economy was basically a centrally-planned one in which, after nationalization of industrial property, the central authority began to plan all economic activities of enter prises down to the most minute detail, instructing to each productive unit a number of targets to be met, alloting them the needed inputs to carry out the assigned tasks, and rewarding the managers for fulfilling and overfulfilling the goals set by the center, among them the most important one was the quantitative output goal. The interesting point about Czechoslovakia is that she had had long years of experience with a democratic- capitalist economic system during the interwar period and for this reason she entered the stage of centralization as a developed country. Nevertheless, during the years of postwar central planning, the economy experienced consider-! able growth - largely because of a major reliance on 353 heavy industry. Indeed, "Within fifteen years after the War's end in 1945, national income had risen by 150 per cent and gross-national product by 250 per cent."'1 Thus, as one scholar has put it: . . . it is questionable whether even this specious form of economic growth achieved by sacrificing quality of production and consu mer interests took place because or in spite of the centralized planning apparatus.2 By 1960, Czechoslovakia began to run into economic difficulties. It became extremely difficult for this industrialized country to segure a consistency between output and use via the central administration. As a result, a great deal of problems emerged. While large inventories of some products had accumulated, chronic shortages of other products had been created. Most available labor reserves had been put to use and many workers had been shifted from agriculture into industry. The international balance of trade had become so unfavor able that imports had to be curtailed, and the incentive Harry G. Shaffer, "Problems and Prospects of Czechoslo vakia's New Economic Model,” in Comparative Economic Systems, ed. Jan S. Prybyla (New York: Appleton-Century- Crofts, 1969), p. 324. 2Harry G. Shaffer, "Czechoslovakia's New Economic Model," in New Currents in Soviet-Type Economies: A Reader, ed. George R. Feiwel (Scranton, Pennsylvania: International Textbook Co., 1968), p. 466. 354 structure based on motivation to fulfill the output quotas had led to such problems as artificial pricing, inflation and the disregard for quality. During the 1960's, Czecho slovakia's growth rate of output and national income, averaging eleven and nine per cent respectively between 3 1957 and 1960, began to drop; both were negative in 1963. These basic weaknesses in central planning seem to have influenced the Czechoslovak leaders and economists to propose for comprehensive economic reforms. After some hesitation, "the New Economic Model" began to be put into practice on a limited basis in 1966, and has been generally; applied as of January, 1967. This model entails a sub stantial degree of economic decentralization, a correspon ding increase in the decision-making power of enterprises, an emphasis upon the role of profit as a criterion of enterprise efficiency and as the base for incentive pay ments, and a substitution of forces of market demand and supply for central command. Nevertheless, the Czechoslovak economy remains very "socialist" in the sense that the means of production are publicly-owned. For all these reasons, Czechoslovakia lends itself very well for a .case study of "centralized-decentralized socialism" as envisioned by Lange in his postwar analysis. 3Ibid. 355 The Functioning of the Economy Adoption of the Soviet-Type Planning Central planning came into Czechoslovakia in 1948 with the consolidation of Communist power. The new regime took immediate steps to vastly extend state ownership. The new nationalization law called for state take over of all enterprises employing more than fifty people. Certain sectors were nationalized entirely irrespective of the number of employees. Private enterprise was cut to about a quarter of its previous level and its share in industry dropped to 5.1 per cent.^ By 1949, for all practicable purposes, the state had achieved complete direct control over the "main levers" of the economy and had virtually wiped away private sector. In agriculture the collectivization drive began in 1948 and was sharply accelerated in 1950-53 period. By mid-1953 the state and the cooperative sectors represented 53 per cent of total arable land and the cooperative sector alone accounted for 44 per cent. In 1956 there was a renewed collectivization drive which shifted 30 per cent of arable land into the cooperative sector by January 1, 1957. By the end of 1959 only 16 per cent of arable land 4Josef Goldman and Josef Flek, Planned Economy in Czecho- slovakia (Prague: institute for feconomic and Social Research, 1949), p. 142. 356 in Czechoslovakia was privately owned. By 1960, 87.4 per cent of agricultural land was in the state-owned and cooperative sector, and collectivization was thus com pleted. ^ The period after 1948 was marked by a major effort to accelerate the growth of selected branches of the economy, thus postponing development of the nonpriority sectors. In the language of Ota Sik this was a period of "extensive development" which was mainly justified by a relative surplus of manpower in agriculture, which could be used in industry. He writes as follows: When such a development solves, on the one hand, the serious social problem of hidden unemploy ment in rural areas and when manpower in industry is increased by menas of the expansion of produc tion funds, and is capable of assuring a still more rapid growth in general social productivity of labor, than there could be if there were more rapid scrapping and replacement of production equipment in industry, leaving substantially unused manpower in agriculture, such development is quite justified in economic terms. It is also feasible in a period of social change in rural areas, when there is a transition to soc ialist collective large-scale agriculture, when conditions for a rapid release of manpower from agricultrue are being created and these could be utilized more productively in the expanding industrial base.6 5Jan M. Michal, Central Planning in Czechoslovakia: Organi zation for Growth in a Mature Economy (Stanford: Stanford University Press, I960), pp. 64-90. ^Ota Sik, Plan and Market Under Socialism (Prague: Czecho slovak Academy o£ Sciences, 1967), p. 56. 357 But as time went by, the "extensive development" of the economy in Czechoslovakia began to produce sectoral imbalances and disproportions. In effect, the most obvious defect of this development was a marked decline in growth of national income. Under these conditions the extensive expansion of industrial plants ceased to have any economic sense, and it became more evident for "intensive develop ment" to play a larger role. In this connection, Sik writes: Only in a period of surplus manpower in agri culture could a slower rise in productivity of labor in industry (as a result of exten sive expansion of industrial production funds) assure a more rapid rise of total production per producer than with an intensive develop ment of industrial funds. But when manpower con tinued to leave agriculture for industry, there resulted an actual retardation of the rise in productivity of industrial labor, whereas in agriculture the relative shortage of manpower (in relation to the technical level of agri culture) became the main obstacle of a more rapid growth of agricultural production, and thus it became necessary to go over to a highly intensive development.7 This transition was possible for the Czechoslovak economy only at the expense of the old centralized adminis-j tration and to go over to a decentralized method of manage-j ment. For this reason, by 1952 the planning system was discredited. The planners complained about the unrelia- j bility of the system to restore its balance. The entire 7Ibid., p. 75 358 burden of balancing rested with the central authority which in order to overcome disproportions, often increased produce tion at almost any cost through redistribution of producers' goods and labor. "Such a solution," as George Feiwel notes, "caused disproportions in other branches and sectors; thus the disproportions were not alleviated, but simply moved from one sector into another and from one branch of industry to another."8 In this way, the central authority was essentially preoccupied with only mitigating on a temporary basis the undesirable effects of the disproportions caused by the system. But, there was a problem in the supply situation. The enterprises often circumvented delivery orders and worked with one another directly. Due to acute shortages such relations apparently aggravated disproportions. The continuous revisions of the plans, allotment of supplies exceeding the allocated amounts that took place at every step of the planning process, further disrupted the process. As a result, no plan was subjected to the test of economic ! efficiency because of planners' major preoccupation with "material balances" as the criterion to balance quantitative proportions in economic plans. 8George R. Feiwel, New Economic Patterns in Czechoslovakia: ; Impact of Growth, Planningf and the Market (New York: j Frederick A. Praeger, Publishers, 1968), p. 6. 359 The Anatomy of the Planning System Economic planning was basically designed as an instrument for the central authorities in mobilizing and channeling resources for forced industrialization. In this path, they depended on central control in transferring resources for their objective rather than relying on market-type forces. Czech economists often argue that central planning was initiated at a period when economic backwardness called for the achievement of certain production targets at any cost, keeping in mind that in 1950 Czechoslovakia had unemployed manpower and unutilized output capacity. As such, planning was not based on any theoretical foundation, but mainly shaped by subjective factors. Ota Sik talks about the harmful effects of this system in the following words: It is this very subordination of theory to sub jective views and interests that was one of the most harmful characteristics of the so-called era of the cult^ Economic theory of the Stalin era, with its purely apologetic and propagandis ts character, could not gain the respect and the recognition of practical economic workers and so no one even used it when there were prac tical economic problems to be solved.9 Ota Sik, "Problems of the New System of Planned Manage*-. :v; . ment," in Czechoslovak Economic Papers, Vol. V, ed. Bedrich Levcik (Prague, Czechoslovak Academy of Sciences, 1965), p. 8. 360 As the planning system was developed to serve the objective of rapid industrialization, the planning problem was essentially one of keeping "the circular production flow moving smoothly without interruptions" and that, under such conditions, the principles of Pareto's optimum as envisioned by Lange in his prewar model were hardly relevent.10 Centralization of economic decision-making was needed for concentrating resources on chosen production targets, for preventing their distribution in other uses, and for ensuring central control over the economy. Due to heavy reliance on this scheme, certain undesirable results emerged, thus rendering the economy very sensitive to bottlenecks. No economic mechanism was provided to alleviate these bottlenecks. In short, the system was a comprehensively-planned economy in which the formulation and execution of central plans were centrally administered. Given the politically determined objectives, and no market for producers' goods, the central authorities had to construct an internally consistent plan. For this purpose, the planners pursued the so-called method of "material balances." This method provided them with the aim of equating total output (and imports) of a product ■^Maurice Dobb, Papers on Capitalism, Development and Planning (New York: International Publishers, 13(57) , p. 194 361 with the quantities that all users (and exports) required to fulfill their quotas. Basically, there was no economic verification of production, and plan construction was primarily designed to fulfill targets set out for the investment sector. Thus, value categories were subordinated to physical planning. Direct assignments of mandatory tasks to enterprises were regarded as the basic instrument for ensuring plan fulfillment. However, there was the problem ; of handling the activity of the enterprise to the minutest task. Therefore, a degree of microeconomic planning was needed. In practice, such task was a hard one - as Feiwel notes, "No system of detailed indexes was capable of entirely eliminating independent action and direct inter enterprise negotiations."^ The whole system was oriented toward the enterprises fulfillment of plan assignments. Production was essentially undertaken to fulfill the plan and not to satisfy the con- ; sumer needs. In case of any shortage, the consumer was at the mercy of the producer. As a rule, the former was not prudent if he were to aggravate the supplier by imposing fines for the low quality of goods, for late deliveries, et cetera. The supplier could, in this case, defend himself by shifting the blame on his own suppliers. ■^Feiwel, op, cit., p. 91. 362 Once the plan specified the product, quantities, and con^ tractual parties, the supplier was, Sik notes, under legal obligation to produce the goods and the consignee to accept them, regardless of the ability of the first to produce 12 and of the need of the second to use these goods. Since enterprises were evaluated on the basis of plan fulfillment and since their employee's earnings depen ded on this evaluation, the enterprises were interested in obtaining low plan assignments in order to fulfill them in the easiest possible manner. The common thing to do was to conceal reserves and to request for more resources than required. This strategy led to undesirable reper cussions. Feiwel describes them as follows: Since the rule of the game was for the producer to offer less output while asking for more in puts, the relationship between availabilities and requirements was increasingly strained. The central planner retaliated by arbitrarily in creasing output quotas and by reducing input allocations, thus intensifying the pressures in the economy. The units which were less able to resist pressures built up from above and below tended to distort the data flowing up so that they would not properly reflect actual potential and requirements, and so that commands would be based less and less on datarreceived. Conse quently, the degree of plan fulfillment varied unevenly, contributing to breakdowns in the inter enterprise flows and upsetting the attempted internal consistency of the plan.13 ^ ■ 2Cited in ibid., p. 93 13Ibid., pp. 93-94. 363 The enterprise was governed by an amalgam of often contradictory indexes, as Sik observes.