The problem with evaluating socialist systems based on notions of efficient markets

I often get into debates online with generally smart people about the inefficiencies of socialism. These conversations often revolve around the planned economy of the Soviet Union. I have argued elsewhere that the Soviet Union was not really socialist (so I’ll avoid addressing that myth here). The most important point to get across to people is that central planning and state ownership are not necessary conditions for a socialist economy. My own preference is a market socialist economy, one in which the majority of firms are worker-owned and consumer cooperatives, but resources continue to be allocated via regulated markets. Although I agree that planned economies have significant drawbacks (mainly principle-agent, incentive, and information problems), I disagree that planned economies are inherently less efficient than market economies. The reason I prefer markets is to maintain consumer sovereignty and freedom of enterprise, not because they are necessarily more efficient. However, the problem with the way in which people generally approach the debate is the software running in the background is the textbook neoclassical model.

This has also been generally the approach by Western economists in the comparative systems literature. The primary aim of the neoclassical approach to comparative systems has been to demonstrate the irrationality and inferiority of the planned economic system to that of the Walrasian competitive market system. The competitive market system is regarded by neoclassicals as producing the most efficient allocation of resources through the interaction of self-interested actors in voluntary exchange pursuant to the goal of profit and utility maximization. The achievement of the most efficient allocation of resources is considered “optimal”. However, the neoclassical definition of optimality is based on a fictional model of the economy, and has never been applicable to real world capitalism.

The key claim of the neoclassical model is that prices carry all the information needed for agents in a competitive market economy to make rational allocation decisions. In theory, competitive markets achieve optimal efficiency at the equilibrium between demand and supply. When equilibrium is achieved, markets are said to be in Pareto optimum, a state in which any reallocation would only make someone else worse off.​In the Walrasian model, Pareto optimality can be proven mathematically, but only under very restrictive assumptions.

1. The system must have constant returns to scale.
2. Consumers must have convex indifference curves.
3. Utility functions must be independent.
4. There is no price discrimination by firms.
5. The key assumption, both households and firms have perfect information for which to accurately communicate the information carried in prices.

The moment we relax any of these assumptions, the model falls apart. And so the Walrasian model has never been applicable to real world capitalism. The fact of the matter is in real world capitalist systems, economies of scale are widespread, there is asymmetric information between consumers and producers, and imperfect competition exists to some degree in nearly all markets. Thus the assumptions noted above are wholly unreasonable to infer any sort of dynamically stable equilibrium exists. The implications of this is that prices in market systems do not actually carry the information claimed by Friedrich Hayek (1945) and others.

In the real world, markets exhibit a fair amount of inefficient allocation resources resulting in significant rents, and overproduction of goods indicated by excess inventories (e.g. cheese glut, food waste, etc.). Underproduction in modern capitalist economies is rare, but less perceived due to the veil of price rationing which prices the poor out of the market (e.g. 12.2% of Americans are uninsured, 1 in 8 Americans experience food insecurity). The most significant indication of market inefficiency is unemployment. Some of these inefficiencies are related to government intervention, but many forget that government regulation comes about most often due to the preexistence of market failure. Despite the inefficiencies of the market economy, capitalist systems appear to be fairly stable (when maniac politicians are not actively attempting to dismantle them), but that stability is due to the institutional features of those systems.

A more realistic conception then of the strengths of capitalist systems is that the profit motive drives competition to keep costs and prices low in an effort to gain market share. Capitalist firms seek out what consumers want, and consumers communicate their demand through consumption. Capitalism has been able to achieve rapid technological innovation, accumulation, increasing consumption and living standards over time. And while capitalism has historically allowed a significant level of agent sovereignty in both consumption and enterprise, it has come at the cost of inegalitarian privileges and influence of a relatively small and wealthy capitalist class.​The defining characteristics of capitalism — production for profit, competition, and wage-labor — are qualitatively different from that of socialism which seeks to build an economy and society based on production for use, cooperation, meaningful labor, and human development. It makes little sense to evaluate these systems on any notion of Pareto optimality, particularly when that notion has little basis in reality.

A more appropriate comparative analysis would be on the basis of performance and outcomes in accordance with the goals and values of the system in question. Socialist systems also have qualitatively different values than capitalist systems. Capitalists systems value self-interest, competition, profit maximization, capital accumulation, protection of private property, access to wage labor, and growth. A socialist economy, on the other hand, values cooperation, meaningful labor, a non-commodity society, and human control over social evolution. To appropriately evaluate system design, an analyst should determine how well the system embodies these values. This does not mean comparative analysts have no means of comparison. Legitimate areas of comparison depend on the goals of the system. Advocates of capitalism generally defend its ability to increase average living standards overtime, stability of the system, and capacity for innovation and technological progress. Additional areas of comparison which have come to be important are income distribution, full employment, and environmental protection.

The neoclassical notions of efficiency or optimality are not a legitimate area of comparison between capitalist and socialist systems as both have forms of waste. Instead, a better question is whether a socialist economy can utilize its resources to produce what is valued at costs acceptable to society.

Originally published at aaronmedlin.weebly.com.