Thursday, January 9, 2014

WHY SOCIALISM FAILED - by Mark J. Perry, Ph.D.

by Mark J. Perry, Ph.D.

Socialism is the Big Lie of the twentieth century.  While it promised prosperity, equality and security, socialism delivered poverty, misery and tyranny.  Equality was achieved only in the sense that everyone was equal in his or her misery.  Socialism is now a bankrupt, discredited, and flawed nineteenth century theory that has failed miserably in countries around the world.

In the same way that a Ponzi scheme or chain letter initially succeeds but eventually collapses, socialism may show early signs of success.  However, as we have seen recently, any initial success of collectivism quickly fades as the fundamental deficiencies of central planning emerge.  It is the initial illusion of success that gives government intervention its pernicious, seductive appeal.  In the long run, socialism has always proven to be a formula for tyranny and misery.

A chain letter or Ponzi scheme is unsustainable in the long run because it is based on faulty principles.  Likewise, collectivism is unsustainable in the long run because it is a flawed theory.  Socialism cannot and will not work in the long run because it is not consistent with fundamental principles of human behavior.  The collapse of socialism can be traced to one critical defect that guarantees that it will always fail - it is a system that ignores incentives.

In a capitalist economy, incentives are of the utmost importance.  Market prices, the profit-and-loss system of accounting and private property rights provide an efficient, interrelated system of incentives to guide and direct economic behavior.  Capitalism is based on the theory that INCENTIVES MATTER!

Under socialism, incentives play a minimal role or are ignored totally.  A centrally planned economy without market prices or profits, where property is owned by the state, is a system without an effective incentive mechanism to direct economic activity.  By failing to emphasize incentives, socialism is a theory inconsistent with human nature and is therefore doomed to fail.  Socialism is based on the theory that INCENTIVES DON'T MATTER!

In a radio debate several months ago with a Marxist professor from the University of Minnesota, I pointed out the obvious failures of socialism around the world in Cuba, Eastern Europe and China.  At the time of our debate, Haitian refugees were risking their lives trying to get to Florida in homemade boats.  Why was it, I asked him, that people were fleeing Haiti and travelling almost 500 miles by ocean to get to the "evil capitalist empire" when they were only 50 miles from the "workers paradise" of Cuba?

The Marxist admitted that many "socialist" countries around the world were failing.  However, according to him, the reason for failure is not that socialism is deficient, but that the socialist economies are not practicing "pure" socialism.  The perfect version of socialism would work; it is just the imperfect socialism that doesn't work.  Marxists like to compare a theoretically perfect version of socialism with practical, imperfect capitalism which allows them to claim that socialism is superior to capitalism.

If perfection really were an available option, the choice of economic and political systems would be irrelevant.  In a world with perfect beings and infinite abundance, ANY economic or political system would work perfectly - socialism, capitalism, fascism, communism or any other system would work perfectly.   However, the choice of economic and polititcal institutions IS crucially relevant in an imperfect universe such as ours with imperfect beings and limited resources.  Only in a world of scarcity is it essential for an economic system to be based on a clear incentive structure to promote economic efficiency.  The real choice we face is between imperfect capitalism and imperfect socialism.  Given that choice, the evidence of history overwhelmingly favors capitalism as the greatest wealth- producing economic system available.

The strength of capitalism can be attributed to a very clear incentive structure based upon the three Ps: 1) prices determined by market forces, 2) a profit-and-loss system of accounting and 3) private property rights.  The failure of socialism can be traced to its neglect of these three incentive-enhancing components.

In a market economy, the price system coordinates and guides economic activity so flawlessly that most people don't appreciate the important role that market prices play.  Market prices transmit information about relative scarcity and then efficiently coordinate economic activity.  The economic content of prices provides incentives which promote economic efficiency.

For example, when the OPEC cartel restricted the supply of oil in the 1970s, oil prices rose dramatically.  The higher price for oil and gasoline transmitted valuable information to both buyers and sellers.  Consumers received a strong, clear message about the scarcity of oil by the higher prices at the pump and were forced to change their behavior dramatically.  People reacted to the scarcity by driving less, carpooling more, taking public transportation, buying smaller cars, etc.  Producers reacted to the higher price by increasing their efforts at exploration for more oil.  In addition, higher oil prices gave producers an incentive to explore and develop alternative fuel and energy sources.

The information transmitted by higher oil prices provided the appropriate incentive structure to both buyers and sellers.  Buyers increased their effort to conserve a now more precious resource and sellers increased their effort to find more of this now scarcer resource.

The only alternative to a market price is a controlled or fixed price which always transmits misleading information about relative scarcity.  Inappropriate behavior results from a controlled price because false information has been transmitted by an artificial, non-market price.

Look at what happened during the 1970s when gas prices were controlled in the United States.  Long lines developed at gas stations all over the country because the controlled price for gasoline was artificially low, which therefore transmitted misleading information about scarcity.  The full impact of the true scarcity was not accurately transmitted because the controlled price was kept artificially low by government fiat.  As Milton Friedman pointed out at the time, we could have eliminated the lines at the pump in one day by allowing the price to rise to clear the market.

From our experience with price controls on gasoline and the long lines at the pump and general inconvenience, we get an insight into what happens under socialism where every price in the economy is controlled.  The collapse of socialism is due in part to the chaos and inefficiency that result from artificial prices.  The information content of a controlled price is always distorted, which then distorts the incentives mechanism of prices under socialism.  Administered prices are always either too high or too low, which then creates constant shortages and surpluses.   Market prices are the only way to transmit information that will create the right incentives to ensure economic efficiency.

