Back to Overview
Review Question


Suppressing Market Information

Just as the role of prices as a rationing system is best seen when it is suppressed, the role that price plays as a communication network is also best seen when it is suppressed. When the Bolsheviks triumphed in the Russian Revolution of 1917, they proceeded to destroy the old system, which was partially a market system. Because Karl Marx had studied only capitalism, trying to explain why it would collapse, the new rulers of Russia could not look to him for an analysis of how socialism would work, but had to learn for themselves. They quickly discovered that if decisions were not made using prices and profit, another method had to be used. They developed a system of central planning.

With a system of central planning, the government decides what the priorities of the society will be and implements these priorities through a central planning agency. However, central planners cannot simply issue orders and expect them to be obeyed. They must first obtain information about what the factories, mines, and farms in the nation are capable of producing. The central planning agency could send out questionnaires, but there is no assurance that the answers that would come back would be truthful because, despite the socialist dream that men should act in total selflessness--for the good of the society as a whole, this does not seem to be the way that people actually act in the real world. It certainly has not been the way that men have acted in nations that adopted socialism.

The central planning agency wants the factories, mines, and farms to produce as much as possible. It must reward those who produce up to their potential and penalize those who do not. Rewards and penalties introduce an incentive to lie when the central planning agency tries to determine potential. If the plant, mine, or farm manager underestimates potential and the central planners believe this estimate, the chances that the production unit will appear to be a good performer are enhanced. Instead of using profit to judge performance (it seemed too capitalistic), the central planning system in the Soviet Union judged performance on how well the productive unit met a set of goals specified in terms of quantities. Managers had an incentive to withhold information about potential and to overestimate the supplies needed to produce their output.

Once the central planners had information about what factories are capable of producing, they tried to coordinate production decisions. One factory's output is often another factory's input. In planning for truck output, did the planners plan for enough steel? To get the steel, did they plan for enough machines to mine the coal and enough trucks to transport it? In a modern economy, there are a tremendous number of linkages and interdependencies. Thus, any change in production of one product sets off a cascade of other changes needed to support the first change. Although the Soviet Union demonstrated that a country could centrally plan its economy, its experience also showed that such a system tends to be rigid and resistant to change.

Between 1920 and 1940 a number of economists debated whether a centrally planned economy could match the performance of a decentralized market economy. One of the most insightful of these economists was Friedrich Hayek, who argued that information is widely scattered in society and cannot be effectively collected for use by a central authority making production decisions for the entire economy. Rather, the existence of market-determined prices communicates vital information that encourages individuals not only to use whatever information they have about production of goods, availability of resources, and how to satisfy consumers' desires, but also to actively search for more information. The market, said Hayek, was a way a society minimized the effort needed to discover and communicate information. The unimpressive performances of centrally planned economies in providing for the average consumer's material well-being seems to be mostly explainable in terms of problems of information and incentive.

Next we see how consumers vote for goods and services.

Back to OverviewReview QuestionNext
Copyright Robert Schenk