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Was Central Planning Really Inefficient?

The great MIT economist Robert Solow once made the joke that the way to do a PhD in economics was to find some crazy social arrangement or outcome in the world and then think of the informational asymmetry that made it constrained efficient.

With this methodology in mind, it should come as no surprise that, contrary to what we presumed in our last post, some people do not regard central planning as that inefficient after all. The most plausible case along these lines was made by Robert Allen in his book Farm to Factory. Allen pointed out, rightly of course, that in 1917 the Soviet Union was a very backward economy with poor institutions and far behind the world technology frontier. Allen’s big leap was to argue that in an environment with poor institutions central planning was a rational way of industrializing such an economy. In fact, if you compare the growth of the Soviet Union to that of other parts of the world, such as Latin America, over the period 1928-1970, the Soviet Union does quite well. The next figure from Allen’s book illustrates this by plotting the level of income per-capita on the horizontal axis against the ratio of the 1970 to the 1928 level.

Though the Soviet Union does not do as well as Japan, it does better than the non-OECD countries which were as poor as it was in 1928 when its first Five Year Plan took effect.

It’s true of course that Soviet industrialization involved the forced collectivization of agriculture which created huge hardship and even deadly famine in the early 1930s, and was also based on the suppression of consumption in order to accumulate capital. Even here Allen argues that this wasn’t too bad. The next figure, again from his book, shows that though there was a 20% fall in average consumption after 1930, by 1935 it was back to the 1930 level.

All the same, even though the facts that Allen lays out are correct, they do not justify the conclusions.

For 40 years the Soviet Union was indeed a growth miracle, but it was a spectacularly unsustainable one based on extractive political and economic institutions. The powerful Soviet state could generate large productivity increases by moving people from rural areas and putting them into factories. But the system totally failed to generate incentives for improving productivity or for innovation except in military areas where they put a huge amount of resources.

Inevitably the Soviet economy ultimately collapsed. When people were not forced to buy the goods Soviet industry produced, they went out of business, and now the Russian economy is held up not by the benefits of centrally planned industrialization but by high natural resource prices.

The important leap in Allen’s conclusion, and the reason why his thesis is ultimately unconvincing is that as Gerschenkron noted long ago in Economic Backwardness in Historical Perspective, partly in the Russian context also, backward economies can grow rapidly and may do so using a variety of arrangements. This is made feasible because they are benefiting from catch-up and technological convergence. The fact that Soviet Russia took advantage of catch-up opportunities and transferred resources from its massively inefficient agriculture to industry implies neither that central planning was efficient in the short run nor that it could be a steppingstone for more growth-enhancing institutional structure in the long run.

Textbooks sometimes simplify things. But in this instance, the textbook treatment of central planning as economically inefficient is right.

So the next question is whether Soviet communists adopted and persevered with central planning despite its inefficiencies, mostly because of their Marxist ideology.

We’ll see in the next post that the answer is largely no.  


Ideology and Comparative Development

In Why Nations Fail we lay out some of the most popular alternative hypotheses about comparative economic development. There we paid little attention to the role of ideas, except to the extent that they play a role in economists’ favorite “ignorance hypothesis”. One form of ignorance could be that policymakers in poor countries just have the wrong ideas about how to make their country rich, or they have such ideas foisted upon them by international institutions or misguided economists. For example, Anne Krueger argued in her 1993 book Political Economy of Policy Reform in Developing Countries, that Latin American countries had inappropriately adopted inward looking “import substitution” policies in the post World War II period because they were fooled by the incorrect ideas of economists like Raúl Prebisch. Better ideas then came along and Latin American countries changed track towards greener pastures.

More recently Dani Rodrik in “Ideas over Interests” takes his cue from Keynes’s famous remark in the General Theory that

even the most practical man of affairs is usually in the thrall of the ideas of some long-dead economist.

Rodrik similarly argues that many policies and arrangements should be understood as outcomes of mistaken theories rather than consequences of some powerful groups to mold them for their interests. Interestingly, his view is not that dissimilar from Anne Krueger’s but with one difference: the sign is reversed!

Rodrik thus sees the policies prior to reform in the 1990s as sensible, and the ones adopted afterwards in the era of the Washington Consensus as the incorrect ones.

Could this be the right way to think about underdevelopment?

In the next few posts, we’ll examine these ideas starting with one of the favorite examples of the ideas-drive-everything camp: government central planning of the economy.

When we were students, almost every undergraduate textbook contrasted the efficient way that markets allocate resources to the massive inefficiency associated with central planning, usually in the Soviet case.

