Theory of Planned Socialism

Theory of Planned Socialism
1. The Socialist Economy considers how socialism resolves the four
fundamental tasks of any ES:
what to produce —a strong central state, through state ownership
and political power exercises considerable influence of what to be
produced ( the output mix favors the producer goods, public
goods and military goods over consumer goods)
how to produce —the state dictates arrangements for production
(central planning as a mechanism to organize resource allocation)
who gets the product —the primary source of income is labor; the
egalitarian distribution of output is pursued; the socialist economy
places greater emphasis on econ equity& socialization, & uses
state policies to offset the problems of unemployment, inflation
and slow econ growth, which are perceived as inevitable under
how to provide for the future —the state exercises substantial
control over econ growth and industrial expansion
2. The Socialist Controversy: The Feasibility of Socialism
• The Marxist-Leninist view of socialism emphasized a strong role of the state and
equal income distribution. Marx and Lenin did not deal with the more fundamental
issue of how resources will be allocated during socialism.
• Resource allocation under socialism has been widely discussed over the past century
and termed as the Socialist Controversy.
• The 1st consistent theoretical framework of resource allocation under socialism is by
Enrico Barone:
Barone: A Theoretical Framework
– 1907 “The Ministry of Production in the Collectivist State” argue that the prices
are not limited only to markets.
– Central planning board (CPB) could establish prices or “ratio of equivalence”
among commodities.
– His model consists of simultaneous equations relating inputs and outputs to the
ratio of equivalence. The equations could provide the appropriate relative
valuations of resources required to balance ss &dd. And the relative prices can
be simulated.
– The CPB computed resource allocation would be similar to that of competitive
– Practicality-not realistic (CPB to gather and solve simultaneous equations for
million products)
Barone developed a theoretical framework of resource allocation under socialism
but failed to develop a realistic scheme.
The discussion about resource allocation went further in 1920’s and
1930’s, when Mises and Hayek created a now famous attack against
the case of rational resource allocation under socialism.
1922- Mises wrote “Econ calculation in the socialist commonwealth”
The Austrian Critique -The Challenge of Mises and Hayek
•inefficiency of resources in a system w/o markets
•a knowledge of prices is essential for the state to direct available resources
•the only way to establish relative prices is through market mechanism, which is
absent under socialism
•difficult or impossible to develop relative prices by simulating (Barone)
•they view socialism as inefficient b/c of difficulties in competition and evaluation
and a lack of incentives. Much has been written about profit motive and private
property. The state owns the resources and profits go to the state, not individuals.
So, the motivation to allocate resources efficiently is lost.
3. The Centrally Planned Economy
The econ and political systems of the SU were so closely interrelated,
understanding the operation of the economy and planning system
requires knowledge of the institutions.
a. Administration of a Planned Socialist Economy
– The Communist Party (Central Committee)
– State owned firms/enterprises (SOEs)
• Arranged under production ministries
• State chooses managers to fulfill plans; member of communist party
State statistics agency collects data on inputs and outputs
State planning agency sets targets for inputs, outputs, technology
State pricing agency sets prices based on state goals and not a market value
State owns banks, collects savings, and allocates capital, labor, land, etc.
• Monobank can ensure that plans are followed.
– The state revenue comes form the SOEs’ profits; the investments and public
goods are paid out of state budget
– International trade is controlled through a state ministry and Foreign Trade
Organizations (FTO).
b. Horizontal versus Vertical Transactions
– Vertical-all administrative orders are issued by administrative superiors or subordinates.
– Horizontal-concluded by subordinates at the same level w/o approval of administrative
c. the economy runs according to vertical orders
– The basic feature of an administrative-command economy is that the dictator decides
both how much X is produced and who gets X; to produce X* & its P*. At this price the
producer is suppose to sell the entire output X* to authorized buyers at the official P*. If
producer realize, is producing valuable good, a number of buyers can pay a higher P**. If
producer sell to unauthorized buyer, producer gains a rent. Those who pay more, are
those who supply the producer of X with another valuable good Y. If producers of X & Y
follow vertical orders they receive P*. If the rent exceeds the reward for vertical loyalty,
the producer engage in “illegal” unplanned horizontal transactions.
S (planned)
d. Planning—resource allocation is guided by plan in socialism
• definition-national econ plan is a mechanism or a set of techniques to guide the
activity of economy through time toward an achievement of specific goals.
