THE ROLE OF PRIVATE PROPERTY IN A CAPITALIST MARKET ECONOMY

Why Not Socialism?

With respect to the discussion here about the benefits of private property, it is worth mentioning briefly several reasons socialism is unlikely to function as effectively as capitalism. The first reason is socialism's disregard for an important element of human justice, that each person shall reap what one has sowed. The second reason is that if socialism is to function effectively it requires both benevolent motivations on the part of the government as well as an enormous amount of centralized information. These conditions are highly unlikely to be satisfied in the real world. The following argument only scratches the surface and focuses only on the extreme form of centrally planned socialism ... but it's a good place to start.

Socialism is simply defined as public, or government, ownership of the means of production. As the owner, government would then be entitled to make all decisions with regard to production by the firms, including what to produce, how to produce it, who to hire, how much to pay the employees, etc. There is typically a presumption made that government would not be beholden to the profit motive and therefore would make decisions that are in the broader social interests. That may mean that government would relieve inequalities by paying lower-paid workers more and higher-paid workers less. It may also be presumed they would solve externality problems and assure that production is done in an environmentally friendly and sustainable way. However, to accomplish these goals, socialism breaks apart the effort-reward structure of private property and capitalism.

I think it is reasonable to say that perhaps the primary reason for an individual to have a sense of injustice about something is when that person puts time, effort and thought into the production of something but afterwards does not receive a reasonable return. This occurs frequently in capitalistic society when workers feel mistreated and underpaid, when companies cause damage to the environment and threaten the health of others, and when monopoly power enables some to acquire an enormous amount of personal wealth. However, these injustices arise, not because of the presence of private property, but rather because too many people do not conform to the ethical principles that must constrain behavior for capitalism to work effectively.

One possible solution is to keep private property and capitalism, but work towards greater recognition, acceptance, and application of these ethical principles. An alternative solution is socialism, whereby a government takes control of the means of production and allocates the returns from production more fairly.

Socialism implies and requires that what one reaps is no longer determined by the efforts of the sower, but rather by the "socially prudent" decisions of the government in power. By breaking that link between effort and reward, by taking the control over property away from individuals, socialism destroys the individual incentive to participate with maximum effort. This is a fundamental flaw in socialism.

Human society has had several large-scale tests of centrally-planned, government-controlled, economies in which private property was abolished and put under the control of the state. The Soviet Union and Communist China both demonstrated unequivocally how incentives were destroyed by public ownership resulting in significantly poorer economic outcomes. The people in these countries were not allowed to reap what they sowed, but instead were encouraged to sow solely for the benefit of others. Socialism asks people to bury their natural tendencies to satisfy their own self-interests and instead work for the good of all. The results are in, the citizens of these countries did not thrive and were not happier.

Of course, one could reasonably argue that the governments of these countries did not implement socialism appropriately. That may well be true, but this argument nonetheless raises several other significant problems with socialism.

The first is the need to have a competent, benevolent-minded, government to implement an effective socialist program. When you take decisions away from individuals, one must consider carefully who are the people in whose hands the decisions will be given and what are their motivations? In a country that is democratically socialist, the government is elected by the citizens with the presumption being that if a government makes poor decisions then citizens can vote in better people in the next election. In this way, government leaders need to maintain public approval. However, this system of checks and balances has not proved to be flawless and consistently has resulted in the elections of leaders who are motivated more by the exercise of power and the enhancement of their own reputations, rather than the betterment of the nation's people. In addition, democracies suffer, to varying degrees, from the problems associated with special interest influence. These special interests can and do tilt policy decisions in their favor rather than striving for the idealized social outcomes that are sought by the advocates of socialism. Thus, even with democratic control over leaders, one cannot guarantee decision-makers will act in line with socialist principles.

In the two grand socialist experiments of China and the Soviet Union, the leadership was not democratically elected, but rather, comprised of a dictator, or supreme ruler, together with a small group of elites. These two experiments began with visionary leaders, Vladimir Lenin and Mao Zedong, who were among the leading thinkers and writers about the socialist revolution at the time and surely both of them strongly believed in the validity and superiority of their principles. They both abolished private property and instituted central planning and they sustained these experiments for over seventy years for the Soviet Union and over 25 for China. By the 1970s, after 25 years of Mao, China was among the most backward countries in the world, not the paradise that was proclaimed as inevitable by its leaders. The Soviet economy performed better overall and its ultimate collapse took much longer, but it's economy too was dragged down by the inefficiencies of public ownership and control.

This suggests that even in these cases where the leadership had supreme power and were well-versed in socialist ideology, they could not implement a successful socialist regime. In the Soviet Union, one reason may be that Lenin did not live long after coming to power, and his successor, Josef Stalin, was one of the most brutal dictators of the 20th century. Fortunately for China, after Mao's death in 1976, its next consequential leader, Deng Xiaoping, carefully steered the Chinese economy towards a capitalist system, allowing a system of private ownership to develop which in turn ignited the incentives to produce. As a result of this transition to capitalism (albeit with Chinese characteristics), China achieved one of the most spectacular episodes of economic growth over a 40 year period and virtually eradicated poverty among it's 1.3 billion people. Thus, one strong argument against socialism is that it has already been tested and the results have not been inspiring.