But why on earth did the Soviet Union adopt such inefficient system? Textbooks usually resort to ideas and ideology as the explanation.

The story goes something like this: When the Bolsheviks took over Russia in 1917, they had a Marxist ideology which crucially relied on collective ownership of the means of production and assets, and on state planning of industry. (Never mind that central planning did not start until after Stalin’s rise to power). So they introduced central planning because of their ideas and ideology.

What were they expecting from central planning? Central planning was seen either as an attempt to create “socialist men and women” stripped of the bad effects of markets and private property on their character and work ethic, or simply as a facet of state ownership of the means of production. When the state owned everything, it had to decide what to do with the resources, which was what central planning was about. It would do this of course with an eye towards social welfare, which the Bolsheviks no doubt saw as something a market economy could not achieve. (However ironic it may sound today that Bolsheviks might have been interested in anybody’s social welfare). Indeed, prior to the adoption of central planning in 1928, they even abolished money (a.k.a. “the root of all evil”) at one point in the period of “war communism” between 1918 and 1921.

So this seems like a pretty convincing exemplar of hugely inefficient institutions introduced because of ideology. But is it?


Mitt, Jared and David

We were doing so well. Writing about economics and politics for the last five months here without once mentioning the US presidential race. But it’s all over. Mitt Romney has given us no choice, wading into the debate about the origins of inequality and prosperity around the world.

Here is what Mitt says:

I was thinking this morning as I prepared to come into this room of a discussion I had across the country in the United States about my perceptions about differences between countries. And as you come here and you see the G.D.P. per capita, for instance, in Israel which is about $21,000, and compare that with the G.D.P. per capita just across the areas managed by the Palestinian Authority, which is more like $10,000 per capita, you notice such a dramatically stark difference in economic vitality.

He continues:

Culture makes all the difference. And as I come here and I look out over this city and consider the accomplishments of the people of this nation, I recognize the power of at least culture and a few other things. One, I recognize the hand of Providence in selecting this place. 

Mitt Romney also identifies the origins of his thinking as David Landes’s The Wealth and Poverty of Nations and Jared Diamond’s Guns, Germs and Steel (though presumably not the origin of his numbers, which are incorrect; the gap between per capita in Israel and West Bank and Gaza is about tenfold).

Well actually, Jared Diamond doesn’t say much about culture. In fact, his thesis is about how geographic and ecological conditions led to the differential development paths and prosperity among otherwise identical peoples. In fact his theory would predict that Israelis and Palestinians should have identical levels of prosperity.

Readers of this blog and of Why Nations Fail have already heard us inveigh against geographic determinism. Those interested in this debate can start from Jared Diamond’s engaging and critical review of our book in the New York Review of Books, and then look at our letter and Jared’s response. Perhaps it’s just us. But doesn’t Diamond just say that he disagrees with us but without substantiating how he counters our arguments?

In any case, we digress. Mitt Romney is instead taking his cue from David Landes. But as we show in Why Nations Fail, cultural differences cannot explain differing levels of prosperity. Deng Xaioping didn´t change Chinese culture after 1978 to make the economy grow, but he did change economic institutions a lot. Indeed, many cultural differences we see are the outcomes of different institutional choices. This is surely the case between North and South Korea, for example. After all, does Mitt and David think that there were huge cultural differences between the north and the south of the 38th parallel before the separation of Korea into two?

Of course the difference between Israel and Palestine is not the same as the two Koreas. It was created by the migration of Jewish people, mostly after World War II. Many came from much more developed parts of the world than Palestine which had endured centuries of debilitating Ottoman and then British colonialism. They brought more advanced technologies and high levels of human capital, which in themselves were the result of the institutions and incentives that they faced. As Maristella Botticini and Zvi Eckstein point out in their book The Chosen Few: How Education Shaped Jewish History, the origins of these very high human capital levels are in the historical adoption of institutions in Jewish society. This is where the roots of Isreal’s current prosperity lie. They have further been strengthened by Israel’s integration into the world economy, which has enabled it to continue the process of technology transfer and encouraged trade and investment.

Why hasn’t this prosperity spilled over to the Palestinians since the British left in 1948? A definitive answer would need to be based on much more research, but a plausible one comes from the reaction of Saeb Erekat, an aide to President Mahmoud Abbas of the Palestinian Authority, to Mitt´s remarks:

this man doesn’t realize that the Palestinian economy cannot reach its potential because there is an Israeli occupation.

It seems to us that Mr. Erekat, not Mitt Romney, has the right idea.

