Despite its strong emotional appeal, there are two fundamental reasons why socialism cannot serve as a productive economic system. The most important of these, as identified by Ludwig von Mises, is that it is effectively incapable of generating an economically efficient price mechanism. To understand why this failure precludes socialism from fulfilling many people’s dreams for it as a viable and ‘fairer’ alternative economic system to free market capitalism, one needs to appreciate fully the essential role that prices play in any economy. The second reason is that the incentives that exist in a market economy are not present in a command economy.
While human needs and demands are infinite, the resources available on Earth to satisfy these needs and demands are finite. This means that there is competition for these scarce resources and a cost is attached to obtaining them in terms of the effort, time, risk, and material expended in doing so. Having grown, made, or discovered something, people invariably need to exchange whatever this is for other goods or services or for money.
How, then, is an objective price to be established for the good or goods that they wish to dispose of, or for those that they wish to acquire? How are relative monetary prices that are readily acceptable to both buyer and seller, and so facilitate economic activity and thereby encourage it, to be established for every one of the millions of items and services that exist in any substantial economy, the relative quantities and qualities of which also keep changing from day to day?
In a free market, capitalist economic system where the means of production are in the hands of private individuals, the objective price of every good and service (including that of labour) is ‘discovered’ by means of the process of negotiation preceding the voluntary exchange of goods and services between free and private individuals, each responding to the market forces of supply and demand and frequently in competition with one another. All prices are determined, not just by what each individual is willing to accept for their good or service, but also by what the millions of individuals making up the community are able and willing to pay for it.
The free market process is itself the price discovery mechanism for all goods and services in a free-market, capitalist economy.
The competition generated in this process further tends to drive prices down and also to ensure the most efficient allocation of scarce resources, to the benefit of all members of the community. Free market exchange is how humans tend naturally to organise themselves economically when they are free and not subject to some authoritarian diktat.
In a socialist economic system, on the other hand, because all property and production is in the hands of the State rather than of private individuals, all prices have to be determined by the State in the absence of a people’s organically-functioning market. The State will be represented by a committee of bureaucratic ‘experts’ who will among themselves have to divine and set relative prices for each and every good and service in existence in society, of necessity changing relative prices as and when relative circumstances change.
Every time, however, that they set an inappropriate price for any good or service, which is likely to be constantly, this misinformation will ricochet through the economy, producing a host of unintended and costly consequences and further misallocating resources. Socialist economies consequently have frequently had to resort to copying prices from free market economies to compensate for the lack of their own efficient pricing-mechanism. We do not have to look further for an explanation of why the Soviet Union collapsed, or why communist China rejected socialism economically and turned to capitalism to drag its people out of poverty. Today the Chinese Communist Party employs free market capitalism for its economic functioning, and utilises the ideology of socialism politically in order to maintain autocratic control over the minds of the Chinese people.
Socialism is not a viable economic system, mostly because public ownership of the means of production precludes an effective method of price discovery. And without meaningful and rational relative prices, one simply cannot have an efficient and productive economy.
The second fundamental reason that socialism is not a viable economic system, is because State ownership and management of the means of production takes production and the potential financial rewards of production out of the hands of private individuals. In doing so, it immediately reduces or eliminates many of the incentives that motivate individuals in society to strive beyond their immediate skills and knowledge, and to take the risks and make the extraordinary effort that is required to succeed beyond the norm in any field. And it is on the exceptional efforts of motivated and highly competent individuals, that society as a whole generally depends for the material discoveries and advances that humanity has benefited from.
In contrast, Soviet workers once joked – “they pretend to pay us, and we pretend to work”.
Socialism makes much of the idea of ‘fairness,’ and free market capitalism is widely condemned morally for the material inequality that it brings about. Inequality of wealth, however, is an absolutely necessary consequence of a highly competitive economic system based on private ownership. This inequality is, however, more than compensated for by the higher standard of living enjoyed by the poor in a capitalist society, than that of the poor in a ‘fairer’, egalitarian society. Significantly, it is the poor in egalitarian societies who seek to emigrate or escape to capitalist ones, and never vice versa.
There are numerous reasons why socialism fails as an economic system, but its total inability to create an efficient price mechanism is by far the most important of these.
Socialism survives among the democratic nations only as an ideological parasite on the underlying capitalist market economies. The entire wherewithal to pay for socialistic welfare benefits in every capitalist society, including Scandinavia, is derived solely from the working, capitalist market economies.
If the free market, capitalist economies were to disappear or wither significantly, as they are in fact doing slowly under the weight of ideological socialistic exactions and excessive bureaucratic regulation, socialism has absolutely nothing to contribute economically to the survival of nations.
Socialism is not an economic system after all, and its continued misperception as a viable economic alternative to capitalism is due only to the economic illiteracy of the general public.
It is, unfortunately, at the very best, a pernicious, quasi-religious political ideology masquerading as an economic system. Socialism projects itself as an economic system in order to acquire the intellectual credibility and authority needed to gain political power in a secular era for the politicians who seek to exploit its emotional attractions to the public.