^ Often, there was a tendency for a single index to gain priority over others, because its fulfillment was most emphasized by the authori ties. Since the central goal of the system was large- scale industrial production, the volume of gross output emerged as the key index. Thus, upon evaluating perfor mance, the first stress was on meeting the output quotas; failure to fulfill other indexes was tolerated. In this evaluation, the system of incentives was j |linked to the fulfillment of plan targets by the enter- i prises. As a result of limited economic freedom, managers were preoccupied with their current activity and paid little attention to technical advancement. At the most, enterprises were willing to introduce only minor technolo gical changes. The bulk of investment was directed to expansion of capacity, while existing enterprises often operated under deteriorating technical conditions. With the exception of some success with a few directive tasks of technical progress, development, the efforts of central authorities to introduce technical progress, Sik notes, "be 15 came only general and rather ineffectual proclamations." It is claimed that the manipulation of plan directives did not necessarily lead either to improved performance or to Incited in ibid., p. 94. -^Ibid., p. 96. better satisfaction of consumers needs. Sik even goes on to argue that due to the nature of price formation and to the built-in rigidity of price changes, in all cases "prices tended to push enterprises in the direction of production that differed increasingly from market demand." This is quite true upon looking into the process of price formation for producer and consumer goods. Prices of producer goods, set on average costs, plus a slight mark-up, played a subordinate role in plan execution. They were primarily used for expressing in summary from the enterprises' mandatory assignments and their fulfillment and to keep records of transactions. Such a price system was unsuitable for guiding enter prises ' activity. Consumer prices remained unchanged for long periods From 1953 to 1960 attempts to reflect demand and supply relations were only made for those goods which could not 1 7 be sold. The separation of consumers from producers prices was considered as a fundamental principle of the price system. This principle enabled the central planner to influence either consumers or producers separately. This separation resulted in a dual price system, with 16Ibid., p. 97. •^Ibid., p. 98. different principles of price formation for producer and consumer goods.Turnover tax was the barrier separating consumers' from producers' prices. By altering the rate or fixed amount of the tax, thecdhanges in one type of price were not transmitted to the other. Therefore, pro duction was not responsive to market impulses. The centralized determination of prices was a burdensome task. The larger the number of prices to be determined centrally, the greater was the possibility that individual enterprises which supplied cost data would influence price setting, for the verification of those prices became extremely cumbersome. In this way, "prices also became outdated because each price revision took several years to prepare during which important shifts took place in the conditions and production program, so 19 that at the outset the new price was obsolete." Producers were entirely isolated from price move ments on the world market and were not knowledgeable about 18In essence "Producers' prices were designed to serve mainly as calculatory and financial devices, constituting above all, instruments for aggregating physical magnitudes and controlling execution of plans. Consumers' prices were designed to perform a rationing function allocating what has been produced among consumers." George R. Feiwel, The Economics of a Socialist Enterprise: A Case Study of the Polish Firm (New York: Frederick Praeger, Publishers, 1965) p. 57. 19 George R. Feiwel.,, New Economic Patterns xn Czechoslova kia; Impact of Growth, Planning and the Market, p. 99. 366 the relationships of domestic to world prices. They were reimbursed for exported output at domestic wholesale prices, set independently of foreign prices. Hence, some goods might have been produced inefficiently, yfet the producer would still make a profit on them. On the other hand, it was possible for the producer to turn out a better product for which the foreign trade organization would get a higher price, but if a deficit domestic price prevailed, or if the relative ratio of prices was unfavorable, the producer would be discouraged from such production. Not even foreign trade organizations were, as Sik notes,. interested in the effectiveness of foreign trade, for the profit or loss on transactions was absorbed by the state budget. Not only was the domestic pattern and cost of production not sensitive to the pressures of the world market, but, apparently, "foreign trade acted as a barrier, preserving the backwardness of many domestic producers and 20 the rigidity of the domestic structure of production." The logic of the system led to intensified centrali zation. Such a tendency was limited by the processing capacity of the central authority. It is true that with the advent of the computer the physical burden of this task was made easier. However, it is argued that a wider use of computers could not solve the problem effectively, as the 20Ibid., p. 99 major flaw in the Soviet-type planning system lies in its planning and information process. One of the major pro blems is still the vital interest of the enterprises in submitting data distorted to fit their own interest, thus impairing the fulfillment of orders coming from the higher levels. Also, increasing centralization calls for an increasing set of norms to regulate the activity of the enterprises. But, since these norms depend on information supplied by enterprises and since the verification of enterprises' data became harder as their number increases, 21 the norms, Sik believes, looses their strength. With the growing complexity of the economy, methods adopted for melting the planners' developmental goals became inadequate for coordinating the specialized branches of the industry.and for coping effectively with the bottle necks emerging in complementary branches of the economy. In short, with the advancement of Soviet-style industriali zation, the inefficiences of the economy became more acute and harder to cope with. Against this background, reforms were approved and introduced about mid-1958. It was hoped that through improved production efficiency and through raised produc tivity, a new impetus would be given to the growth momentum. 21Ibid., p. 101. 368 The 1958-59 Reform As far as 1957, the party Central Committee had decided that central management of "fundamental matters" ought to be combined with extended rights and responsi bilities of plant managers in "current matters" and that more emphasis should be given on material incentives. On April 1, 1958, certain economic reforms were introduced. One of therreform^s objectives was to eliminate the excess of overcentralization. The central planner was to cease his preoccupa tion with minute details, with countless reso lutions of conflicts, and with ad hoc operational interventions, in order to devote more attention to long-term planning, which was being stressed. At the same time, the applicability of the market mechanism to the functioning of the socialist economy was denounced, stressing the adverse effects of the market's spontaneity and the incom patibility of the plan and the market.22 The backbone of the reform was, in essence, a broadening of the decision-making process at the lower levels of the hierarchy, but it just stopped short of the enterprise. A new organization was created to replace the central agencies which had functioned as a medium between the enterprise and the ministry." These "economic produc tion units"consisted of a single leading enterprise, sometimes embracing an entire branch of industry or a 22Ibid., p. 104. 369 group of smaller enterprises producing a given assortment of goods or services. These production units were directly subordinated with the bulk of operative management func tions , such as the elaboration of production plans, deciding on technical advancement and expansion, marketing and formation of decentralized financial resources. The ministeries were supposed to refrain from interfering in. daily activity, but, instead, they were to. reprganizel, the drafting of annual plans, to prepare the norms for the production units, to evaluate the long-term sharing in vprofits and depreciation, to set prices, to determine long-term development, to concentrate on redistributing financial resources, to control wage policy, and to guide over-all economic activity.^ By 1959, innovations were being introduced in the planning system. Two novelties were' the "personal incen tive normatives" and "enterprise incentive normative." The construction of "personal incentive normatives" for raising average wages promoted the increase of targets by the economic production unit or the enterprise. If the latter raised their labor productivity targets, they were entitled to the aforementioned incentive in excess of the average set for them. The starting point for setting ^Miroslav Rosicky, "Organization and Management of Industry and Construction in the Czechoslovak Socialist Republic," Czechoslovak Economic Papers, Vol. II, pp. 41-46. “personal incentive normatives” for 1959-60 was, according to Feiwel, the actual performance in 1958. Then, he continues: The 'personal incentive normatives' for calcula ting the premium fund was to be, in most cases, a stable percentage of profit or its increment. In some cases the 'personal incentive normatives' was related to cost reduction or to the wage fund. However, the source of the premium fund was not profit, but wages, upon profit plan ful fillment. Moreover, its importance shoilld not be overestimated, for premiums gravitated to around 10 per cent of basic wages.24 The "enterprise incentive normatives" was construc ted so that the ministry could increase or decrease the share of an enterprise in the profits igeaiiifoed. or in the increment of profits if the enterprise augmented its targets, or refused to accept them on the ground that they were too "taut.” Some side conditions, such as the rates of cost reduction and of growth of output, were imposed. "To further counteract conservative planning, from 1961, the enterprise was no longer bound to remit the budget's share in planned profits in case of profit plan underful fillment." But, instead, "-the shares" as Feiwel notes, "were scaled down proportionately to the profit achieved." The following general rules were established for setting the "enterprise incentive normatives?* (1) the 2^Feiwel, op. cit., p. 107 371 normatives were to be differentiated according to condi tions in various branches and enterprises; (2) maximum stability of normatives was to be sought; (3) the share of profit was at least to amount to 20 per cent of the increment of profits; (4) the normatives were to be specified in detail for all the years of the Five-Year- Plan; (5) the normatives were to determine the volume of decentralized investments; and (6) the share in profits for financing investments was to increase; only in excep tional cases would all investments of an enterprise be 26 covered by the share in depreciation. ” Centralized investments were restricted to the major projects so that in the early 1960's decentralized investments were about sixty per cent of all state investments. In 1958 enterprises were entrusted with 27 large financial resources for decentralized investments. Enterprises received directives specifying the centralized investments. On the basis of normatives prescribing the shares in profits and depreciation, they planned the decentralized investments. Before the final plan was approved, the investors were to enter into contracts with suppliers for both centralized and decentralized invest ments . 26 Rosicky, op. cit., pp. 50-54. 2?Michal, op. cit., p. 173. The fundamental shortcomings of the planning system were not eliminated with the 1958-59 reform. The directive assignments of plan targets were retained as the basic planning tool; their fulfillment remained the fundamental performance criterion. The lower levels were, indeed, entrusted with wider decision-making, but since price formation was not altered, prices could not be used as choice signals. In fact, the reform failed to cope with the problem of market mechanism in a socialist economy and with the question of employee's incentives. The reason was perhaps due to an ideological aversion to the reform which was held to be "capitalistic" in essence. Search for Decentralized Socialism Plan and Market: Proposals for Change As was already noted in an earlier section of this chapter, the Czechoslovak economy suffered from a retarda tion of growth performance in the 1960's, and produced the undesirable results of a negative growth rate of national income in 1963. Needless to say, criticisms had been voiced in the late 1950's, and that partial reform measures were taken, as we saw earlier. But it should be noted that these early criticisms lacked constructive suggestions for the formation of a decentralized socialist economy. These events prompted the Czechoslovak economists to take 373 a hard look at economic realities. One such economist is Ota Sikf the director of the Czechoslovak Academy of Sciences and a member of the Central Committee. The following development will, in turn, draw heavily upon his views in an article he wrote in 1965 in regard to the 28 adoption of a new reformed system. The Centralized Model. The centralized model adopted after World War II featured a series of important character istics. It was characterized by (1) concentration of practically all economic decisions on the central level, except for individual choice in consumption and employ ment; (2) hierarchic structure of plans and vertical ties between different links in the economic mechanism; (3) trans mission of decision from top to bottom in the form of direct orders; (4) predomination of calculation in physical terms; (5) central establishment of both consumers' and producers' prices, where the latter are not the indicators of economic choice but calculatory magnitudes as means of balancing; and (6) passive funcjtion of money in the realm of state ownership. With such a model, centralization helped to acceler- : ate the social andlstructural remolding of the economy and to ensure progress along socialist lines. But as socialist ; 28 * Ota Sik, "Czechoslovakia's New System of Economic Plan ning and Management," World Marxist Review, VIII, (March, 1965), pp. 22-29. 374 economic development gradually continued, the rigid centralized planning and management became the main impediments to greater efficiency. This is particularly true because "the comparatively rapid growth rate notwith standing, the emphasis on extensive rather than intensive 29 development resulted in a lag in efficiency." The result was, of course, the decline in the rate of national income. Sik gives the following reasons for this phenomenon: 1. The bulk of investments, which the Czechoslovak state financed through centralized channels from the revenue from enterprises and their accumulations, went into building new factories and producing additional machines. This left less and less for replacement of existing plant. The newly-created capacities, however, did not compensate for the diminishing returns caused by the aging of the old plant. As a result, investments, despite their steady growth, proved less and less effec tive. This became evident in the slowdown in the rate of growth of the national income. 