Socialism also collapsed because of its failure to operate under a competitive, profit- and-loss system of accounting.  A profit system is a very effective monitoring mechanism which continually evaluates the economic performance of every business enterprise.  The firms that are the most efficient and most successful at serving the public interest are rewarded with profits.  Firms which operate inefficiently and fail to serve the public interest are penalized with losses.

By rewarding success and penalizing failure, the profit system provides a strong discipline mechanism which continually redirects resources away from weak, failing and inefficient firms towards those firms which are the most efficient and successful at serving the public.  A competitive profit system ensures a constant reoptimization of resources and moves the economy toward greater levels of efficiency.  Unsuccessful firms cannot escape the strong discipline of the marketplace under a profit/loss system.  A competitive, market-based system forces companies to serve the public interest or suffer the consequences.

Under central planning, there is no profit-and-loss system of accounting to accurately measure the success or failure of various programs.  Without profits, there is no way to discipline firms that fail to serve the public interest and no way to reward firms that do.  There is no efficient way to determine which programs should be expanded and which ones should be contracted or terminated.

Without competition, centrally planned economies do not have an effective incentive structure to coordinate economic activity.  Without incentives the results are a spiraling cycle of poverty and misery.  Instead of continually re-allocating resources towards greater efficiency, socialism falls into a vortex of inefficiency and failure.

A third fatal defect of socialism is its blatant disregard for the role that private property rights play in creating incentives that foster economic growth and development.  The failure of socialism around the world is a "tragedy of commons" on a global scale.

The "tragedy of the commons" refers to the British experience of the 16th century when certain grazing lands were communally owned by villages and were made available for public use.  The land was quickly overgrazed and eventually became worthless as villagers exploited the communally owned resource.

The tragedy of publicly owned assets is that there are no incentives in place to encourage wise stewardship.   Whereas private property creates incentives for conservation and the responsible use of property, public property encourages property to be used irresponsibly and wastefully.  If everyone owns an asset, people act as if no one owns it.  And when no one owns it, no one really takes care of it.  Public ownership encourages neglect and mismanagement.

Since socialism, by definition, is a system marked by the "common ownership of the means of production", the failure of socialism is a "tragedy of the commons" on a national scale.      Much of the economic stagnation of socialism can be traced to the failure to establish and promote private property rights.

As Peruvian economist Hernando de Soto remarked, you can travel in rural communities around the world and you will hear dogs barking, because even dogs understand property rights.  It is only statist governments that have failed to understand property rights.  Socialist countries are just now starting to recognize the importance of private property as they privatize assets and property in Eastern Europe.

Therefore, without the incentives of market prices, profit-and-loss accounting and well- defined property rights, socialist economies stagnate and wither.  The economic atrophy that occurs under socialism is a direct consequence of its neglect of economic incentives.

No amount of natural resources is ever enough to compensate a country for its lack of an efficient system of incentives.  Russia, for example, is one of the world's wealthiest countries in terms of natural resources; it has some of the world's largest reserves of oil, natural gas, diamonds and gold.  It also has valuable farm land, lakes, rivers, streams across a land area that encompasses 11 times zones and yet it is on the verge of becoming a third world country.  Natural resources are helpful, but the ultimate resources of any country are the unlimited resources of its people - human resources.

By their failure to foster, promote and nurture the human potential of their people through incentive-enhancing institutions, centrally planned economies deprive the human spirit of full development.  Socialism fails because it kills and destroys the human spirit - just ask the people leaving Cuba in homemade rafts and boats.

As the former centrally planned economies move toward free markets, capitalism and democracy, they are looking to the United States for guidance and support during the transition.  We have an unparalled 250-year tradition of open markets, market prices, private property and democracy.  The United States is uniquely qualified to be the guiding light in the worldwide transition to freedom and liberty.

We have an obligation to continue to provide a framework of free markets and democracy for the global transition to freedom.  Our responsibility to the rest of the world is to continue to fight the seductiveness of statism around the world and here at home.  The seductive nature of statism continues to tempt and lure us into the Barmecidal illusion that the government can create wealth.

The temptress of socialism is constantly luring us with the offer: "give up a little of your freedom and I will give you a little more security".  As the experience of this century has demonstrated, the bargain is tempting but never pays off.  We end up losing both our freedom and our security.

Programs like socialized medicine, welfare, social security and minimum wage laws will continue to entice us because on the surface they appear to be expedient and beneficial.  Those programs, like all socialist programs, will fail in the long run regardless of initial appearances.  These programs are part of the Big Lie of socialism because they ignore the important role of incentives.  Socialism will remain a constant temptation.  We need to be vigilant in our fight against socialism not only around the globe but also here in the United States.

The global failure of socialism has begun a worldwide renaissance of freedom and liberty.  For the first time in the  history of the world, the day is coming very soon when a majority of the people in the world will live in free societies or societies rapidly moving towards freedom.

Capitalism will play a major role in the global revival of liberty and prosperity because it nurtures the human spirit, inspires human creativity and promotes the spirit of enterprise.  By providing a powerful system of incentives that promote thrift, hard work and efficiency, capitalism creates wealth.

The evidence from history is very clear.  The main difference between capitalism and socialism is this: Capitalism works.

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