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Chapter 9: Order conceptions part III

Outline:

01st Introduction

02nd The Laissez-faire liberalism

03rd The Ordoliberalism

04th The popular capitalism

05th The welfare state

06th The overall control

07th The Planning

08th The concerted action

09th The nationalisation of the key industries

10th The market socialism

11th The Yugoslav model

12th The centrally administered economy

09th The nationalisation of the key industries

The conception of the nationalisation of the key industries, as represented by the German social democracies until the Bad Godesberger program of 1959, went much further in the criticism of the market economy (capitalism) than the order conceptions discussed so far and approached much closer to the concept of a state planned economy.

Of course the social democrats also shared the criticism from a social point of view until that time. The way as, for example, the criticism was raised from the representatives of the popular capitalism against a pure market economy, which was rooted in the statement that the social concerns of the general public were insufficiently considered and that the income distribution would develop to the disadvantage of the employees.

The social democrats also criticised the allocation results of the market, for example, as they have been imposed by the representatives of a planning in France for a long time, whereby the main focus of criticism was set on the possibilities of the market failure and the market deficits.

But the social democrats did not stay with this criticism. Just like the old liberals had a deep aversion to any kind of state interference on the economy, the social democrats were convinced that the private property and the pursuit of profit of the entrepreneurs constituted the root cause for the determined disproportions and thus had to be regarded as something bad per se. Thus, the entire commercially invested capital would have to be nationalised.

For what reasons, though, did the social democrats confine themselves to the demand to nationalise nevertheless not all enterprises, but only the key industries until the Bad Godesberger program? The reason for this was the fact that the social democrats professed a liberal socialism at a very early stage already and, moreover, the negative experiences that socialism had created in the communist countries (in Russia) with planned economy systems.

On the one hand, a dictatorship of the proletariat, as propagated and practiced by the Russian communists, was rejected. On the other hand, it was feared that in the case of a total nationalisation of all enterprises the state planning authority could acquire so much power, that it could escape the control by the parliament.

Therefore, the social democrats demanded only the nationalisation of the so-called key industries. One was also convinced that, even with this restriction in the nationalisation to a few economy sectors, the actual aim of this order conception could be achieved: namely the orientation of production to the needs of the people, especially the employees.

Now, what was meant by key industries? By this term the energy industries, in particular coal production, furthermore steel production as well as the banking sector was understood. Thus, by this concept not only industries in the narrower sense are covered, since only steel is produced by industrial methods. At the time, the energy industry was limited to coal production that was the mining, and the banking system was and is of the sector of services.

Now one was convinced that even with a nationalisation of only the key industries, a control of all markets could be guaranteed. For the production and consumption of almost all goods actually energy would be needed. A demand for steel exists - or existed at that time - particularly in the automobile and machine industry; machines, though, are in turn used for the production of most of the goods, they represent a part of the production capacity.

Finally, the banking industry comes into play thereby that almost all enterprises need loans which are loaned from the banks. For the large corporations comes in addition that they buy their capital mainly on the capital markets and that the banks provide help in this regard. But it is precisely the large corporations which in the opinion of the Socialists are responsible for the lack of orientation of the production to the needs of the people.

By taking control of bank lending and the allocation of steel and energy by a nationalisation of the key industries, the state was now in a position to align the entire production of an economy with the ideas of the government.

The possibility that there is policy failure besides market failure and that the policy failure can be greater than the market failure in the concrete individual case is not considered in this conception. At the same time, it is overlooked that a bureaucratic system is highly inefficient and thus inferior to a system of free enterprises.

The bureaucracy lacks incentives to strive for the most efficient solution for the production of goods, the bureaucrat does not have to pay for the losses caused by him and is therefore also ready for risky tasks; he also does not receive the profits he has generated. If, however, losses and profits are calculated by political means, it is generally the politicians and not the bureaucrats who make and implement the individual concrete decisions.

10th The market socialism

The order conception of the market socialism developed by Oskar Lange differs from the previously approached conceptions of socialism particularly in the rationale. His aim is to develop a theory of the state planning of a socialist national economy.