2. Moreover, Czechoslovakia experienced what may be called "over-exhaustion" of manpower sources - above i all, the enlistment of housewives at a time when the conditions for this had not been properly ripe for the transfer of part of the agricultural labor forces to 29Ibid, p. 23. 375 industry since all-around mechanization had not been carried far enough to compensate for the outflow of man power . 3. Another problem was the unfavorable trends in the production structure, both the macrostructure - the proportions between branches of industry - and the micro structure - the ratio between the output of various items within each branch. This problem was unfavorable from the standpoint of the correlation of foreign trade and the economy as a whole. The conditions of the time compelled the economy to increase the share of engineering in indus try as a whole, and primarily the share of heavy machine- building as the basis for expanding industry,rendering industrialization to progress, and increasing foreign trade. The problem was, however, the continued "extended reproduction" of the same macrostructure without taking due account of the country's natural resources and economic conditions. The key criticism was not the postwar changes in the structure of industry but the insufficient flexi bility used by the system in fringing further adjustment of both the macrostructure and the microstructure. In this respect, Sik Writes: For a country possessing a relatively advanced industry but poor in natural resources and hence compelled to import a substantial part of its raw materials, arid with a relatively restricted home market not permitting sustained 376 highly efficient quantity production, foreign trade is a precondition of economic progress.30 The mechanism of fluctuations in the growth rate, as implied by Sik in the above statement, may be described as follows. In a relatively small, industrially developed, socialist country like Czechoslovakia, there was a tendency for the raw material base to lag behind the growth of manufacturing industries whenever the rate of growth exceeded a certain optimum level. Such development was due to a tendency for under fulfillment of production (and investment) plans in the extracting of basic materials industries and for over fulfillment of such plans in the higher-stage manufacturing industries, resulting in the formation of what has come to be known as the raw-material barrier. This, in turn, brought additional imbalances in the foreign trade balance, thus aggravating the resultant loss to the economy. In this way, there seemed to be no solution for Czechoslovakia's problems except changing from the tradi tional model under conditions of "extensive development" over to a new system of economic planning and management under conditions of "intensive development." This transi tion became necessary as Czechoslovakia was coming to have such a wide variety of consumer goods as central 30Ibid. 377 planning was unable to achieve correct allocation of resources among all of these goods. It was also deemed as necessary because of the argument that Czechoslovakia was highly dependent on foreign trade and so must increase its efficiency and the .quality of its goods in order to procure the best terms of trade. The more general ideo logical argument for a radical change in economic thinking is presented by 3ikr who contends: Until recently, the connection between planning and the market was incorrectly understood and the concept of the market was applied to the socialist economy in a sort of shamefaced way. It was held, wrongly, that planned management of production, was the absolute antipode of orientation on the market, of utilizing market levers .... These tenacious theoretical pre mises brought such harm; because of them a system of planning and management was adhered to which meant that production could not be adequately geared to its proper aim . . . and consumers could not exert any direct influence on the producers .... Socialist planned pro duction should consistently seek to satisfy market demand. The Decentralized Model. The discussion on the traditional model was concerned with changes in the system of planning and administration of the economy within the framework of a socialist system. The proposals were considered only as technical variants of the socialist system taken as given. In a recent appraisal of the 31Ibid., p. 24. 378 development of economic thought in postwar Czechoslovakia, Sik referred to the discussion as the initiation of "a genuinely scientific theory, examining and analyzing the facts and the real phenomena" as opposed to the subjective methods of the Stalin era. He contends: These methods are naturally incompatible with a genuinely scientific and objective investigation of the causes of various growing economic contra dictions. The hidden relationships among the economic processes and the effective forms of surmounting the shortcomings that are discovered. A leading worker^who is of a genuine Leninist type does not base his personal prestige on 'omniscience' and 'infalibility,' does not decide according to which side power is on and does not orient economic analyses and reports according to a priori conclusions and interests. A Lenin ist bases his decisions on really profound and well-grounded scientific analyses of reality, the conclusions of which must take priority over a personal interest.32 In this way, the discussion featured a radical departure from the stigma of Stalinist dogmatism, but, instead, focused attention on the acceptance of modern theory of value and of the market and market-type instru ments via, in Sik's words, "a re-examination of Marxist principles." To initiate these reforms, Sik saw their basic premises in rendering enterprises more.responsive to market pressures, in strengthening the "buyer-seller 320ta Sik, "Problems of New System of Planned Management," in Czechoslovak Economic Papers, Vol. V, p. 8. 379 relationships," and in systematically uprooting the old administrative methods of planning. The postulated wider utilization of the market necessarily entailed not only the introduction of market devices, but also a re examination of the methods of plan formulation, in order 33 to adapt them to the blending of the>plan and the market. The central economic plan should be limited to "questions of macroeconomic growth based on realistic * ! analyses of demand trends, technological economic analyses and competing optimal solutions." "Socialist market rela tions" mean that enterprises "do not work completely separately and independently of each other, according to their own interest and decisions, for a more or less unknown market." On the contrary, their path is mapped out; and coordinated by the macroeconomic plan and the "basic structure of their output programmes is regulated by over-all price relations; the general price level; technological development, investment, and manpower policies - all these are laid down by the plan. Key investment projects are incorporated in the long-range i plan in order to regulate the "main proportions." The implementation of macro-plans would be induced primarily by the use of economic and financial levers. 33Ibid., p. 18. 380 The socialist market helpsr within the scope of the macroeconomic plan and through the con tact of interests between producers and consu mers , to encourage enterprises to undertake production of commodities that are in demand, steadily improve their assortments while lower ing production costs. 4 Stress was laid on long-term planning to assure sustained growth and to map out the basic development of individual sectors and branches of industry. As a rule, the long-range plan would primarily encompass the basic construction of projects in accordance with the restruc turing of the economy; the main trends of technological progress; the production of those goods in short supply; the correlation of international division of labor and the Czechoslovak economy, primarily from the standpoint of fulfilling long-term agreements with other socialist countries; the forecast of the size and composition of labor force; and the principal trends in the distribution of national income. But the important question arises; what criteria would be used to ascertain what the correct proportions are? Sik believes that the drafting of such plans would from the start enlist the active participation i of enterprises in calculating and evolving the alternative j variants. In this connection the central organs would O A Ota Sik, "Socialist Market Relations and Planning," in Socialism, Capitalism and Economic Growth; Essays Presented ; to Maurice Dobb, ed. C. H. Feinstein (Cambridge; Cambridge : University Press, 1967), pp. 154-155. 381 have to ensure that the more or less independently con structed branch plans correspond to the general guidelines 35 as provided by the lower levels. Under the new model the enterprises themselves would in large measure determine the quantity and type of output, all the micro-proportions, and decide questions pertaining to technology, quality,aand expenditures involved in the production process. Two circumstances, Sik says, necessi tated this relative independence of enterprises as social ist producers: 1. The fact that, as experience has shown, the central planning bodies cannot be expected to know all the concrete conditions of production and marketing at every given moment. For Czechoslovakia now produces roughly a million and a half different types of output. 2. That the decisive role in production plan ning by enterprises is played by the material interest of the workers.3® Thus, the new system of management is aimed at creating an economic climate in which the workers, when taking relatively independent decisions concerning their production program, would have the maximum material incentive to work for the fullest possible satisfaction of the requirementseof society and make the most effective i 35Ibid., p. 156. 3®Ota Sik, "Czechoslovakia's New System of Economic Plan ning and Management," pp. 26-27. 382 use of both labor and the means of production. To put it differently: The new concept of material interest is exhi bited primarily in the new concept of relations between enterprises and society. Formerly this relation was founded on the principle that soci ety decides for the enterprise how much it should save and the enterprise was then obliged to pay into the State Budget the planned profit. Apply ing this principle led, of course, to a number of anti-social tendences, such as hiding reserves, changing types of goods produced to make specu lative profits, without regard to the needs of society, lowering the quality and the technical levels of products, struggling to get low targets in the plan, etc.3/ A no less important problem was a flexible control of wage trends. If a complex and integrated management of the enterprise was to be made possible, with an effec tive combination of production factors assured, and the deforming effect on material interest of imperative targets done away with, it was essential for the enterprise to have considerable freedom in managing its own finances, i.e., how it can use its money on wages or on investments, et cetera. The new system is aimed to respond positively to this request in such a framework that differentiations in remuneration would be possible. The procedure, as described by Sik, is as follows: 37Miroslav Sokol, "Changes in Economic Management in Czechoslovakia," in Czechoslovak Economic Papers, Vol. VIII, p. 13. 383 After the basic deductions for the state of a percentage of gross income or planned profit for a long period ahead, the enterprise will draw on its income to lower other commitments, such as repayment of credits, interest, etc. . . . The income of the enterprise will also be drawn upon to cover the so-called deduct- tions from production funds, assessed in pro portion to the net value of both fixed and working capital. The balance after the above deductions, remains at the disposal of the enterprise to be used to augment the technical development fund and the reserve fund, for minor investments in the enterprise, and pri marily to replenish the general fund for remun eration of labor. The latter fund will be used in keeping with the present regulations for basic wages and bonuses for additional bonuses and special premiums.38 Finally, the new system, in order that it may be considered "rational," would need a price system. For effective regulation of price trends, a price system would be created to include the following: 1. Fixed prices. These prices will be set by the center for a limited group of the most important raw materials and the basic consumer needs. 2. Regulated Prices. These prices will operate for much the greater part of other products, specially those in the limited price category where the central body will set maximum and minimum boundaries within which the supplier plant fixes the sale price by mutual agree ment with buyers. ^®Sik, op. cit., p. 27. 