Ha-Joon Chang - 23 Things They Don't Tell You about Capitalism

Despite this, the system still failed to function well because of the inefficiency of the communist central planning system, which was supposed to be a more efficient alternative to the market system.

The communist justification of central planning was based on some quite sound logic. Karl Marx and his followers argued that the fundamental problem with capitalism was the contradiction between the social nature of the production process and the private nature of ownership of the means of production. With economic development – or the development of productive forces, in Marxist jargon – the division of labour between firms develops further and as a result the firms become increasingly more dependent on each other – or the social nature of the production process is intensified. However, despite the growing interdependence among firms, the Marxists argued, ownership of the firms firmly remains in separate private hands, making it impossible to coordinate the actions of those interdependent firms. Of course, price changes ensure that there is some ex post coordination of firm decisions, but its extent is limited and the imbalance between demand and supply, created by such (in non-Marxist terms) ‘coordination failures’, accumulates into periodic economic crises. During an economic crisis, the argument went, a lot of valuable resources are wasted. Many unsold products are thrown away, machines that used to produce now-unwanted things are scrapped, and workers who are capable and willing to work are laid off due to the lack of demand. With the development of capitalism, the Marxists predicted, this systemic contradiction would become larger and consequently economic crises would become more and more violent, finally bringing the whole system down.

In contrast, under central planning, the Marxist argued, all means of production are owned by the whole of society and as a result the activities of interdependent production units can be coordinated ex ante through a unified plan. As any potential coordination failure is resolved before it happens, the economy does not have to go through those periodic crises in order to balance supply and demand. Under central planning, the economy will produce only exactly what is needed. No resource will lie idle at any time, since there will be no economic crisis. Therefore, the central planning system, it was argued, will manage the economy much more efficiently than the market system.

That, at least, was the theory. Unfortunately, central planning did not work very well in practice. The main problem was that of complexity. The Marxists may have been right in thinking that the development in productive forces, by increasing interdependence among different segments of capital, makes it more necessary to plan centrally. However, they failed to recognize that it also makes the economy more complex, making it more difficult to plan centrally.

Central planning worked well when the targets were relatively simple and clear, as seen in the success of early Soviet industrialization, where the main task was to produce a relatively small number of key products in large quantities (steel, tractors, wheat, potatoes, etc.). However, as the economy developed, central planning became increasingly difficult, with a growing number of (actual and potential) diverse products. Of course, with economic development, the ability to plan also increased thanks to improvements in managerial skills, mathematical techniques of planning and computers. However, the increase in the ability to plan was not sufficient to deal with the increase in the complexity of the economy.

One obvious solution was to limit the variety of products, but that created huge consumer dissatisfaction. Moreover, even with reduced varieties, the economy was still too complex to plan. Many unwanted things were produced and remained unsold, while there were shortages of other things, resulting in the ubiquitous queues. By the time communism started unravelling in the 1980s, there was so much cynicism about the system that was increasingly incapable of delivering its promises that the joke was that in the communist countries, ‘we pretend to work and they pretend to pay us’.

No wonder central planning was abandoned across the board when the ruling communist parties were ousted across the Soviet bloc, following the fall of the Berlin Wall. Even countries such as China and Vietnam, which ostensibly maintained communism, have gradually abandoned central planning, although their states still hold high degrees of control over the economy. So, we all now live in market economies (well, unless you live in North Korea or Cuba). Planning is gone. Or is it?

The fact that communism has disappeared for all practical purposes does not mean that planning has ceased to exist. Governments in capitalist economies also plan, albeit not in the same comprehensive way that the central planning authorities in communist countries did.

Even in a capitalist economy, there are situations – a war, for example – in which central planning is more effective. For example, during the Second World War, the economies of the major capitalist belligerents, the US, the UK and Germany, were all centrally planned in everything but name.

But, more importantly, many capitalist countries have successfully used what is known as ‘indicative planning’. This is planning that involves the government in a capitalist country setting some broad targets concerning key economic variables (e.g., investments in strategic industries, infrastructure development, exports) and working with, not against, the private sector to achieve them. Unlike under central planning, these targets are not legally binding; hence the adjective ‘indicative’. However, the government will do its best to achieve them by mobilizing various carrots (e.g., subsidies, granting of monopoly rights) and sticks (e.g., regulations, influence through state-owned banks) at its disposal.

France had great success in promoting investment and technological innovation through indicative planning in the 1950s and 60s, thereby overtaking the British economy as Europe’s second industrial power. Other European countries, such as Finland, Norway and Austria, also successfully used indicative planning to upgrade their economies between the 1950s and the 1970s. The East Asian miracle economies of Japan, Korea and Taiwan used indicative planning too between the 1950s and the 1980s. This is not to say that all indicative planning exercises have been successful; in India, for example, it has not. Nevertheless, the European and East Asian examples show that planning in certain forms is not incompatible with capitalism and may even promote capitalist development very well.

Moreover, even when they do not explicitly plan the entire economy, even in an indicative way, governments in most capitalist economies make and implement plans for certain key activities, which can have economy-wide implications ( see Thing 12 ).

Most capitalist governments plan and shape the future of some key industries through what is known as ‘sectoral industrial policy’. The European and East Asian countries which practised indicative planning all also practised active sectoral industrial policy. Even countries that have not practised indicative planning, such as Sweden and Germany, have practised sectoral industrial policy.

In most capitalist countries, the government owns, and often also operates, a sizeable chunk of the national economy through state-owned enterprises (SOEs). SOEs are frequently found in the key infrastructure sectors (e.g., railways, roads, ports, airports) or essential services (e.g., water, electricity, postal service), but also exist in manufacturing or finance (more stories about SOEs can be found in the chapter ‘Man Exploits Man’ of my book Bad Samaritans ). The share of SOEs in national output could be as high as 20 per cent-plus, in the case of Singapore, or as low as 1 per cent, in the case of the US, but the international average is around 10 per cent. As the government plans the activities of SOEs, this means that a significant part of the average capitalist economy is directly planned. When we consider the fact that SOEs usually operate in sectors with disproportionate impacts on the rest of the economy, the indirect effect of planning through SOEs is even greater than what is suggested by the share of SOEs in national output.