Starting point of his considerations are the results of the recent theory of welfare. If one proceeds from the welfare theory developed by Vilfredo Pareto, the welfare optimum of a national economy is determined by the tangential point of the transformation curve with a collective indifference curve. Let us consider this correlation by the following graphic:

On the coordinates, the quantities that are to be produced of two goods (bundles of goods) x₁ and x₂ are drawn. The red curve represents the transformation curve, which indicates which goods combinations can be produced with the given resources. The blue curves render the collective indifference curve, which connects all the combinations of goods, which guarantee an equal high welfare.

The intended combination of goods must firstly be at (or if need be below) the transformation curve, since only such combinations are possible at all. Secondly, from the number of the possible combinations should those be selected which guarantee the highest welfare. Since the indifference curves are the further distant from the coordinate origin, the greater is the welfare which reflects this curve, thus exactly that point of the diagram fulfils this condition, at which a collective indifference curve is tangent to the transformation curve.

Those combinations of goods, which lie on the lowest indifference curve and cut the transformation curve but are not tangent to this, are possible, though do not express the highest possible welfare; those goods combinations, which lie on an indifference curve which does absolutely not touch the transformation curve, would indeed indicate a higher welfare than the tangential point, but they are not realisable because they are not at all on the transformation curve.

Now the traditional welfare theory has shown that in a market economy under very specific conditions the welfare potential is just being aimed by trend. One of the two most important conditions is the requirement that there are no external costs present, thus all costs incurred by a national economy are also borne by the enterprises which incur such costs. On the other hand, complete competition has to prevail on all markets and on both sides of the market.

If we assume, for the sake of simplicity, that there are no external costs, it is relatively easy to prove that, at the presence of complete competition and in equilibrium precisely the goods combination is realised which corresponds to the tangential point of the transformation curve with a collective indifference curve and which thus guarantees a welfare optimum.

In a first step, it is proven that whenever the entrepreneurs strive to expand the production of their goods until the marginal costs correspond to the given prices, in equilibrium the marginal rate of the transformation corresponds to the marginal cost ratios and these to the price ratios. If complete competition prevails, the entrepreneurs will maximise their profit namely just when this marginal- cost pricing rule is met.

In a second step, it is proven that households maximise their benefit precisely when the marginal rate of substitution corresponds to the price ratio of the goods. If two values are equal to a third one, they are also equal to each other. If both the marginal rate of substitution and the transformation correspond to the goods price ratio, then corresponds also the marginal rate of the substitution necessarily to the marginal rate of the transformation. Since the equality of both marginal rates constitutes the requirement for a welfare optimum, it is thus proved that in the case of complete competition (and avoidance of external costs) the welfare optimum is realised.

Now, Oskar Lange assumes that this requirement is not fulfilled in reality. The markets show monopolies and oligopolies, still not all economic costs are charged to the causative enterprises. For these reasons it must be assumed that the free market does not head for an optimal solution in reality.

Now, here starts the solution suggested by Oskar Lange. If an optimal solution could be achieved in the case of complete competition, then the optimality can also be achieved when the production managers are urged to behave like free entrepreneurs in competitive markets and to extend their production until the marginal costs correspond to the goods prices. The enterprises get nationalised and the production managers are bound by directives.

But this model works only if the prices set by the state reflect the scarcity of the goods and thus correspond to the equilibrium prices on the markets. Since the state can not know the scarcity relations in advance at the assumption of the consumer sovereignty, it is necessary to simulate the balance mechanism. The state authority assumes any prices and varies these as long as supply and demand do not correspond, whereby an excess supply must be answered with price reductions, and an excess demand must be answered with price increases, though.

To criticism, though, it must be noted that this concept neglects all internal administrative coordination problems. Within a market economy, entrepreneurs keep the marginal-cost pricing rule out of self interest. Entrepreneurs are trying to maximise their profits, and this is precisely the case when the entrepreneurs observe the marginal-cost pricing rule.

For the production managers, this rule constitutes initially only an instruction and it has to be checked whether respectively under what conditions the production managers have an interest in passing over these instructions. Since the superordinate authorities do not know the trend of the marginal costs per se, but are dependent on the data provided by the production managers, the possibility must be expected that the production managers try to conceal the amount of marginal costs.