384 3. Free Prices. These prices will be permitted for products where the market is sufficiently satiated and where it would be good to have a rapid reaction of prices to supply and demand conditions. The state will unquestionably exert the decisive influence on the dynamics of prices through the centrally fixed and regulated prices', and also through general regulations and systematic control of prices and quality, without, however, affecting their role as an economic lever and restricting the necessary flexibility of price movement. In this way, price policy combined with incentives will encourage enterprises to search for the most rational solutions. The Draft Principles of the New Economic Model The original draft principles of the "new economic model" as they appeared in 1964 hardly provided a blueprint of the reformed system. The document was largely based on Sik's proposals in his decentralized model. In essence, the draft principles envisaged the scrapping of detailed economic planning from the center and proposed to substi- tute for it theimechanism of a market economy operating within the framework of a broad overall social plan. With reliance on this view, the draft principles proclaimed value parameters as the basis for economic calculation, thus avoiding physical^balancing. The ultimate hope was to base the fulfillment of quantitative targets on cost and benefit tests. To encourage enterprises to enhance the quality of their output and to produce efficiently, they were vested with greater decision-making authority. Enterprises, in other words, will be free to decide by themselves or in conjunction with other enterprises all economic details within the limits of the broad outlines laid down at the center. Central planning bodies and central control agencies are to concentrate their efforts on broad, long-term planning; on such important, fundamental questions as price, wage and incentive policies, and the balanced economic development of individual regions; and on the control of situations presenting 'the gravest danger' of 'anti-social trends' (such as, pre sumably could arise if large production units were left 'as much as possible' to the basic economic units Dr their joint organizations). The long-term plan "must originate within the systematic constructive cooperation," between central planning bodies and economic units. The plan must become, as Sik believes, "the fundamental instrument for manage ment of the socialist economy - an obligatory directive 40 for economic policy at all levels." The shift from extensive into intensive development would require that 39shaffer, °P* cit., p. 472. ^Cited in George R. Feiwel, New Economic Patterns in Czec hoslovakia: Impact of Growth, Planning and the Market,p.147 386 all investments should be handled with efficiency calcula tions, so that resources may be effectively utilized. Crucial investments for development that essentially affect the given branch and sector would be decided by the central authority. Otherwise,cguided by considerations of profitability, enterprises will be responsible for their own investment. They will finance them out of their own funds or through bank loans. The foreign trade mechanism is to be liberalized. To motivate domestic enterprises to sell abroad, they are to have the right to keep a part of the foreign curren cies they have earned. On the other hand, they will also be relatively free to purchase their supplies abroad if foreign producers can deliver them more cheaply than domestic suppliers. In this respect, Feiwel writes: Since world prices express progressive tendencies, they ought to condition domestic production. The revenue of enterprises producing for export would reflect the sales value of their products on the world market. Similarly, the enterprise that uses imported inputs should be aware of their real costs. Moreover, the export producer should be drawn organizationally closer to the foreign markets. In many cases the foreign trade enter prises would be directly tied to the producing units. 1 41lbid. 387 The enterprise would be driven to maximize their "gross income."42 Gross income would remain after the deduction of the costs of materials, power depreciation, and transport cost from sales revenues. Gross income would be also used for meeting certain other obligations such as bank interest charges, interest and installment payments on state investments in the enterprise and contributions to the state budget. The remainder would thenbbe used for paying basic wages and for awarding bonuses to espec ially deserving employees. In order to make the system more "rational" so that ; the market mechanism would allocate resources so as to meet consumer demand, arbitrarily set prices had to be replaced by economically meaningful prices which reflected scarcity. The new economic model in conjunction with Sik's thinking called, therefore, for three types of prices: fixed, "limited," and free. Raw materials and all basic products such as coal, electricity, steel, wheat, et cetera, will carry fixed prices set at the center. "Limited" prices will be permitted:!.for standard products, with centrally- i determined ceilings and possibly with floors, which would I be the boundaries for free fluctuation of these prices. 42This is a concept borrowed and adapted from the Yugoslav brand of "decentralized socialism." Incidentally, this concept is also similar to the behavior of Ward's Illyrian firm, which was discussed in Chapter II. The Czechoslovak firms are then given the will to maximize their individual incomes. 388 Free prices will be left to respond, without limiation, to the forces of supply and demand. The new types of prices were to be introduced gradually, with a view to the market situation. Finally, the draft principles placed the burden of success of the new system upon the shoulders of enterprise managers. The new economic model was, in this sense, directed to emphasize on skillful and enterprising management, in other words, on enterprise directors who not only are trained, but who also have a personal initia tive in the fulfillment of their task; in short, men who can act as entrepreneurs in the best sense of the word. The selection of qualified personnel for top positions was thus emphasized as an urgent matter, but it was followed by a continuing stress on political and ideolo gical acceptability of the "economic workers." The 1966 Version of the New Economic Model The main characteristic of this model is the decentralization of most economic decisions concerning production and consumption. The number of commodities, the production of which is being determined by central planners in physical units or in gross value terms, has been reduced from approximately 2,000 under the old system to twelve under the new system. The Basic Ordiance emphasizes that even these pro duction tasks will be eliminated later if 'the enterprises behave in a normal way' (probably, 389 do not misuse their monopolistic or monopsonis- tic power). In the future, the central direc tives should be limited to some research tasks, to investments financed from the State budget, to the economic development of backward regions, and to defense. Otherwise, the production de cisions would be up 'to the managers and to the trusts of the socialist enterprises.43 The managers would also decide what input mix to use, but there would be certain "limits." These direct controls of intermediate consumption will apply, for example, to the inputs subsidized by the government, and to some basic commodities such as wood. In addition, indi vidual ministeries and local governments may impose certain production tasks on the enterprises; however, if enter prises can prove that this has caused them losses, they can claim damage. In short, the socialist managers will have a substantial freedom to decide what and to whom to sell, and what and from whom to buy, in response to financial incentives. These incentives, however, changed partially in 1966. One such change was the use of gross income scheme in most industries, with the profit scheme used in excep tional cases, for example, the food industry. The creation and distribution Of gross income (profit) is as follows: 43Jan M. Michal, "Market Socialism: The Case of Czecho slovakia," in New Currents in Soviet-Type Economies: A Reader, p. 488. 390 Gross income is created out of the gross money revenue from all sales by the enterprise after (a) deduc ting the cost of materials and services supplied by other enterprises, (b) deducting the turnover tax on products, (c) deducting the.proceeds of the resales, if any, of previously purchased raw materials or of fixed capital assests, (d) after adjustment for the change in inventories of products, (e) after deducting the contributions to the trusts of enterprises, and (f) after adding price sub sidies from the State budget. After gross income is created, the enterprise has to pay a set of charges out of it. These charges are as follows :44 1. Levy on Capital. This is actually a charge on fixed capital. This levy was introduced to promote better utilization of fixed assets, to induce enterprises to carry out expansion and modernization economically, and to reject investments that bring in low returns. This is an important innovation in the Czechoslovak socialist economy. 2. Amoritization Charge. This is a temporary payment of depreciation charges to the State so that the enterprises that in the past obtained large amounts of free fixed capital do not have an undue cost advantage 44Ibid., p. 489 391 over enterprises which are at present enlarging and paying for their fixed capital stock. 3. Charge on Inventories. This is also another charge that the enterprise must pay. 4. Charge on Land Taken Away from Agricultural Use. This is obviously a substitute for rent. 5. The So-Called Stabilization Charge. This is a combination of a tax on the wage bill and a very heavy tax on the increase in labor employment. 6. The Charge on Gross Income. This is a charge which is levied on a residual after deduction of the charges on fixed capital, inventories, and some other contributions. It is basically a combination of a tax on net revenue and an additional tax on the wage bill. After having paid all the charges and obligations, the enterprise can allocate the residual of gross income to its funds; the reserve fund, the fund for cultural and social projects, the investment fund, and especially the worker fund. It is out of the latter fund that premiums are paid to the management and workers if the allocation to the find exceeds the total of fixed-rate wages. At the enterprises where profit incentives were used, the distribution of profit was similar to that of ! gross income, but wages were included in costs and, instead of workers’ fund, a premium fund was created. 392 Early in 1966 it was realized that no significant moves toward the new system could be made without a major reform of the price system, which reflected neither rela tive production costs nor relative scarcities. The first attempt was to provide central calculations based on a 92 sector input-output table to produce wholesale price levels for each secter. These prices attempted to cover average production costs plus a profit markup which is intended to provide a six per cent return on capital and a twelve per cent margin over basic wage payments. They were passed on to enterprises, which worked out new prices for parti cular groups of their products. These were then checked for consistency and eventually new price indices were produced for 25,000 commodity groups. Taking these as a basis, enterprises elaborated still more detailed price 45 lists, which came into effect in January, 1967. From now on, further price changes will be regulated as follows: 1. For the main fuel and material and basic con sumer goods (about two-thirds of all trans actions in 1967), central fixing of price ceilings; 2. For most other products, central fixing of price ranges; 4^United Nations, Economic Survey of Europe in 1966, Recent Economic Development in Eastern Europe and the Soviet Union (E/67/II/E.11), June, 1967, p. 55. 393 3. For a small remainder - an estimated seven per cent o£ transactions - prices will be determined by the market. This is only the starting point of a long journey to go. The hope is to gradually move towards equilibrium prices. It is also hoped that as profit margins on dif ferent products then change under the impact of market forces of supply and demand, investments will be diverted to the most profitable lines of production and it will prove possible progressively to remove the remaining price controls as market equilibrium is reached. In regard to financing the investments, it is hoped that enterprises' depreciation funds plus retained profits will serve to finance about twenty-five per cent of all fixed investment this year, while sixty per cent will be financed from bank credits and fifteen per cent from the 46 central budget. But this last figure does not represent the limit of effective centrol over the detailed pattern of investment. . . . theiNational Bank will take into account the views of the 'branch directorate' as well as 'efficiency criteria* in deciding which enterprises should be granted credit for invest ment projects. Moreover, obligatory investment ! targets can still be set centrally for projects 46Ibid., p. 45 394 of key Importance, aside from those financed directly by the budget; and all projects above a certain value, however financed, re quire central approval. Thus, the National Bank is being given, at least potentially, enormous power to influence the direction of investment down to the level of the firm . . .4' Lange and Czechoslovakia's New Economic Model The proposals for reform in Czechoslovakia's new economic model are indeed interesting. When and if com- leted, these reforms would put Czechoslovakia along the Yugoslav road to a decentralized socialist economy, leaving behind the old methods of Soviet central planning. Sik, as the main architect of the new model, agrees that a socialist economy needs an overall economic plan stating general means and ends for a given time period, but he also believes that a market mechanism is one necessary means to achieve plan fulfillment. While he is in favor with extending the market mechanism, he contends that the real question is how to achieve a harmony of plan and market. Within such framework Czechoslovakia lends itself for a comparison with the postwar Lange model of centralized-decentralized socialism. The notion that Lange called "the minimum condition of plan" has been accepted by Sik in his proposal for a ^"Czechoslovakia: What the Reform Means," The Economist, CCXXIV (August, 1967), pp. xxii-xxv. 395 new economic plan should be limited to questions of macroeconomic nature such as distribution of material income between accumulation and consumption and the allocation of investments between different sectors of the economy. Given these basic conditions of macroeconomic plan and certain other "main proportions" such as the general price level, technological development and certain manpower policies, the implementation of macro-plans would be induced by the use of economic incentives at the lower levels. "Under socialism, then, these are conditions for a planned orientation of the development of the production base and of the basic proportions of production in harmony with the fundamental long-range needs of society, together with the conditions for the most effective development." These conditions, Sik believes, would include the intro duction of "socialist market relations" at the lower levels so that their utilization may "harmonize group and social economic interests either at the time decisions are made on the long-range production activity in its relation to a future market, or in deciding on minor, direct,changes in production activity in accord with the direct, insuffi- 48 ciently foreseen changes of the market." Sik does not consider the extension of the market and the attempt to harmonize the market with the plan to ^®Ota Sik, Plan and Market under Socialism, pp. 221-222. 