• categories
– indicative planning—targets are set in the hope of affecting econ outcomes by
providing info external to the market; the aggregate output growth is planned
– directive planning—targets are set by planners w/ the expectations of directly
altering outcomes. “The plan is law”
• steps in planning econ. activity
– goals & objectives to be achieved and the means of achieving within a specified
time frame
– organizational mechanism for executing the plan (incentives)
– evaluation of outcomes
e. Planning Techniques
• Material Balance Planning (MBP)
– MBP has been widely used in the planned socialist econ. to allocate resources. Material
balances focus on the needs to determine aggregate ss & dd for basic industrial goods and
bring them into balance w/o mkts. The CPB specifies a list of goods & services to be
produced in the plan period. Once the CPB determines the inputs (land, labor, capital)
needed to produce 1 unit of output, it can draw up a list of inputs necessary for meeting
the specified output objectives.
– Example—coal (physical units, metric tons)
Domestic Production 1,000
Inputs used for
Soviet planners and theoreticians pursued the theory of planning under conditions of social
ownership. The most important practical work of the period “the golden age of Soviet
mathematical economics” was development of I-O model, introduced by Wassily Leontief.
•The Input-Output Model—alternative approach to the MBP, and provides the
theoretical underpinnings of MBP
– Linear relationships between quantities of outputs, material inputs and resources
– Technical coefficients aij—how much of input Xi is needed to produce one unit of output
in the jth industry
– Sources=Intermediate Uses +Final Demand
– Solution of a system of simultaneous equations using matrix algebra (number of
calculations rises exponentially with the number of equations)
Intermediate Uses
Final Uses
1. X1-S1+M1 = a11X1+a21X2+a31X3+…+ a1nXn+ C1+I1+Ex1
2. X2-S2+M2 = a21X1+a22X2+a32X3+…+ a2nXn+ C2+I2+Ex2
3. X3-S3+M3 = a31X1+a23X2+a33X3+…+ a3nXn+ C3+I3+Ex3
n. Xn-Sn+Mn = an1X1+an2X2+an3X3+…+ annXn+ Cn+In+Exn
Xi—output of the ith industry (planned target)
C—consumer use
S—change in stocks
I—investment use
M—planned imports
Ex—planned exports
aij—requirement for input Xi per unit of output in the jth industry
aij—are typically derived from the previous year’s planning experience. These coefficients
are normally assumed to be constant over varying ranges of outputs. A matrix of these
coefficients was maintained for 250 of the most important product groups.
• Example—handouts
– Simple economy with four sectors
• In theory, I-O model gives planners an opportunity to determine balances quickly
(through high speed computers) and hence to explore alternative resource
• Limitations:
– Aggregation: the fewer sectors is easier to manipulate
– Static model, not allow for a change over time
– Input-output ratios are the same, regardless of volume produced.
f) Evaluation of Planning Process—which plan to choose?
• Ideal plan would have to be
– consistent
• achieves balance between sources and uses of all resources and
commodities (supply and demand)
– feasible
• both consistent and possible
– resources and technologies actually exist to do what the plan requires
– efficient
• must be feasible
• plan efficient if planners cannot reallocate resources so as to increase one
output without having to reduce others
• infinite number of efficient plans
– optimal
• Selecting the best plan of all consistent plans
• the one efficient plan most desirable from planners’ perspective or the
plan that maximizes the planner’s objectives or to produce the max output
given available resources
• Actual planning process so cumbersome consistency never achieved for
overall plan
• Those parts that were consistent often turned out to be infeasible
• Inconsistent and infeasible plans cannot be efficient
• Even if efficiency could be achieved there would be no way to try out
different efficient plans to choose the most desirable.
• The Material Balance Planning aimed in achieving a balance, and not
optimality. The planners were able to prepare two or three variants, and there
is no reason to believe that it was optimal. MBP was a mechanism that
worked, although at a low level of efficiency.
4. Critics of the planned socialist model
• impossible in reality
• millions of products, it is not possible to compute the
optimal combination of inputs and outputs
• problem with creating incentives to use the optimal
combination of I-O
• generation and processing of data
• obtaining agreement on the objective function of society
5. The Performance of Planned Socialism: Hypotheses
a. Income Distribution
– income more evenly distributed
b. Efficiency
– do not perform well in terms of both dynamic and static efficiency
c. Economic Growth
– rapid growth is promoted by the high savings rate & by the planner’s
direction of resources into growth-max pursuits; ? relative growth
d. Stability
– hypothesize that the planned socialist econ will be more stable
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