Only a theory which, on the one hand, describes the individual motives of the production managers and, on the other hand, explains the incentive systems operating within the bureaucracy, can clarify whether and under which conditions it can be expected that the marginal-cost pricing rule is observed by the production managers also.

11th The Yugoslav model

A special variant of a socialist planned economy is found in the model which Tito had realised in the immediate period after the Second World War in Yugoslavia. While in most socialist models the criticism of the capitalist system led thereto that the commercial private property was laid in the hands of the state, thus was nationalised; in the Yugoslav model, a socialisation of commercial private property takes place, in which the previous private property was transferred into a property of the respective workforce of the individual enterprises. One was of the opinion that the deficiencies of the monopolistic capitalism could be overcome by transferring the production capital into the hands of the workforce.

As with the concepts of the French planning in other respects it is trusted largely in the effectiveness of the markets. Existing market imperfections shall be overcome and corrected by means of indicative macroeconomic plans and by state subsidy policy. No interest is levied on the capital invested in the enterprises and the production credits granted to the enterprises, since the socialist idea assumes that only labour would create value and that therefore only the work input but not the capital contribution justifies an income reference.

It must be noted critically that disincentives emanate from this system. For example, leads the deactivation of the capital market mechanism to an inefficient use of resources. Like every price in a market-economy system, does the interest not only have the function of paying a compensation to the saver for temporary renunciation of consumption, but has to ensure primarily that the scarce capital is used efficiently, thus flows in each case into the productions in which the capital generates the highest possible return.

This allocative task is no longer required simply because one passes from a pure market economy to a socialist system. Also in a socialist state applies that capital as a factor of production is scarce and growth losses occur if the efficient use of capital is not ensured. For a bureaucracy it is quite impossible to recognise the sectors in which the capital investment occurs optimal, at least if it is intended to adapt the production to the wishes of the consumers. If the interest rate is zero, also such productions are expanded that promise a lower capital yield than it corresponds to the interest rate.

On the one hand, a too low interest rate leads to an excess demand for loans, the government authorities have to allocate the too scarce capital; in the absence of proper efficiency criteria, political criteria are applied which lead to inefficient productions.

On the other hand, it must be feared that where capital is used inefficiently, where additional production capacities are built which do not correspond to consumer wishes, the individual holdings will have to be closed sooner or later because of insolvency and thereby capital is destroyed. The result is a reduction in economic growth.

A second deficiency of the Yugoslav model is that the labour market also becomes imbalanced. It is a serious mistake to think that if the interests of the enterprises are put in the hands of the respective workforce that then the interests of the entire workforce would be represented best possible automatically. In this way, the problem of unemployment can not be solved satisfactorily.

The interests of employed workers often deviate from the interests of the not yet employed workers. The workforce represents only the interests of the employed workers; for example, it has to be feared that the workforce will also impose such wage increases which will lead thereto that not all workers will find employment. It is therefore overlooked here that the workforce can not represent the interests of the unemployed workers.

12th The centrally administered economy

In conclusion, let us turn to the order conception of the centrally administered economy, the antipode of a pure market economy; we follow the classification made by Walter Eucken.

Representatives of a pure central administration system were, on the one side, the communists in the former Eastern bloc, although it must be stated indeed that Karl Marx had dealt extensively with the alleged weaknesses of a capitalist economic system, but made very few thoughts about how a Communist Economy would work, on which way the allocation would be regulated after the markets had been eliminated.

Karl Marx was too much convinced that an economy that is liberated from the profit interests of the capitalists, and in which capital is used, could produce goods in abundance and therefore was able to satisfy all the needs of the population; in view of this expected abundance, the problems of an efficient allocation of the resources faded into the background.

A centrally administered economy was furthermore realised in the western states during the wars, but here it was less a desired arrangement, but rather because there was no other possibility regarded to allow market regulations during a war. A war economy is characterised by a particularly severe scarcity of material resources. The war aims and the supply of the armies with the goods essential to the war effort have a clear priority. Here, a market economical guidance would only interfere.

A centrally administered economy is characterised by the fact that all fundamental economic decisions are based on a central governmental plan. This determination does not say anything about the size of the central planning authority initially. This depends basically on the size of the entire national economy. In large industrial societies, an extensive planning authority is required which is spread on numerous levels which are structured hierarchically.