396 be a retreat from socialism, but an improvement in the process of socialist aims. After all, under the Czecho slovak new system the profits of socialist enterprises still do not go to a private entrepreneur; they can be used only for wages to workers, reinvestment, or for social; consumption. The workers in turn may use their wage income only for the purchase of consumer goods and services, and not for investment in productive outlets such as would bring private profit, private rent, or private interest. The other aspect of planning where there is a fairly common bridge between Lange's position in his postwar analysis and Sik's planning doctrine is connected with the evolutionary character of economic planning and management. This can be seen from the Czechoslovak experience in the postwar transition from "extensive" development into "intensive" development. Along with the transition there was also a necessity for a shift from centralized planning methods to a decentralized system of management. In this regard, Sik writes; The development of the Czechoslovak socialist economy in recent years has shown the necessity fad overcome the negative extensive growth and to go over to a highly intensive development .... A basic prerequisite for this is doing away with the system of administratdvesplanfied management which had caused a loss of perspec tive because of the instability in the long-range plans, and also determined production by one sided, mainly quantitative and uneconomic orien tation of activity and incentives . . . Changing 397 over to a genuinely planned management and a , consistent use of socialist market relation ships is, therefore, a condition for a lasting improvement in a socialist society.49 Needless to say, Czechoslovakia entered the stage of centralization as a developed economy-* This is to the contrary of Lange's prediction that centralized socialism is vehicle for the process of economic development in an underdeveloped economy. Obviously, the tendency to discard a substantial part of central command in favor of "planning by economic means"in the 1960's has been a function of industrialization, on the one hand, and of the dependence on foreign trade, on the other. The former function is, undoubtedly, in line with Lange's thesis: at an early stage of socialist economic development to achieve certain priority goals such as large-scale indus trialization and rapid economic development, but at a later stage there will be a dire need for decentralization of economic affairs to attain economic efficiency.5® In Sik's terminology, the latter stage came about under the phenomenon of "intensive development." Vaclav Holesovsky, however, rejects the thesis that reforms in Czechoslovakia have been the direct 49Ibid., pp. 97-98. 50 Oskar Lange,Political Economy of Socialism (The Hague, VanKKeulen, 1958), p. 9. consequence of the level of industrialization, but, instead, claims that they have emerged because of the dependence on foreign trade. He proposes that internal reforms have been caused by strains and dislocations in the intrabloc foreign trade, of the crisis of bilateralism among Soviet-bloc countries, and their Western neighbors. Quoting Holesovsky: . . . the time has passed when the more advanced countries processed raw materials for their less developed partners into industrial equipment and were paid for the job in raw materials and food stuffs for their own use. The less-developed countries have begun to use the accumulated in dustrial equipment to absorb their raw materials themselves, gaining an interest in exporting their own wares, losing interest in articles previously imported, and losing the ability to exportort agricultural produce just when the need has become most pressing.5l Thus, Czechoslovakia, as one of the most advanced countries of the bloc, found itself saddled with an econo mic structure and a composition of output geared to the preceding stage of initial industrialization of its partners. For this reason, Czechoslovakia was forced to adjust to an entirely new situation in foreign demand and supply, which also meant entering Western markets on a larger:;scale and competing with Western articles on the ^Vaclav Holesovsky, "Problems of Transition to the New Economic Model in Czechoslovakia," in New Currents in the Soviet-Type Economies: A Reader, p. 475*1 399 Soviet-bloc market. This led to the search for economic reforms which were responsive to economic criteria. Although there are common links between Lange's thinking and Sik's views, the Czechoslovak system differs in many ways from Lange’s model of decentralized socialism. The following development will briefly describe these differences. The first difference is connected with the behavior of the socialist enterprises under the Czechoslovak system. These enterprises do not follow Lange's rules, but, . r instead, are supposed to maximize net profit or gross income (after the payment of all charges) . According to Sik, "While Lange's approach is noteworthy as the first attempt to link planning and market under socialism" his proposal "cannot assure a solution of the basic clashes of interest between the enterprises' advantage and that of society, between producers' and consumers' interests, and in the final analysis, it will lead logically to an administrative uneconomic solution." The reason is, Sik continues, "it is not enough to outline for the directors of enterprises only the general rules for making decisions and] to overlook the fact that they will have to act under the pressure of the economic interests of the enterprises' 52 workers." 52sik, op. cit., pp. 274-275. 400 The second difference is related to the capital market. In the Czechoslovak economy, the market for capital goods is determined by central allocation of investment funds (within enterprises and socioeconomic plans). But these funds, contrary to Lange's model, are not rationed by an equilibrium rate of interest. In the Czechoslovak economy the market for capital goods is centrally planned. Not only the overall rate, but the broad composition of investment is still centrally planned. The National Book is given an annual credit plan for fixed investment with very significant discretionary : power: it is responsible for allocating credit by sector in the light of the national plan and of its knowledge of balances already available to firms in their depreciation and investment (retained profit) funds. The allowances for interest charges in t i t i e gross profits of enterprises are arbitrarily determined, without relation to the scarcity value of capital. Within each sector, the National Bank allocates credit in accordance with the likely effectiveness of the project and may vary repayment terms (and possibly interest rates) from one sector to i another in order to retain funds within planned limits. It : does not necessarily disburse all credit allocated to a particular sector if insufficient projects satisfy its minimum profitability criteria. Major new projects are 401 still a matter for central decisions, though a centrally determined industrial project is still to repay its initial credit, with interest, within a stated period. The fourth difference between the Lange model and that of the Czechoslovak system is based on the determi nation of prices. In the Lange model the initial accounting prices are given free forces of demand and supply so that the resulting calculated prices may be regarded as "objective." Only then will the force of demand and supply be allowed to correct these accounting prices in the market place, pushing and nudging them toward equilibrium levels with the help of the Central Planning Board. In the Czechoslovak system, most prices are arbitrarily determined. With the introduction of 1966 version of the "New Economic Model" prices of certain products were to be freed from all central controls. The range of freely priced goods was to be gradually enlarged. Yet, central guidance of most prices holds. The new wholesale prices are supposed to give the economy only a rough but consistent set of approximations of average-cost prices, built up from existing labor- cost relations, existing depreciation allowances, and with a profit markup calculated according to a uniform rule: as a sum of a certain percentage on fixed capital stock and a smaller percentage on the labor cost. As such, "prices set at average production costs, exclusive 402 of capital charges on rents, were totally divorced from considerations of demand, so that enterprises seeking to maximize profits, were induced to produce an assortment out of harmony with the demand of their customers and to use relatively inefficient combination of inputs to pro-* 53 duce their output." In this manner, prices of producer goods are still supply?determined. They are based on production costs that reflect inefficient input-output relations at a time when the central planners most likely wish to correct these relations and deploy resources to achieve a more "intensive development." So far as consumer goods are concerned, a system of central fixing of prices has historically prevailed in Czechoslovakia. A system of prices based on costs cannot be completely satisfactory. In this connection Joan Robinson writes: For a long time to come there will be particu lar scarcities of supply to relative demand. A pattern of supply-and-demand prices has some how or other roughly been established by differ ential rates of turnover tax. To move directly to a pattern of prices based on relative costs would fail to maintain a fit between demand and supply. Yet there is no reason why a particular enterprise should benefit (in easier profits) from the scarcity of the type of productive cap acity it happens to command. Moreover, since the socialist sector of the economy imports 53 John M. Montias, "The Czechoslovak Economic Reforms in ' Perspective," in New Currents in the Soviet-Type Economies: A Reader, pp. 507-508. ; 403 consumer goods from cooperative agriculture, and imports a great deal from capitalist and from other socialist countries, there are bound to be unforeseen changes in supply from time to time, which are more convenient to deal with by alter ing prices than by rationing. The remedy is, Robinson continues, therefore, to •let the office of price administration set final prices to the consumers so as to maintain an overall balance between sales and expenditure and consequently an equality between demands and supplies. Once this proposal is followed in Czechoslovakia, it will bring the system closer to the spirit of Lange's Central Planning Board. General Appraisal The life of the new system has been much too short to permit an empirical evaluation, but we can speculate on the likelihood of its success or failure. The reform is undoubtedly a step forward away from the Soviet model which was not suited for a small industrialized country like Czechoslovakia with an inadequate raw material base and a heavy dependence on foreign trade. There are certain j limitations which will affect the performance of the new i system. In the following it will be useful to devote our i 54 Joan Robinson, "Socialist Affluence," in Socialism, Capitalism, and Economic Growth; Essays Preiented to Maurice Dobb, p. 1'84. 404 discussion to these limitations which, if the new system is to be viable, must gradually go out of the system. Price Reform If, according to Sik, the re-establishment of market conditions is the main goal of reforms in Czecho slovakia, the most basic prerequisite for these conditions is the formation of a rational price system. In the past, relative prices have been fixed largely without regard to relative cost and, on the wholesale level, almost completely disregarding the pattern of demand for consumer goods. Retail prices of consumer goods were supposed to be brought to clearing levels by the so-called turnover tax. Such attempts came to a failure due to this extremely discriminatory tax. On the other hand, the wholesale prices proved to be irrational as they were applied to transactions between socialist enterprises. Quoting Michal: Prices of material inputs and outputs have been fixed in such an inconsistent way that some enterprises, although efficient from the view point of preferences of the planners, suffered continuous losses and had to be subsidized, whereas some inefficient enterprises easily realized relatively large profits.55 The price reform which was enforced in the recent version of Czechoslovakia's new economic model had to 55Michal, op. cit., p. 495. 405 fulfill two objectives: to raise the wholesale price level sufficiently to leave the enterprises with a positive net revenue (after the payment of all charges) as a sufficient inducement to produce? and to bring the struc ture of wholesale prices more in line with the structure of cost and with the pattern of demand. But, in essence, there were two problems. On one hand, the market could not take care of such a tremendous restructuring of wholesale prices. In this connection, Holesovsky writes: . . . the distance of existing relative price levels from any set of prices calculated according to a consistent formula has been shown to be so enormous that a direct trans ition under the power of market forces alone would be bound to end up in a chaotic criss cross of feedback sequences with a degree of uncertainty which it is hard to imagine a real market handling successfully.56 Since Lange assumed that the necessary price adjustments were to be small, this question of price adjustment was relatively an easy process in his model. But in practice the necessary price adjustments take a long time and for this reason it is hard to reach equili brium prices. However, if the general instructions in the Czechoslovak system to the enterprises is in terms of net profit or gross income, this makes sense only if 56Holesovsky, op. cit., p. 481. 406 the system is sensible. The proposal is then to rationalize the price system by gradually introducing the role of demand, because, secondly, the new wholesale prices were more of a price revision than price reform. These prices still remain purely supply prices, with little attention paid to demand conditions. They are based on cost data taken from the mid- 1960's which was a period of serious disequili- bria characterized by distorted wages, wasted material and fuel consumption, under-utilization of stock, and a mixture of shortages and sur? pluses.5' Moreover, the turn-over tax still so extremely un even, the consumer demand has little impact on the pattern of output, and the new system is far from being optimal from the consumers' point of view. Finally, little has been done about agricultural and foreign trade prices. Caution Against Monopoly There is no doubt that Sik's proposals have intended to approximate the Lange-type model of a decen tralized socialist economy. As there is a possibility for Lange's managers to disobey his rules and thus behave monopolistically, the organizational structure and the incentive system in Czechoslovakia are such that the same behavior patterns are conceivable. 5?George Staller, "Czechoslovakia: The New Economic Model of Planning and Management," American Economic Review, LVIII (May, 1968), p. 564. 407 Each major commodity group is produced and sold by a limited number of national enterprises supervised by the same directorate with exten sive powers. The profit maximizing enterprises interested in bonuses for both managers and employees as well as in internal funds for re investment, are unlikely to engage in competition, and in fact the directorate, which is involved in the financial success of the subordinate enter prises, is a convenient place where people of the same trade . . . meet together.'^ The Czech remformers are aware of monopolistic elements in their markets, but they maintain that either foreign competition or direct state intervention will hold them in check. Their expectations, however, are unlikely to be realized. For one thing, the foreign trade sector continues to be separated from the domestic economy and the balance-of-payments difficulties, especially with the hard currency (Western) countries, will not permit foreign competition to play any role in years ahead. For another thing, arbitrary government intervention is exactly the main intention of the reforms to avoid. In short, the exercise of strong monopolistic powers could become a main obstacle on the way to a more flexible price system. Thus, it is necessary to prevent potentially strong monopolistic power from being exercised in a harmful manner. As Sik 58Ibid. 408 said to an American economist, in a recent interview: "We must have very strong anti-trust laws."