The communist views
Communism in its purest proposition envisions a society that abolishes private property and relies on central planning to allocate resources. Communists argue that capital is a collective product, the result of labor by many members of society, and therefore should be converted into common property. When communists and socialists saw that large companies could organize activities at scale, they decided that the government could do this too, and do it better.
Criticisms of the communist blueprint emerged quickly. One set came from several economists associated with the Austrian school (Ludwig von Mises and Nobel Laureate Friedrich Hayek, the latter of whom also became associated with the Chicago school), who pointed out that a central planner cannot easily figure out how to allocate resources in the total absence of markets and prices. How much input should the planner give each producer? How much output should it give each consumer? In their view, prices played a crucial role in reflecting relative scarcities so that resources could be directed to places where they could generate the most value, while markets played a crucial role in coordinating actions in a world of dispersed information.
In response to these critiques, socialist economists began to acknowledge that it could be useful to introduce prices and markets to help the central planner, which led to the notion of market socialism. In this vision, introducing prices and markets for consumer goods seems reasonable and straightforward. Doing the same for firms is less obvious. Some of today’s companies are larger in terms of output than the smallest countries, but it may not be realistic to introduce central planning in either. Why? One possibility is that even the biggest companies tend to specialize in a certain domain, and many have failed miserably when they have tried to venture into unfamiliar territories. The central planner would need to master many more things than even Amazon and Google do in order to manage the same amount of output. Another possibility is that the world is dynamic rather than static, and large firms still go through the process of natural selection and get displaced by better ideas and products. A central planner may not be able to effectively pick winners and losers among all possible ideas and investment amid this constant change.
One of the leaders of the market socialism tradition was Lange, who was on the faculty at the University of Chicago from 1938 to 1945. He was hired by the university not, I suspect, because of his communist views but in spite of them. Eventually, Lange returned to his native Poland to practice central planning and became a high official in the Polish government. Later, in 1950, Hayek arrived at UChicago. His famous book, The Road to Serfdom, had been published in the US by the University of Chicago Press in 1944, after meeting much resistance elsewhere. Today, Hayek remains a familiar name among economics students, whereas Lange is little known. It’s intriguing that we remember more about the viewpoints of one side of the debate and less about those of the other, even though people on both sides actively and persistently argued with each other for decades.
A second set of criticisms of the communist blueprint, raised by Hayek and many others, revolved around incentivizing managers in a communist system. How does a central planner figure out whether managers have exerted effort and taken the right actions? Lange thought that the agency problem (whereby someone working on behalf of others may take self-interested and suboptimal actions) exists in any organization, and indeed, corporate governance has become an immense field of research. But there can be additional challenges to solving agency problems in a world with collective ownership. For example, it’s now common practice to use equity compensation to align employees’ incentives with company performance, which could conflict with egalitarian collective ownership. With pay for performance, some people will receive more than others. If the central planner intends to always distribute profits equally among everyone, extra effort will not generate extra rewards.
A third set of criticisms centered around how to discipline a central planner. Even if the managers follow orders perfectly, how do we make sure the government represents the people properly and acts benevolently? What if the government pursues the agenda of the politicians instead of efficiency or the wishes of the people? How do we prevent corruption? Again, governments in any society can face these issues, but the costs of failures can be larger when a government, under central planning, controls a vast amount of economic resources and activities.
Through the grand social experimentation of the 20th century, it became evident that the pure form of communism was not realistic. But even though central planning and collective ownership faced serious challenges, the debates about them sharpened a number of concepts that we use in economics research today. The knowledge problem (that information is distributed) is a key insight in organizational economics. The managerial agency problem plays a crucial role in finance as well as in numerous other domains. The fallibility of the government is essential for political economy. Many problems related to the debate over communism remain far from perfectly understood. For example, the optimal realm of an organization, be it a firm or a government, is difficult to fully specify. Even outside of the pure form of communism, a substantial degree of planning by firms and governments still exists. The Lenin-Coase cycle lives on.
The capitalist views
Moving to the other side of the spectrum, we have the capitalist blueprint. Whereas the pure form of communism has a relatively clear benchmark of full central planning and collective ownership, the benchmark of capitalism is more nuanced. Having no government and pure anarchy is evidently infeasible, and perhaps a close approximation is “minimum” government services in a laissez faire economy with private ownership and market competition.
Every advocate of free market capitalism has to deal with its definition, and Friedman provides an extensive discussion of the minimum necessary functions of the government in his 1962 book, Capitalism and Freedom:
Good society requires that its members agree on the general conditions that will govern relations among them, on some means of arbitrating different interpretations of these conditions, and on some device for enforcing compliance with the generally accepted rules.
Therefore, the government plays a role in maintaining law and order, enforcing property rights, adjudicating disputes about the interpretation of the rules, providing a monetary framework, and collecting taxes to implement programs.
That said, the optimal boundary of the government is not easy to draw, and disciples of free market capitalism may disagree with one another. According to an interview Friedman gave with the PBS broadcast Commanding Heights, von Mises once stormed out of a discussion while saying that a group of Chicago economists, including Friedman and Nobel Laureate George J. Stigler, were “all a bunch of socialists.”
But regardless of where we draw the exact bounds of government, the capitalism blueprint confronts several perennial questions, including a familiar one having to do with how to address inequality. Frank Knight, one of the leaders of the Chicago school and Stigler’s PhD adviser, wrote, “There appears to be a deep-seated conflict between liberty and equality on the one hand and efficiency on the other.” Knight’s reservations about laissez faire capitalism turned into lectures under the title The Case for Communism, although he ultimately rejected communism and was considered by Hayek to be a key thinker when it came to the development of free societies.