How Prosperous Can a Command Economy Be?

Image Source: South China Morning Post

A compelling metaphor used by Nobel Prize winners George Akerlof and Robert Shiller (2010) eloquently describes the functioning of a healthy economy as follows:

“There have to be rules and there has to be a referee who enforces them – and a good and conscientious referee at that. Otherwise there will be random cheating that destroys the sense of the game, and dangerous and aggressive play, so that many people will get hurt and the game will cease to reward good play”.

The role of government intervention in a prospering economy is undeniable – to avoid the unexpected consequences profit-maximising incentives from reaching cataclysmic magnitudes, and to ensure that “good play” remains rewarded, an effective regulatory body must exist. With that in mind, some may argue that a superior strategy would instead be for the government to seize full control over the framework of the economy.

Such “command economies” – those in which the government maintains full control over an economy’s resources – though largely extinct now, became prominent with the rise of the Soviet Union’s sphere of influence in the latter half of the 20th century. Characterised by a “communist” system and dictatorial rule, these economies consisted of state ownership over the means of production: land and capital were distributed by the state, and with all major industries remaining under the control of the state, it virtually acted as the sole employer of labour. Concepts of entrepreneurship and profit became alien in these economies. Instead, there was a great emphasis on allocating resources through setting production quotas. As a result, some may argue the perils that can arise from profit-maximising incentives are eliminated: individuals are no longer incentivised to act in potentially destructive ways to maximise their own utility, but instead act in a way that is endorsed by their government.

Although many point towards the eventual demise of the Soviet Union as undeniable proof of communism being an inferior ideology, it is hard for the achievements of the USSR to go unnoticed. The Five-Year Plans that began under Joseph Stalin had transformed Russia from a primitive agricultural economy by early 20th century standards to an industrial powerhouse. The first Five-Year Plan alone, lasting between 1928-32, had expanded the USSR’s industry from being the fifth largest in the world to the second, with the US remaining at the top (Riasanovsky and Steinberg, 2011). Within this period, production of capital goods increased by 158%, consumer goods increased by 87% and industrial output increased by 118% (Dobb, 1953). Arguably, only a centralised economy could ever allocate its resources in a way which allowed for these goals to be pursued to such absurd lengths.

Growth and regulation was not the only issue communism attempted to solve - by doing all of the employing itself, the state aimed to eradicate unemployment. Within the first three Five-Year Plans, between 1928-40, the number of workers in industry, construction and transport had roughly tripled, from 4.6 million to 12.6 million (Hunt et al., 2010). Officially, there was no unemployment in the USSR, as the state would allocate jobs to every individual of working age in its population.

An important question arises given these impressive growth and employment figures: why did the USSR collapse?

Greater scrutiny must first be placed on the extent to which the USSR’s economy actually expanded. In reality, it is hard to validate any of these figures with absolute certainty. The targets established under the Five-Year Plans were wildly unrealistic, especially given the time frame they were set within – for instance, heavy industry was expected to expand by 330% within the first Five-Year Plan (Library of Congress, n.d.). On the other hand, the first Five-Year Plans occurred at the time of Stalin’s purges, where managers who were deemed incapable of meeting expectations would be promptly disposed of, as they would be considered saboteurs to the communist system. This incentivised those in charge of meeting production quotas to exaggerate their results greatly. It is perhaps for this reason that Stalin announced that the first Five-Year Plan had met its goals earlier than expected, despite the plan never amounting to its Herculean targets. While more realistic estimations of the USSR’s growth figures have been generated since and they remain impressive nonetheless, it is impossible to determine the exact magnitude of this.

However, although “officially” there was no unemployment in the USSR, issues of underemployment - where individuals work in an industry or field despite being capable of or desiring to work in another – were more likely to occur in its command economy. This is due to the conflict that can arise between the state and the people over their theory of value: what the state may deem as valuable may not be valued by its people. Of course, this conflict is not exclusive to the labour market, but could also occur over the production of goods, whereby individuals may disagree with the production decisions of the state. In the USSR, industry remained a priority over consumer goods in a majority of the Five-Year Plans. Although one may argue that individuals would rationally oppose such a decision, the state’s power and propaganda machine effectively created a collectivist culture that placed one’s labour and contribution to society as paramount to receiving economic security and living a fulfilling life. In other words, the Soviet state deteriorated the free will of its citizens, replacing it with a guaranteed sense of security instead, so long as they abided by the state’s agenda. Although some rebelled against their given conditions, the majority embraced this culture and pursued security instead, as the risks associated with pursuing freedom in Stalinist Russia, which was characterised by ruthless purges and fear, far outweighed any potential benefit. Under such circumstances, accepting the decisions of the state, regardless of whether you agree with them or not, becomes the most rational decision. Given such a situation, while growth and development can occur in a command economy, this is not to say that the people always “prosper” within it.

The Solow growth model can be used to visualise not just the limited freedom and prosperity of Soviet citizens, but how limited and unsustainable the economic growth of the USSR really was:

The model consists of two graphs. On the left, it displays the relationship between:

1. Capital per effective worker (K/AN – it is the amount of capital in the economy (K) divided by the number of effective workers (AN). An effective worker is a worker who can utilise technology. “A” in the model represents the stock of technology in the economy, whilst “N” is the number of workers)

And

2. Output per effective worker (Y/AN – it is the total output (Y) in the economy divided by the number of effective workers)

In this model, the production function (the Y/AN curve) has decreasing returns to capital, meaning that if labour is to remain fixed, increases in capital lead to decreasing increases in output. On the other hand, there are two more curves to take note of on this graph:

1. The savings function, given by S(Y/AN), illustrates the level of savings in the economy. This model assumes that savings (S) equals investment, as any income that is saved will be spent on purchasing new capital.