^ Avoidance of Inflationary-Pressures1 Historically, inflation has been a macroeconomic problem in Czechoslovakia. A hidden inflationary pressure came as a result of an administrative system of management. This inflationary development was shown mainly in the growing demand by enterprises for capital investment without genuine material coverage. This tension in the field of investment brought about wide-spread diversion of investment projects and also an extension of the length of time for construction projects, and consequently the price of investments. In the field of consumer goods inflationary pressure made itself felt, not only in the moderatexrise in average prices of various groups of goods, but also in the lowering quality of durability and style of the products and in the public's loss of time spent looking for the needed goods. Inflation has also been a problem in recent years. It came about as a result of the unsuccessful operation of the recent price reform. In his recent interview with an American economist, Sik explained the problem as follows: 59Harry G. Shaffer, "Problems and Prospects of Czecho slovakia's New Economic Model," in Comparative Economic Systems, p. 331.__________________________________________ 409 The intention of the price reform had been to increase wholesale prices sufficiently so that enterprises could operate profitably .... But what happened was that wholesale prices rose too much. As a result, enterprises began to earn unreasonably high profits; now they have a lot of money to distribute in the form of higher wages and increased investments, but there is no equivalent increase in output of goods. We therefore have a situation today that looks like prosperity to workers and mana gers; but in reality, there is a shortage of goods, there are strong inflationary pressures, and there is no adequate incentive to induce enterprises to strive for more efficient per formance. But a necessary condition for an acceptable opera tion of socialist markets is the avoidance of severe | inflationary pressures on the macro-level. Sik proposes | that a second price reform is not feasible. However, an | | attempt must be made to develop gradual pressure on prices either where it is possible through competition, or where it is not possible through certain centrally directed simulated market conditions in order to put the enter- ! prises under heavier market pressure. But questions j arise as to whether this price reduction will not cause hardships for many enterprises. Sik believes that the pressure to reduce prices will cause a lot of diffi culties for the enterprises. He s-tates: There will be not only individual enterprises but entire branches that will run into diffi culties. Yet, there is no ;other way. 60Ibid., p. 327. 410 Enterprises will have to be able to manage or they will have to be closed * Inefficient enterprises cost society more than they bring to it; they simply must be shut down. This saves raw materials; workers can be shifted to where they can be comparatively more pro ductive/ etc.61 i Decentralization of Economic Power — ■ - — - — - -. - . . . . . . ; Last, but not least/ a decentralized socialist i |economy in the spirit of Lange presupposes a genuine | decentralization of economic power. At present it seems i |that in addition to the complexity of economic problems facing Czechoslovakia, the new system itself represents a challenge between the economically desirable and the |politically feasible, as illustrated by the Russian j |intervention in 1967. This remains to be seen in the |future, as decentralized socialism in Czechoslovakia is a very interesting economic experiment to watch. i | Summary Contrary to Yugoslavia, Czechoslovakia entered the stage of centralization as a developed country. In this stage, Czechoslovakia experienced considerable growth until the early 1960's when she began to run into economic problems. These problems emerged because in Czechoslo- i valia, a small but industrially developed country, there was a tendency for the production of raw materials to lag 61Ibid., p. 328. 411 |behind the growth of manufacturing, when the traditional I I jmethods of centrally planned management were in operation. jSuch development caused underfulfillment of investment I plans in the extracting and basic materials industries • ! for the overfulfillment of such plans in the manufacturing industries. This, in turn, caused many disproportions in the economy until 1963 when Czechoslovakia began to |experience a drop in national income. Present economic reform in Czechoslovakia is |concerned with replacing the old directive system of |planning and management with a new one based on nationwide i |economic planning with a controlled market mechanism. The need for applying a more efficient system of socialist I planning and management emerged from theoretical analyses i !of Ota Sik, the main architect of proposals for reform. He contended that centralization helped to accelerate I the social and structural remolding of the economy, but that it became gradually the main impediment to greater efficiency. In this way, there seemed to be no option for Czechoslovakia except changing from the traditional model under conditions of "extensive development" over to a new system of economic planning and management under conditions of "intensive development." This transition has brought Czechoslovakia from a centrally-planned economy toward a decentralized-oriented 412 economy which has in turn caused certain related macro- economic problems. The proposals for reform, when and if completed, would put Czechoslovakia along the Yugoslav i road to a decentralized socialist economy. Within this framework, the new Czechoslovak economic model both resembles and differs from the theoretical Lange model of | !socialism (centralized and decentralized). Its similari- i !ties include: (1) "the minimum condition of planning," as |accepted by Sik, limiting the central economic plan to .questions of a macroeconomic nature such as distribution j 5 of national income between accumulation and consumption I land the allocation of investments between different sectors |of the economy; (2) taking into account that Czechoslova- |kia entered the stage of centralization as a developed I economy and thus being in conflict with Lange's prediction |that centralized socialism is a vehicle for the process i |of economic development in an underdeveloped economy, the other aspect of planning which has to do with its evolu tionary character is in agreement with his position. This can be seen by looking at the Czechoslovak experience in i the postwar transition from "extensive development" into |"intensive development," thus causing a shift from centralized planning methods to a decentralized system of management. At the same time, the proposals for reform !in Czechoslovakia differ from the Lange model of market | isocialism in several respects: (1) Enterprises do not follow Lange's rules for choosing outputs and inputs, but, instead, are supposed to maximize profits; (2) the j market for capital goods is not controlled by an equili brium rate of interest, but is determined by central allocation of investment funds; and (3) prices are mostly |arbitrarily determined. 414 ! CHAPTER VIII I SUMMARY AND CONCLUSIONS Summary i | This study began with a survey of the socialist jcontroversy over the issue of rational economic calculation J junder socialism. It consisted primarily of a theoretical j |analysis of the prewar Lange model of decentralized social ism along with Lange's postwar writings on centralized j |socialism in comparison with contributions made to this !subject by such Western neo-Marxists as Dobb, Sweezy, and |:Baran. Attention has also been concentrated on the relevance of Lange's theoretical writings (prewar and i jpostwar) to the development of the Yugoslav and Czecho- j Slovak economic systems. i | The socialist controversy over the issue of rational I | jeconomic calculation under socialism formally began in 1920 with Mises' criticism. He argued that without private l ownership of the means of production there would be no market for capital goods, no possibility of determining "objective" prices for them, and consequently no way of determining rationally how they should be used. Mises' criticism was the first step in the history of the contro- j versy to assess that rational economic calculation is a theoretical impossibility under socialism. Robbins and 415 Hayek, however, in 1934 and 1935 respectively pointed out that rational economic calculation, although theoretically possible, cannot be practically feasible. Their argument is focused upon the fact that a rational allocation of factors can be solved by a set of simultaneous equations. While they admit that such a solution is theoretically plausible, they rule out the solution as "humanly impos sible." They argue that the operation of such method |requires the assembling of statistical data and the |quantification of technical knowledge necessary to formu late theeeorrect equations for such a solution - a task which is beyond human capacity. | Mises' attack on socialism, as well as the Robbins- i Hayek criticism, while being followed by similar reactions by Halm and Weber, led to a number of counter arguments. The main step in this direction came from Taylor who had suggested by 1929 that socialists could solve the problem by giving accounting values to primary factors and then subsequently adjusting these values through a process of "trial and error." Developing on this suggestion in the 1930's, Lange, for the first time, made a clear blueprint for resource allocation under socialism. Lange's model consisted of two parts. The first part was basically an answer to the Mises-Robbins-Hayek |argument that rational economic calculation can be i I attained by a CPB performing the functions of the market, 416 thus demonstrating that an efficient allocation of resources is feasible and practicable in a socialist economy. Given such goals as freedom of consumer choice, freedom of occupational choice, and consumer sovereignty, the CPB's artificial "accounting price" system represents exactly the same sort of parameters to which producers and consu mers would have to react under- competitive market capital ism. To illustrate his point, Lange argued that Mises jwas confused between two types of prices: the first kind j is price in the ordinary sense, i.e., the exchange ratio jof two commodities on the market; the second kind is in |the generalized sense, i.e., "the terms on which alterna- j |tives are offered." It is only the latter sense, Lange i |points out, which is fundamentally important for the ! problems of rational economic calculation and allocation of resources. | It is possible to attain prices in the latter sense, jLange argues, by using a method similar to the free | jmarket, i.e., by a method of successive "trial and error;" i 4 The central planners can start such a method with a given jset of prices chosen at random, though in practice the |trial and error method- would be based on historically I |given prices. All that is required is that producers and |consumers take these prices as given and then play the rules of the game. Consumers cire free to allocate their ! j income in any manner which maximizes satisfaction for 417 them. Producers, instead of maximizing profit, should follow two rules: (1) they should keep the total costs for the output at a minimum, and (2) they should push production to the point where marginal costs are equal to the price of the product. As a result the quantities of each commodity supplied and demanded would be determined. In the event of imbalances between quantities supplied and demanded, shortages and surpluses would be alleviated by the CPB through changing the prices and equilibrium i |prices would thus be established through the method of !"trial and error." i I In regard to the practical difficulties raised by I j Robbins and Hayek in attaining rational economic calcula- |tion under socialism, Lange argued that such difficulties can be overcome by the same method of "trial and error.” The CPB would not need to have complete lists of the I ! | different quantities of all commodities and would not have j to solve hundreds of thousands of equations. The only equations which have to be solved would be those of con sumers and managers. Lange argues that everytime Hayek buys a newspaper, these two equations are solved. Within such a framework, Lange designed a model of decentralized socialism in which there is a distinction between public ownership of the means of production and social processes for coordinating economic decisions. As i j such, the Lange model is a microeconomic model of resource | 418 |allocation for decentralized socialism which is quite similar to Walrasian system under competitive market capitalism. The main difference is that under the decentralizedamodel of socialist economy, a CPB would perform of the functions of the market in attaining equilibrium prices. i | The second part of Lange's model was a broader j"case" for socialism. In this part, Lange, using personal | lvalue judgments, argued that socialism would have certain i i ! macroeconomic benefits over capitalism which would in j i I turn make the former desirable over the latter. More |precisely, the decentralized socialist "case" for socialism |is essentially threefold. First, it is contended that i i 'socialism can allocate resources efficiently and in |accordance with consumer preferences as well as, indeed i ! better than, competitive market capitalism. Second, a j socialist economy would or could be in a better position to promote greater income equality, full-employment stability and economic growth than capitalism. Third, capitalism in practice is not competitive. Lange's scheme has been criticized on many grounds. On tWo grounds, however, the criticism seems to be strong.1 First, it seems that there would be a lower •^Friedrich A. von Hayek, Individualism and Economic Order (Chicago: The University of Chicago Press, 1963)^ pp. 192, 197. 