Ludwig von Mises in Omnipotent Government or Friedrich Hayek’s in The Road to Serfdom brilliantly describe the “economic calculation problem.” Mises famously said that “…that rational economic activity is impossible in a socialist commonwealth.” As far as state socialism, he’s completely correct, but what baffles is how anyone believes that most any form of capitalism is not almost as vulnerable to this critique as state socialism.
Capitalism does great advantage over, say, Soviet central planning to the extent that it relies on the “spontaneous order” of the price mechanism. But this reliance is extremely limited, applying at most to a few narrow areas, such as selling price and wage levels, while in all other areas decisions are made via central planning.
As an example, in capitalist societies, all publicly-traded corporations are governed by a politburo of (usually 12) well-connected governors. Like in the Soviet Union, there are elections for these people, but they are a sham, as is pointed out (for example) in this article by noted capitalist Carl Icahn. Elections are only open to voting by party members, who are known as “shareholders.” It is the job of this Central Committee of 12 to set all basic policies of the corporation (which may be as large economically as the Soviet Union under Stalin or China under Mao; often larger). Policies set by the gang of 12 include the hiring of the Chairman (or CEO) and all chief Commissars, who then delegate to political officers below them, who delegate to officers below them, who then relay the policies of the Central Committee to bottom level workers through a system that resembles a parlor game of ‘telephone.’ The nomenklatura, or ruling class of any sizable corporation is usually known as “the management.” Management members rarely are promoted up from people who know how to do or have done the actual job, but instead are usually brought in from various ideological training Commissariats called ‘business schools.’
At every level throughout the Corporate Commissariat, decisions are made not on the basis of reliable price signals, but instead by centrally-planned attempts to reconstruct them. For example, workers may be evaluated on the basis of output per hour, but then this may have the unintended effect of workers working faster but more sloppily, so another centrally planned policy of a quality control mechanism and quality control Tsar will have to be enacted. This may lead to yet another problem, such as workers working to fulfill the narrow goals set by the central planners while neglecting other important job functions not yet measured, which will in turn require yet more testing mechanisms to provide feedback to the Commissariat. This results in a large, expensive class of managers, human resources personnel, security guards etc. who do little work themselves aside from supervising the work of others.
Another glaring example of inefficiency is that workers are rarely rewarded on the basis of their economic contribution to the Commissariat, (in part because this is unknowable due to the absence of internal price signals), but instead workers are usually compensated in the best case on the basis of an individual manager’s limited information, or, worse, his personal whims. This usually leads to an attitude of indifference towards the organization similar to those of workers in Soviet factories; promotion and firing decisions are seen as somewhat whimsical decisions of management (often unseen upper-management), so workers and management become more interested in ingratiating themselves personally with individual superiors, with maintaining an outward appearance of productivity and with meeting the centrally planned production criteria, regardless of their broader rationality. This can lead to whole organizations of people who’s main concern is carefully calibrating their work speed to fill the time allotted, to find ‘make work’ projects so as not to appear idle, and to ingratiating themselves with politically essential Comrades.
If Central Planning doesn’t work, why does it persist?
The Soviet Union lasted almost a century, survived a World War and long survived the Cold War hostility of the West. It’s replacement has hardly been a utopia of freedom, prosperity and decentralization. So why does central planning happen, how does it survive? The simple answer is simply that central planning works very well, for the people who control it. Just like the upper level of Soviet society enjoyed a life of unearned luxury and power, so too does the upper level of the business world. An extremely blatant example of this are the “golden parachute” provisions negotiated by many corporate politburo members, which guarantee a high level of compensation regardless of performance.
Free-market capitalism couldn’t prove its superiority within the Soviet-sphere for a simple reason; it would be stomped out by the nearly infinite capacity for violence of the state. Existing varieties capitalism and ownership by title can likewise only exist with the subsidy and backing of the violence of the state. Most employees in any industry only consent to be ruled by economic central planners because their three options are to leave and work for another set of central planners, to comply, or to be attacked by state-subsidized violence. If the state were not expected to interfere, the management, shareholders and bondholders of very many corporations would be overthrown, and replaced by internal price signals, such as democratic decision making capacities within departments, self-management and individual compensation by the performance of the individual, unit and firm, and repayment of investors only in dividends, not in political control. There are very good reasons to believe that such a system would be vastly more efficient, both in cost per unit of output and in reducing externalities onto society than the current model of highly concentrated property-by-title.
The main function of the state is to enforce and expand the property claims of the dominant class. In the Soviet Union this was the Communist nomenklatura and in the West this is the ‘market winners’ or those with accumulated wealth in conjunction with the government class. As central planning by private investors and shareholders continues to increase, it will become increasingly irrational, as we are in fact now seeing in the decline of demographic indicators across the board in the U.S. and many post-Soviet economies as well. Concentrated private property ownership is in a death spiral because it makes rational economic activity impossible.