2. The required investment function, given by δ(K/AN), illustrates the level of investment required to maintain the current level of capital in the economy. In the model, δ represents the percentage of capital that depreciates over a given period.

On the right, the model displays total output in the economy over time. The slope of this curve is given by:

gY = gA + gN

Whereby gY is the rate of growth in output, gA is the rate of growth in technology, and gN is the rate of growth in population.

In the case study of the USSR, we will assume that growth rate in technology and population remains constant, setting the value of gA and gN at zero. While this may be an extreme assumption, and the growth rates in technological innovation and population were far from zero in Soviet Russia, they paled in comparison to that of mixed economies such as the US. This is perhaps because, without the freedom of creativity and the incentive to innovate that comes with the pursuit of profit, technology evolved more slowly. Omitting the impact of population growth allows us to observe the effect of lacking technological innovation more closely. With these two variables being set at a value of zero, the growth rate in output remains constant in the model.

The implementation of a Five-Year Plan resulted in an increase in the savings rate, and thus investment in the economy. This is illustrated as an upward shift in the savings function on the graph on the left side. As the savings rate now exceeds the level of required investment, the economy shifts away from its current steady state (where the savings rate equals required investment), and the level of capital per effective worker increases gradually in smaller and smaller increments in a negative feedback loop until a new steady state is reached. Output per effective worker now increases from Y/AN to Y/AN*. On the graph on the right side, the rate of output increases exponentially, before stagnating once again. Nevertheless, output is now at a higher level than before.

With every Five-Year Plan, this process was repeated multiple times. It is here that the limitations of these policies, in terms of both freedom and economic growth, become abundantly clear:

Each and every time the savings rate increases, the rate of output increases exponentially, but always returns to a stagnant level, despite the new level of output being higher than before. In this situation, growth is dependant entirely on increasing savings/investment in the economy. However, there is a limit as to how much the government can increase the savings rate in the economy – considering that this model is of a closed economy, and government spending is also omitted, total output in the economy is equal to the sum of consumption (C) and investment (which is equal to savings). As such, the area below the savings function in the model represents the level of savings in the economy, whilst consumption is represented by the area above the function. The state could only increase the level of savings up to a level where consumption would equal zero, and once that level is reached, output would remain fixed indefinitely unless technological and population growth were greatly incentivised. To put it simply, the Five-Year Plans only incentivised short-run growth, and were incapable of achieving growth in the long-run.

Low consumption was a very prevalent feature of the Soviet economy, and this was only exacerbated by the pursuit of industrial growth under the Five-Year Plans. For example, the campaign for the collectivisation of farming in the midst of the first Five-Year Plan, which consisted of seizing farmland under the control of the state and forcing peasants into working collectively under these landholdings, had been unable to meet the increasing urban demand for food under the push to transform the USSR’s industry. This was because the seizure of produce by the state had been fiercely resisted against and had incentivised peasants to simply produce less. The “kulak” class of peasants that had been previously well-off from their bountiful yields had faced terrible prosecution and even execution by the millions in a campaign of “dekulakisation.” The inefficiencies of the collectivised farming system, in tandem with the pursuit of unrealistic industrial growth, resulted in one of the worst famines in history.

Overall, the prosperity of a command economy system is limited by design. Without the innovation and creativity generated in a free-market system by the desire of profit and freedom, the technological advancement necessary for limitless growth in the long-run is impossible to achieve. Though the state in a centralised economy is capable of easily allocating resources in a way which allows for specific goals to be pursued to great lengths in the short-run, the Solow growth model illustrates that its achievement of these goals is limited without the freedom of its citizens. Although the communist system had profound negative economic consequences on the Russian people, the most profound negative consequence is political and cultural in nature, yet remains prominent today. Despite Russia having transitioned to a “free-market” system, its resources remain under the private ownership of the Kremlin elite from a bygone era. Its government, also comprised of this elite from a time long past, continues to suppress the freedom of thought through extensive propaganda and legislation, in a fashion not too dissimilar from 1930s Soviet Russia. While some fall victim to it, and some bravely rebel against it, the majority choose to remain indifferent. Instead of pursuing the risk that comes with the freedom of expression, most instead choose the security that comes with political indifference, regardless of what they may think, because it is simply the most rational decision given their circumstances. The values instilled in its previous generations and the consequences of its previous communist system prevails in Russia’s relatively modern “free-market” economy. Evidently, the Kremlin continues to use this to its advantage, acting without limit despite the negative impact its actions may have on its society and economy.

REFERENCES:

Akerlof, G.A., Shiller, R.J., 2010. Animal spirits: How human psychology drives the economy, and why it matters for global capitalism. Princeton University Press, Princeton, N.J Woodstock.

Dobb, M., 1953. Rates of growth under the five‐year plans. Soviet Studies 4, 364–385

Hunt, L., Martin, T.R., Rosenwein, B.H., Smith, B.G., 2010. The making of the West: Peoples and cultures: A concise history, 3rd ed. Bedford/St. Martin’s, Boston, MA.

Library of Congress, n.d. Revelations from the Russian Archives [WWW Document]. Library of Congress. URL https://www.loc.gov/exhibits/archives/intn.html#e2livest (accessed 8.18.23).

Riasanovsky, N.V., Steinberg, M.D., 2011. A history of Russia, 8th ed. ed. Oxford University Press, New York : Oxford.