419 I level of efficiency in his model than a perfectly competi- | jtive system. This is due to the fact that central planners Jset prices while managers set outputs. Thus, Hayek argues that in reality Lange's model would adjust to supply and demand very slowly because all of the information for ’ changing prices would have to flow up and down through a [vast bureaucracy. ! Second, Hayek argues that there would be an j additional problem in getting the managers to follow the j I j correct rules for optimal input and output mixtures. jSpecifically, if the manager is merely supposed to ■maximize the profit of the enterprise, then under conditions; I of monopoly, he would make decisions contrary to social ioptimization. The manager of a monopolistic firm will not i i [maximize profit by merely setting his output at the point I I ;where marginal cost equals prices, but at the point where [marginal cost equals marginal revenue. This is another j way of saying that a monopoly will restrict output to a |lower level in order to set higher prices and make higher | [profits. Furthermore, Hayek argues that the CPB will not j automatically correct the situation because the lower supply relative to demand is a proper sign for the CPB to [raise prices. Presumably, the board does not know the | j marginal cost curve of the enterprise, and it would destroy j the simplicity of Lange's scheme if they tried to find j out marginal costs for all ofthe enterprises. | 420 i | The postwar experiences of many Communist and underdeveloped countries going into the process of economic development via centralized socialism as a vehicle for industrialization made Lange's "economic theory of socialism" merely a blueprint. For this reason, socialists such as Dobb, Sweezy, and Baran focused their interest on centralized socialism as a type of economic system suitable i |for achieving priority goals in underdeveloped countries. j jLange, in his postwar writings, accepted this view at i |least in the first stage of socialist economic development; in a later stage when the important goals of centralized i socialist planning have been achieved, then a socialist ;economy should and can become, in large part, decentralized i The crucial difference between decentralized social- |ism and centralized socialism is the abolition of consumers !sovereignty in the latter and the replacement of the jpricing process by ex-ante coordination. Taking the abolition of consumers' sovereignty for granted, obviously the centrally planned economy is a command economy in the sense that production follows a predetermined course, which cannot be materially changed by individual members of the economy, by the managers, wage earners, or consu mers. In this way, the central authorities must secure the opinions of experts in setting aims for the economy, just as they need the help of the managers in the formu lation and execution of the central plan. | 421 While administrative measures were needed to attain a high level of economic development in the first stage of socialist planning, in Lange's opinion, they become impediments to further development as the economy becomes mature and complex. They lead to a waste of resources due to inflexibility and make it difficult to adjust production to consumption and the needs of people. For | this reason, in the second stage of socialist planning | ! the use of economic means becomes primary to attain j j economic efficiency. More specifically, Lange argues that i ! there are two bases for decentralization: first, economic j planning should be decentralized so that the decentralized j j decisions would be the same as if they had been made centrally. Second, economic planning must be decentral ized if central planning in some situations responds too late. In the second stage of socialist planning, the economy would thus be decentralized. Yet, within this I sphere of decentralization, which controls all the micro- economic decisions of enterprises, there are certain macroeconomic decisions which are to be minimum inclusions under central planning. The plan should include two things: division of national income between investment and consumption and the distribution of investment among different sectors. Beyond these two minimal requirements, the plan would include the production of basic commodities ! 422 |like steel and capital goods, but the decision as to the i [details as to assortment of goods would be up to the i I | enterprises. Whether centralized socialism is able to provide the i i conditions for rational economic calculation is a matter of value judgment. It obviously depends on personal |opinion as to whether the preference scale expressed by jconsumers and laborers is superior to that of central i jauthorities or vice versa. A critic of centralized social ism would be inclined to argue in the following fashion. |Although, in a centrally planned economy, the authorities I should think in terms of alternatives sacrificed (because, [after all, the intention of acting rationally is implied in I the concept of planning), opportunity cost calculations, ! jhowever, are not practical in physical units and of little i lvalue because they are based on prices which have been [artificially set by the authorities. In other words, due i I to abolition of consumers' sovereignty, the price system i • i becomes irrational and rational economic calculation would thus become impossible. Lange, as a socialist, preferred freedom of consumption and occupation in a socialist system. The Yugoslav economy originally followed the centralized model of socialism. What the Yugoslavs called "administrative socialism" was envisaged as a full-fledged command economy correspondent to the model of centralized } 423 i ! |socialism as perceived by Dobb, Sweezy, Baran, and Lange I in his postwar writings. Nevertheless, in the early 1950's, Yugoslavia was the first Communist country to move toward a more liberal form of socialism and thereby make a widespread use of decentralization, profit motive, and mar ket prices as important ingredients bf the new system. I This movement began with two major institutional I jreforms. First, the Yugoslavs decided to discontinue collectivization of argriculture. Second, the Yugoslavs |decided to democratize the Yugoslav socioeconomic system i by giving the workers the right to manage their enterprises i |through the elected Workers' Councils and Management Board, thus establishing social ownership. The economic and social reform introduced in 1965 has brought further decentralization of economic controls, and a further exposure of industrial enterprises to competitive domestic forces to increase efficiency. Within such a framework, Yugoslavia has not only |left the fellowship of underdeveloped countries, but has |also moved toward a "mixed" or a "market-planned" economy. In this transition, Yugoslavia has revived some of Lange's theoretical recommendations from his prewar and postwar models. However, there are certain important differences between the contemporary Yugoslav economy and the Lange prewar model of decentralized socialism, described in Chapter VI. 424 Contrary to Yugoslavia, Czechoslovakia entered the j stage of centralized planning as a developed country - an | event which is contrary to Lange's prediction in his i postwar analysis. With a high level of economic develop ment already attained, the traditional system began to extend socialist reproduction with its detailed output targets, centrally determined and compulsorily imposed, and its corresponding technique of factor allocation. This j system, as noted in the course of this study, made possible | and even induced "spurious" production of goods that were i | not in demand, excessive growth of stocks and incompleted j | construction, and failed to secure minimization of factor I j inputs or to stimulate technical advance. All these j | induced what was called in Czechoslovakia as "extensive i jdevelopment." j ! As time went by, the possibilities of further S j "extensive development" became exhausted - especially when I Czechoslovakia experienced a decline in industrial output in 1963 - and the changing conditions rendered the need of I changing over to "intensive development." At this time, a conflict developed between the given system of economic planning and management on the one hand and the economic conditions under which it was supposed to function, on the other. This created a need for economic reforms which came about largely by the efforts of Ota Sik as the main archi- i tech of Czechoslovakia's new economic model. ! 425 | The original draft principles of this model, as they j |appeared in 1964, hardly provided a blueprint of the reformed system. The document was largely based on Sik's proposals in his decentralized model. Essentially, his proposals were to substitute the mechanism of a market economy operating within the framework of a broad overall social plan for detailed economic planning coming from the center. In 1966 a new version of the model was proposed | i j for further decentralization of most economic decisions ] |concerning consumption and production. The most signifi- i leant element in the new system was a major reform of the i |price system, which heretofore reflected neither relative production costs nor relative scarcities. The general functioning of the reformed price system was conditioned by the rehabilitation of the economic function of prices - something which had been severly suppressed in the centrally i |administered, directive-based model of management. In this connection, a theoretical analysis of different prices came from Sik. In brief, there were to be three types of prices:2 (1) basic constructing of prices in production; (2) specific wholesale prices; and (3) con struction of retail prices. 20ta Sik, "Prices in the New Economic System of Management in a Socialist Economy," in Planning and Markets: Modern Trends in Various Economic Systems, ed. John T. Dunlop and Nikolay P. Fedorenko (New York: McGraw-Hill Book Company, 1969), pp. 217-228. 426 I Since one of the main goals in a planned economy is to assure harmony between the interest of society in an effective development of the economy with the interests of the enterprise and its employees in maximizing income, production prices of the different types of goods were to be formed by deriving the profit-share of the price from the value of fixed assets and circulating capital, as r j well as from the value of the wage funds (production funds used). Specific wholesale prices will deviate more I |or less from production prices formulated as the basic price construction. These deviations, although temporary, are needed to adapt supply to change in demand. In this way only, can a price equilibrium be achieved. This problem, Sik argues, is, in a broader context, a problem between the market mechanism and the socialist I (economic planning. "It is not always possible to assure an absolutely correct prognosis in the overall social (plan. Therefore, there must constantly be additional . 3 |corrections to previous basic decisions." Consequently, |the more need there is for such correction of past deci- |sions in production (particularly in investment), the more j is the conflict between supply and demand and the more need for the wholesale prices to deviate from production I prices. i I i |^Ibid., p. 222. 427 i Lange realized this problem in the 1930's - that |there is a considerable monopoly of supply as compared to Sdemand. However, he proposed measures against the abuse of |the monopolistic position of Socialist enterprises in (regard to prices. He suggested that the setting of j "parametric functions of prices" should be transferred.! to the central bodies. Sik is not an advocate of this procedure when writing: | Experience today shows that neither from the stand- i point of a possible recognition by the center of the price equilibrium of each individual product, nor from the standpoint of the conflict of interest ; in cases of setting rules by central institutions i for the enterprise, can Lange's idea be carried j out.4 i | The realistic procedure would be for the equilibrium price to be established by a direct clash of interests between the producers and consumers in the market. Given this interaction, there should be a restriction upon unjustified monopoly. This can come by certain financial |instruments - such as credit, interest, taxes, foreign trade measures,, and so forth. Retail prices for consumer goods must be based on trade prices as the basic price construction. The latter cannot diverge for long from the level of production prices if there is no conflict between the market mechanism and 4Ibid. 428 the planning of the national economy. Retail prices in i i selling consumer goods are to exceed the consumption of I employees for production. The difference would take the i I form of turn-over tax and trade differential - the differ- i ence between the total production price of consumer goods : and its total trade price - which goes to society as a i | whole without being first appropriated by the producers. ! Thus, Sik concludes that wages and prices are the basic : instrument for distributing the national income and for I covering certain social needs. Within this framework, the Czechoslovak economy i will in future move toward the decentralized form of a socialist economy as conceived by Lange in his prewar | model. Although there is a fairly common bridge between j i j Sik's proposals for reform and Lange's thoughts as | registered in his prewar model, there are certain differ- ! ences between them. These differences were described in i l ! Chapter VII. I ! Conclusions I ■— — . I t The hypotheses set forth in the introductory chapter were two: (1) given such goals as freedom of consumer choice, freedom of occupational choice, and consumer ! sovereignty, the Lange-type model of decentralized social- 1 I ist economy is capable of functioning by a Central Planning j j Board performing the functions of the market; (2) at an ! 