Rarely do we see proponents of socialism, or democratic socialism, explain in any detail how to guarantee that the leadership will have the correct socially oriented motivations to implement the appropriate policies. Indeed, this issue should be a required element in any intellectual argument for government control of anything, be it redistributive policies, or health insurance provision, or regulations. However there must also be a second element in any socialist leaning policy proposal, namely, how is one to assure that the government decision-makers have sufficient information to calculate the best levels of intervention. It is this second issue that we turn to next.

In a socialist economy, private owners no longer exist, therefore instructions must be given to workers about what to produce, where to obtain materials, how much to pay its workforce, etc. In a market economy with private property that task is accomplished with two things, prices and the profit motivation. Business owners make higher profit in a competitive market when they can supply the goods and services that are demanded at the lowest possible cost. Prices send the signal of abundance or scarcity with low-priced products being relatively abundant and high-priced products being relatively scarce. This does not mean producers always gravitate to purchase products at their lowest prices though, because they must still provide a product that satisfies the expectations of the consumer and sometimes that will require higher-priced inputs.

The most amazing thing about a market economy remains one of the market's most elusive concepts, that of the invisible hand. Adam Smith first introduced the idea in the Wealth of Nations but offered only a cursory explanation of the term itself. He did describe man's natural propensity to truck, barter, and exchange one thing for another in pursuit of one's self-interest and it is this propensity that has led to a complex web of supply and demand chains that stretch around the world, much of which was true even in Adam Smith's time. It is the invisible hand, or what Friedrich Hayek called the spontaneous economic order, that makes possible my dinner with tomatoes from Mexico, olives from Greece, wine from France, and vegetables from California, while no one person, even myself, could have known that I would be demanding these items on this particular day, and while no central authority controlled the decisions that were needed by all of these producers to make this possible. It is so amazing that it should be considered a wonder of the world ... except for the fact that the invisible hand is not "the effect of any human wisdom (that) foresees and intends the general opulence to which it gives occasion," as Adam Smith proclaimed.

And yet for many promoters of socialism the invisible hand remains so elusive that some have convinced themselves that it doesn't even exist. (see these remarks by Nobel Laureate Joseph Stiglitz whose statements will surely encourage this sentiment). If one cannot see how the market works without human control and intervention, then the only solution to make it work better would seem to be to control it with human wisdom. Some have said this is why many smart people gravitate to socialism; it requires the application of a lot of human wisdom to make it work. In the 1930s, Oskar Lange was one economist who argued that central planning could work if the government constructed a mathematical model of the economy and adjusted production in response to shortages and surpluses. The model he devised relied on the way a free market uses prices to allocate goods and services, but argued this could be done solely by command and control. This was done at a very early stage of computing and there were heady dreams at the time that as computing capacity grew and data collection became more widespread, economists would be able to construct a super-model of the economy and use it to forecast future outcomes and control them as desired. But, this proved to be little more than a pipe dream.

Economic modeling of national economies has turned out to be much more difficult, even in an era where computing powers and data collection has grown exponentially during the past half century. The economy is simply too complex and is changing too rapidly to be able to capture it in a computer model and predict its future course. And yet, that is what all-out socialism would require to work effectively.

One of Friedrich Hayek's most important contributions to the understanding of capitalism was the recognition of how the price system effectively transmits information from those who have it (Company A has oil and is willing to sell it at price P1) to those who need it (Company B needs oil and is willing to buy it a price P2). As long as P2 is greater than P1 a deal will be struck at a price in between. But when a disruption in the supply of oil occurs company A will raise its price and that signal will be sent down the line to every purchaser of oil that oil is becoming scarcer and thus economizing will ensue. To the extent the higher oil price raises the price of other products such as gasoline and electricity, consumers of these products will adjust their demands in response. In other words, the price system and the profit motive combine to transmit information in a much more effective manner than could ever be achieved via command and control.

So why not socialism? Because state socialism, in which the state owns and controls the means of production, has failed in every country that has tried it. Not only does the elimination of private property destroy individual incentives to produce, no socialist state has been able to maintain consistent and effective leadership and manage the extremely complex information network necessary for the system to function efficiently.

But remember that saying no to socialism is not the same as saying no to all government involvement in economic matters. Government can play a role helping to achieve a more functionally efficient economy, but government intervention can go too far. How far is too far? Well, I hope most could agree today that state ownership and control of the means of production would be going too far. Lesser degrees of government control could be effective, however, any such intervention still has to contend with the problems highlighted here, namely, how can one assure consistent and effective leadership and how can the government manage the complex informational requirements to solve the economic problems efficiently? Anyone proposing government solutions to problems should be expected to address these issues and explain how they will be solved.

Steven Suranovic, April 26, 2020