A central authority formulates the basic aims of the planning and determines the allocation of scarce resources to the individual large economic sectors. Subordinate bodies specify these plans according to the exact specifications of the central. These receive detailed instructions, which are passed top down. However, since the central planning requires a variety of individual facts which can only be determined at the lowest level, the data has to be collected before the planning aims are defined, whereat the data flow occurs here from the lowest to the highest department.

In contrast to the planning and the Yugoslav model, there is not an indicative planning but an imperative planning present. In the case of the centrally administered economy, the central does not confine itself to specify the allocation of the scarce resources, but it defines bindingly the individual usage types of the scarce resources.

In the pure form of a centrally administered economy, the planning is carried out up to the permitted consumption of the individual households. To them, the consumer goods are allocated in form of ration coupons (e.g. food ration cards). Formally, the employees receive indeed income as in the market economy, while prices for the individual goods are still fixed which must be paid from the income for the consumption of consumer goods. But in contrast to the free market can the household only buy the goods and in the quantities for which it has ration coupons. Here, the prices do not have the function, unlike as in market economies, of indicating the scarcity of the individual goods and resources and thereby to direct production.

So far about the presentation of the centrally administered economy in its purest form. Two variants have been developed in the course of the implementation of this order conception: on the one hand, there is a state planned economy with freedom of consumption, on the other hand there is a decentralisation of the planning authority with more or less large decision-making scopes for the subordinate planning authorities.

This easing of the state planning economy occurred mainly due to the competition of the systems which had developed between the western-oriented economies and the Eastern bloc of communism since the fifties of the last century. Thus Khrushchev introduced a limited freedom of consumption in the course of a general liberalisation of the economy in 1953 after the death of Stalin.

Later, mainly in the eighties of the last century, Gorbachev initiated a major decentralisation of the planning, the top planning authorities confined themselves to set the most important fundamental aims of the planning, while the subordinate planning authorities were given broad scope for the decision-making.

The question, whether in the context of a centrally administered economy an efficient planning could be carried out at all, was discussed controversially for a long time. Walter Eucken was still of the opinion that in this economic system no rational economic planning was possible at all. A fixing of the prices for the individual consumer goods was only possible if the scarcity and thus the prices of the individual production factors are known. The scarcity of the production factors and thus the appropriate level of the factor prices, though, can in turn be determined only if the prices of the end products and with them the exact demand for these goods are known. Only a market economy system was capable of solving this allocation problem satisfactorily by a simultaneous determination of all prices - of the final products as well as of the production factors.

As a further argument for the impossibility of a central efficient economic calculation it was pointed out during the period directly after the Second World War that the computer systems known at the time were not capable at all of calculating equation systems with functions of higher degree. As is well known, in the production theory we assume Cobb-Douglas production functions which are determined by non-linear parameters.

In response to this criticism, K. Paul Hensel, a follower of Walter Eucken, had tried to show that a rational economic calculation is possible within the framework of a centrally administered economy, namely thereby that the planning is confined to quantity variables.

Furthermore, on the one hand, the capacities of the computer systems have been increased many times over meanwhile. On the other hand, the development of the concept of the 'linear programming' has attempted to display the production processes by means of linear production functions and thus to increase the computability of the production processes.

It must be critically stated, though, that in all models of a governmental bureaucratic economy all coordination problems are disregarded. It is assumed as naturally that the instructions of the authorities are followed by the subordinate authorities a hundred per cent.

The experience shows de facto that also bureaucrats are guided by own interests, that they often also have sufficient power against the politicians to circumvent the instructions. It is one thing to describe the ideal-type functioning of an economic system and a completely different thing to ask for the specific procedures of this system.

The theory of state planned economy has been confined mainly to the idealistic consideration. The criticism of the models of a state planned economy has pointed out that not only in market economies, but in all real systems, especially also in the systems of a state planned economy, failures and shortcomings set in repeatedly which cause the result of the real economic process to diverge more or less from the ideal-type results.

These real difficulties are to be expected especially, if the centrally administered economy allows freedom of consumption. This fact raises doubts as to the efficiency of state planning, since nowadays an economic order without freedom of consumption is not conceivable in any remaining communist state.