429 |early stage of development, a high degree of centralization in planning and administration is necessary, especially when structural changes and a high rate of capital accumulation are on the agenda for rapid industrialization and economic development; but at a later stage of develop ment, there will be a need for decentralization to promote economic efficiency - this was the message- of Lange in his postwar writings. | It is the writer's contention that the first hypo- | |thesis was substantially proven but that many problems I jremain. First, the theoretical framework of the Lange (model is logical and plausible; that is, microeconomic (allocation of resources through the Central Planning Board to satisfy the consumer demand. The main problem is still motivational in character - it has to do with the manager behavior. Whether the manager would follow the Lange rules and, while doing so, take prices as given is (still unknown. For one thing, he can disobey the first rule by not following the combination of factors of produc tion which would minimize total costs by equalizing average cost with the prescribed price for the product, when he sees he has not means of inducing his suppliers to offer more factors of production (or inducing his purchasers to buy more) if he is,interested in expanding production. In this case, the only way for him to expand production would [be to use uneconomic methods and inferior means of | 430 ! production; and, when he cannot sell at the set price and j !until the price is lowered by the CPB, he will have to | stop production; whereas, under pure competition he would have lowered his prices. Thus, the Lange model of central ized socialism has turned the manager from a "price adjus ter" into a "quantity adjuster" who can cause bottlenecks in production. For another thing, the Lange manager may not take prices set by the CPB as given. This is perhaps due to | |his strategic position in the economy if the size of his i producing unit happens to be large relative to the market served. In this case, he might restrict the output in the same way as a monopolist does in a capitalist economy in I |order to make a larger profit. Doing this, he would ! cause inefficiencies in allocating the needed resources for the restricted production. Thus, the Lange model of decentralized socialism may act monopolistically rather j than competitively, as it is supposed to do. | i Second, the Lange macroeconomic argument incorp orated in the second part of his prewar model is too persuasive in character, that is, the argument that social ism would replace capitalism. In his comparison between capitalism and socialism, his most important point is !concerned with the question of whether or not the continu- i : ation of capitalist systems in the future will be consis- j tent with economic progress. In response, he bases his skepticism on the argu- : ment that as the size of firms becomes too large in a j jnumber of industries for easy entry of new firms, the |existing firms in those industries will try to hold back | |on the introduction of innovations until the existing capital has been amortized. Lange thinks that in a mature capitalistic system there would be a sharp slowing j I down of the rate of economic growth. In his opinion, this istage had been already reached at the time when he was writing his model, which was in 1936 and 1937. Lange seems further to have accepted the stagnation i I thesis, for he took the position that a shortage of pro- j f itable investment opportunities would develop in mature |capitalistic systems. Writing in the context of the 1930's jdepression in the United States, it is easy that one can see why Lange was so pessimistic in his evaluation of the prospects for capitalism. Since he could see no practical solution to the problems of serious instability and i stagnation under capitalism, he concluded that socialism 'represented the only effective alternative. In evalua ting Lange's conslusion, it can be said that he tended to ! overgeneralize from the extremely bad conditions of the I |1930's depression. In this respect, Dominick Armentano Iwrites: 432 For one thing, he appears to have underestimated the extent of competitive industries. Though there is undoubtedly concern among such firms in regard to the timing of the introduction of new innovations, it seems clear that there is not the massive tendency among them to withhold investments which Lange describes. The growth rate achieved by the United States in the period since World War II and particularly during the most recent decade of 1960's could not have been realized if Lange's contention had been appli cable over this period. In short, the experience of the postwar period indicates that the problem of growth with reasonable stability can be han dled effectively within the framework of an adaptable mixed-capitalist system.5 | In regard to the second hypothesis, it is the |writer's contention that the theoretical framework has been |implemented in practice'to a large extent judging from the jmaterials in Chapters VI and VII. However, there are vital j jramifications and problems which have emerged in practice i jdue to the fact that Yugoslavia and Czechoslovakia have i |gone beyond Lange * s proposals. i j In the case of decentralized socialism in Yugoslovia, 1 I where the enterprise sets both prices and outputs and makes most investment decisions, several concrete problems may ibe expected to arise (and most of these have already shown to some extent). Many of the efficiency problems will be |identical to those allegedly present under competitive 5 ; Dominick Armentano, "Socialist Thought: Liberal and jAuthoritarian Socialism," in William P. Snavely, Theory of ! Economic Systems: Capitalism, Socialism and Corporatism |(Columbus, Ohio: Charles E. Merrill Publishing Company, j1969), pp. 157-158. imarket capitalism. Thus, one would expect to find j i ! (1) monopolistic restriction of output by some enterprises - contrary to consumer preferences, (2) higher prices and ' profits by some monopoly enterprises, and (3) elimination !of competition as a source of efficiency. i In addition, in an economy where enterprises are run by Workers’ Councils on the Yugoslav Model, other I types of inefficiencies may also be expected. For example, there is the fact that the desire for democratic partici pation of workers in the councils may lead to much smaller scale enterprises than would be dictated by the purely ! economic criteria of the economies of scale. Against ! this, the Yugoslavs argue that the Workers’ Council system provides more incentive for the workers than central planning. 1 However, the efficiency of the system will be ; determined not only by how well it allocates the resources i at a given moment under given conditions, but also how | well it succeeds over a period of time under changing conditions. Considering this, it is too early to conclude ! how well these problems are being solved or can be solved, | as the Yugoslav system has been evolving for almost j twenty years. It is only with time that one can predict i ! the efficiency of the system. j The gist of the argument as applied to Czecho slovakia is that a centralized system of planning is a ! 434 ! suitable vehicle for "extensive growth" - a rapid expansion I of industrial output by means of massive injections of : labor and capital, using many established techniques - but that it is not capable of maintaining smooth and rapid | i "intensive growth" at a later stage of development based |on technical progress, improved organization and product development. To the extent that Czechoslovakia has moved from the former into the latter, the Czechoslovak economic system has adopted a decentralized system of management : and planning - thus putting into practice some of Lange's recommendations in his postwar analysis. This movement, however, has not come as efficiently and rapidly as the Yugoslav case. The Czech reformers believe that the new system of planned management with the utilization of the market mechanism (along with I . the reformed price system), compared to the traditional methods of directive distri bution of production factors, represents a higher type of planning, since it offers better possibilities of insuring a stable and balanced economic growth and rational 1 criteria for moving the Czechoslovak economic system more efficiently. No doubt many problems similar to those in Yugo- I ! | slavia will emerge. Yet, one should remember that these i ! problems are natural outcomes of the convergence of !central planning with market socialism in both Yugoslavia I |and Czechoslovakia. Granted that a mixed solution is I 435 optimal, there is no question that the contemporary Yugoslav and Czechoslovak economic systems do approximate : the basic rudiments of the Lange model of centralized- ! decentralized. This model is definitely a "mixed" economic i (system combining certain features of central planning with |others associated with the theory and practice of market capitalism. Within the framework, although there are certain differences between the Lange model in theory and in practice, in the Yugoslav and Czechoslovak "mixed" systems there has been a "division of labor" on the same basis that Lange envisioned - wherein the enterprise managers would make all of the current and short-run decisions concerning the use of available labor, raw materials, and capacity, the central planners would be free of this detail, so that they could concentrate on long-run macroeconomic planning, investment planning for expansion iof capacity, global planning regarding the division of ’ national income between accumulation and consumption, and introduction of new technology. 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"Czechoslovakia's New System of Economic Planning and Management." World Marxist Review, VIII, (March, 1965). Staller, George. "Czechoslovakia: The New Economic Model of Planning and Management." American Economic Review, LVIII, (May, 1968). Stanovink, Janez. "Planning Through the Market: The Jugoslav Experiment." Foregin Affairs, An American Quarterly Review, XL, (January, 1962). Taylor, Fred M. "The Guidance of Production in a Socialist State." American Economic Review, XIX, (March, 1969). United Nations. Economic Survey of Europe in 1966. Recent Economic Development in Eastern Europe and the Soviet Union, (E/67/II/E.11), (June, 1967). Vickery, William. "Some Objections to Marginal Cost Pric ing." Journal of Political Economy, LVI, (June, 1943). Ward, Benjamin. "The Nationalized Firm in Yugoslavia." American Economic Review, LV, (May, 1965). C. Articles Taken from a Book Armentano, Dominick. "Socialist Thought: Liberal and Authoritarian Socialism." William P. 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Comparative Economic Systems: Models and Cases. Edited by Morris Bornstein. Homewood, Illinois: Richard D. Irwin, Inc., 1965. Halm, George. "Further Considerations on the Possibility of Adequate Calculation in a Socialist Economy." Collectivist Economic Planning. Edited by F. A. von Hayek. London: George Routledge and Sons, 1935. 444 Hansen, Bent. "A Note on the Rules for Competitive Social ism." On^Political Economy and Econometrics: Essays in Honour of Oskar Lange. Warsaw, Poland; Polish Scienti fic Publishers, 3.965. Hayek, Friedrich A. von. "The Nature and History of the Problem." Collectivist Economic Planning. Edited by F. A. von Hayek. London: George Routledge and Sons, 1935. Holesovsky, Vaclav. "Problems of Transition to the New Economic Model in Czechoslovakia." New Currents in the Soviet-Type Economics: A Reader. Edited by George R. Feiwel. Scranton, Pennsylvaniainternational Textbook Co., 1968. Lange, Oskar. "On the Economic Theory of Socialism." On the Economic Theory of Socialism. Edited by Benjamin E. Lippincott. Minneapolis: University of Minnesota Press, 1938. Lange, Oskar. "The Computer and the Market." Socialism, Capitalism and Economic Growth: Essays Presented to Maurice Dobb. Edited by C. H. Feinstern. Cambridge: Cambridge University Press, 1967. Lavrac, Ivan. "Competition and Incentive in the Yugoslav System." Yugoslav Economists on the Problems of a Socialist Economy. Edited by Radmila Stojanovic. New York: International Arts and Sciences Press, 1964. Liberman, Evsey G. "Plan, Profits and Bonuses*" i-n The Liberman Discussion: A New Phase in Soviet Economic Thought. Vol. I of Planning, Profit and Incentives in The U.S.S.R. Edited by Myron Sharpe. New York: Inter- national Arts and Sciences, 1966. Maksimovic, Ivan M. "Professor Oskar Lange on Economic Theory of Socialism and Yugoslav Economic Thinking." On Political Economy and Econometrics: Essays in Honour of Oskar Lange. Warsaw: Polish Scientific Publishers, 1965. Michal, Jan M. "Market Socialism: The Case of Czecho slovakia ." New Currents in Soviet-Type Economics: A Reader. Edited by George R. Feiwel. Scranton, Pennsylvania: International Textbook Co., 1968. 445 Mises, Ludwig von. "Economic Calculation in the Socialist Commonwealth." Collectivist Economic Planning. Edited by F. A. von Hayek. London: George Routledge and Sons, 1935. Montias, John M. "The Czechoslovak Economic Reforms in Perspective." New Currents in the Soviet-Type Economics: A Reader. Edited by George R. Feiwel. Scranton, Pennsylvania: International Textbook Co., 1968. Neuberger, Egon. "Central Planning and its Legacies: Implications for Foreign Trade." International Trade and Central Planning. Edited by Alan A. Brown and Egon Neuberger. Berkeley and Los Angeles: University of California Press, 1968. Pierson, N. G. "The Problem of Value in the Socialist Community. Collectivist Economic Planning. Edited by F. A. von Hayek. London: George Routledge and Sons, 1935. Robinson, Joan. "Socialist Affluence." Socialism, Capital ism and Economic Growth: Essays Presented to Maurice Dobb. Edited by C. H. Feinsteln. Cambridge: Cambridge University Press, 1967. Rosicky, Mikoslav. "Organization and Management of Industry and Construction in the Czechoslovak Socialist Republic." Czechoslovak Economic Papers, Vol. II. Edited by Bedrich Levcik. Prague: Czechoslovak Academy of Sciences, 1962. Rothschild, Kurt W. "Long-Term Planning of New Industrial Development." On Political Economy and Econometrics: Essays in Honour of Oskar Lange. Warsaw, Poland: Polish Scientific Publishers, 1965. Samardzija, Milos. "The Market and Social Planning in the Yugoslav Economy." Comparative Economic Systems. Edited by Jan S. Prybyla. New York: Appleton-Century- Crofts, 1969. Shaffer, Harry G. "Czechoslovakia's New Economic Model." New Concepts in Soviet-Type Economics: A Reader. Edited by George R. Feiwel. Scranton, Pennsylvania: International Textbook Co., 1968. 446 Shaffer, Harry G. "Problems and Prospects of Czechoslo vakia 1s New Economic Model." Comparative Economic Systems. Edited by Jan S. Prybyla. New York: Appleton- Century-Crofts, 1969. Sik, Ota. "Problems of the New System of Planned Manage ment." Czechoslovak Economic Papers, Vol. V. Edited by Bedrich Levcik. Prague: Czechoslovak Academy of Sciences, 1965. Sik, Ota. "Prices in the New Economic System of Management in a Socialist Economy." Planning and Markets: Modern Trends in Various Economic Systems. Edited by John T. Dunlop and Nikolay P. Fedorenko. New York: McGraw- Hill Book Company, 1969. Sik, Ota. "Socialist Market Relations and Planning." Socialism, Capitalism and Economic Growth: Essays Presented to Maurice Dobb. Edited by C. IH Feinstein. Cambridge: Cambridge University Press, 1967. Sokol, Miroslav. "Changes in Economic Management in Czechoslovakia." Czechoslovak Economic Papers, Vol. VIII. Edited by Bedrich Levcik. Prague: Czecho slovak Academy of Sciences, 1962. Vito, Francesco. "Decentralization in a Collectivist Planned Economy." Comparative Economic Systems. Edited by Jan S. Prybyla. New York: Appleton-Century- Crofts, 1969. D. Unpublished Materials Elliott, John E. "Comparative Economic Systems: Theories, Philosophies, Strategies." Unpublished Manuscript. Perlmutter, Edith. "Organization, Methodology, and Implementation of Economic Planning in Yugoslavia." Unpublished M.A. Thesis, University of Southern California, 1966.

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Creator Tafazzoli, Fereydoon (author)

Core Title Oskar Lange'S Contributions To The Theory Of Socialism, With Applicationsto Yugoslavia And Czechoslovakia

Degree Doctor of Philosophy

Degree Program Economics

Publisher University of Southern California (original), University of Southern California. Libraries (digital)

Tag Economics, theory,OAI-PMH Harvest

Language English

Contributor Digitized by ProQuest (provenance)

Advisor Elliott, John E. (committee chair), Backer, Edward H. (committee member), Brown, Alan A. (committee member)

Permanent Link (DOI) https://doi.org/10.25549/usctheses-c18-445331

Unique identifier UC11363203

Identifier 7026535.pdf (filename),usctheses-c18-445331 (legacy record id)

Legacy Identifier 7026535

Dmrecord 445331

Document Type Dissertation

Rights Tafazzoli, Fereydoon

Type texts

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Access Conditions The author retains rights to his/her dissertation, thesis or other graduate work according to U.S. copyright law. Electronic access is being provided by the USC Libraries in agreement with the au...

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