Those who designed the Soviet economic system began with a belief that "the problem with capitalism is that it produces for profit instead of for people's needs," and they set out to build a system that produced directly for people's needs and not at all for profit. "There was a period early in Soviet life when it was argued that the Soviet worker and manager would work because of their enthusiasm for the revolution and their ideological fervor. That phase passed rather quickly."1 Because use of markets violated Marxist ideology, there was only one system of coordination possible. A system of central planning evolveda system in which all decisions about what people needed were decided from the top.
To see how this system worked, consider how the operator of a shoe factory in the United States would make decisions. His major concern would be whether he could sell at a profit the shoes he made. In the Soviet Union, however, profit was of no concern to the manager of the state-owned shoe factory. Neither did he worry about selling the shoes. His only concern was to produce what he was told to produce, and if he could do that, both he and the workers of the plant received sizable bonuses. The problem the Soviet Union had was that it is very difficult to specify in physical terms what a manager should do. (If you do not believe this, try to write down a set of instructions specifying what sort of shoes should be produced. Remember, instructions to produce "good shoes" or "attractive shoes" involve instructions that are not measurable.) The Soviet Union produced huge numbers of shoes that no one would buy because they were of such low quality.
Or consider a nail factory. If it were told to produce as many nails as possible, it would produce only small nails. If told to produce as large a weight as possible, it would produce only very large nails. The Soviet Union wasted billions of rubles searching for energy because it rewarded drilling crews on the basis of the number of feet drilled. Because it is easier to drill many shallow wells than a few deep wells, drillers drilled lots of shallow wells, regardless of what was advisable geologically.
Unwanted incentives can be given whenever there are attempts to measure performance. In a series on the Soviet Union, the Chicago Sun Times reported a case in which a hospital had turned away a seriously ill patient because "they were nearing their yearly quota for patient deathsand would be criticized by authorities if they exceeded it."2 Certainly, a good hospital should have fewer deaths than a bad hospital, other things constant. Thus, it seems reasonable to ask hospitals for their death statistics, and these could be used to evaluate them. If they are evaluated on the basis of this statistic, they have the incentive to provide quality care. But they also have the incentive to avoid patients who are likely to die.
However, one need not go to the Soviet Union for examples of incentives with unintended results. An incentive problem that occurred in the Job Corps program in the United States in the late 1960s was much like the hospital example of the previous paragraph. Job Corps was designed to provide job training for those who had very low levels of skills. In evaluating various centers that implemented the program, an attempt was made to see how many of those who went through the training got jobs. This statistic was used to determine how funding would be distributed in the future. On the surface, this seems a very reasonable way to evaluate each training center. Those that are good should have had a higher placement rate for their graduates than those that are poor. However, this evaluation method had an undesirable consequence. Training centers began to try to attract people who were only moderately deficient in skills because they would be more likely to get a job, and they began to discourage those who were severely deficient from the program.
A reason that designing effective incentives is so difficult is that information and knowledge are scarce. People have a limited capacity to know. In small groups, people know a great deal about others simply from day-to-day interaction. But in large groups, knowledge about others requires expenditure of time and effort. For a modern, complex economy to function well, people must coordinate their actions with the actions of many people, but all of these people have very limited knowledge of how their actions fit into the big picture. A good set of incentives gives people the essential information they need to know so that their decisions will mesh with others, and then encourages them to make those decisions. Not all sets of incentives do this task equally well and none is without problems.
Next we consider limitations of the economic approach.
1 Marshall Goldman,
U.S.S.R. in Crisis: The Failure of an Economic System. New York: W. W. Norton & Co., 1983, p. 32
2 Nov 22, 1983, p. 4
Copyright Robert Schenk