We end this by agreeing with what Sandeep Baliga and Jeff Ely say on their blog. Mitt should do some more reading.


South Africa: The Fear of Becoming Colombia

South Africa didn’t collapse economically after the end of Apartheid. In fact, following the tails of a long decline from the mid 1970s, its rate of economic growth picked up after the transition in 1994 and has been positive, though moderate, ever since. Despite how modest progress towards a different society has been, South Africa has not veered to populism, though as we saw in our last post there have been some threats.

But perhaps populism is not the main threat to South African democracy in any case. Perhaps the real danger lies elsewhere.

In Why Nations Fail we tell the story of how Latin American societies became highly unequal and extractive during the colonial period. Though they gained independence 200 years ago, most of Latin America, for example Colombia, continued along this path, with the traditional or new elites firmly remaining in control despite electoral democracy taking root. Though electoral democracy and other reforms removed the de jure control of these elites, their de facto command remained largely unchallenged.

Could it be that the endpoint for the transition in South Africa is a transition from Apartheid to a Colombian model?

Here is why this scenario is not so far-fetched: in Latin America, the elite managed to keep de facto power in attendance because it still controlled the main economic assets and wealth, and could capture and co-opt the new political elites. The situation is similar in South Africa. Economic assets and influence are still hugely concentrated. In the face of the economic power of the economic elite, the ANC leaders found themselves with both serious constraints on their behavior and new lucrative economic opportunities. Legitimately they feared the economic collapse that might have followed from the implementation of too radical a program. So they went slowly. But slow progress left economic power, opportunities and decision-making where they had been before. The once radical ANC began to empathize with the problems of business; they worried about the bottom line of businesses — after all, wasn’t business confidence crucial for the new South Africa? Private sector banks were involved with the attempt to build houses for the millions of black people living in shanty towns, but banks worry about collateral and profits, not about the positive externalities and the social transformation that would follow from an integrated society. The ANC started sympathizing with the banks, perhaps even forgetting about that social transformation.

In the meantime the reality of Apartheid fell into the past. People, especially new generations, started to get used to inequality. Perhaps with Apartheid gone, inequality appears less unjust, less rigged today.

The bottom line of this is that a clear trajectory for South Africa is not as a NIC or a BRIC but as a NLC, a Newly Latinamericanized Country, one with high inequality and persistently poor economic performance as a result of the fact that the vast majority of its population will still be poor and excluded from economic opportunities. Some people, of course, will be doing extremely well.

It is interesting that the German state after World War II, though devastated by the war and de-Nazification, was still able by the 1960s to largely re-build the infrastructure which the Allies had pulverized in the closing stages of the war. In contrast, the South African state has been unable in the same amount of time to get the poor people, who fought for the end of Apartheid and voted for it, out of shacks and shanty towns.


South Africa: The Fear of Populism

The slow progress in changing economic institutions since 1994, which we have discussed in the last two posts (here and here), whatever its cause, creates another problem, or maybe two.

One is the obvious one that the lack of progress will create a huge populist backlash against the ANC. In 2009 after Thabo Mbeki had been forced out of power by his own party, the ANC opted for Jacob Zuma as the president. Many saw this at the time as a lurch towards radical chance in the platform of the party. Indeed Zuma’s theme song of “Bring me my machine gun” seems to be a radical departure from the pipe smoking cerebral Mbeki. You can see Zuma singing it here at the ANC national conference:

The translation of the words reveal that this is a song with a simple message.

My machine my machine gun
Please bring my machine gun
My machine gun my machine gun
Please bring my machine gun
My machine gun my machine gun
Please bring my machine gun
Please bring my machine gun
You’re pulling me back
My machine gun, Please bring my machine gun

Many others in the ANC would like to reach for their machine guns as well. A notorious one is Julius Malema, former head of the ANC Youth League, who reveled in singing another song of the struggle against Apartheid called “Shoot the Boer” (Boer referring to white South Africans of Dutch descent) whose (Zulu/English) lyrics are:

Ayasab’ amagwala (the cowards are scared)
dubula dubula (shoot shoot)
dubula dubula (shoot shoot )
ayasab ‘a magwala (the cowards are scared)
dubula dubula (shoot shoot)
awu yoh
dubula dubula (shoot shoot)
aw dubul’ibhunu (shoot the Boer)
dubula dubula (shoot shoot)
aw dubul’ibhunu (shoot the Boer)
dubula dubula (shoot shoot)
aw dubul’ibhunu (shoot the Boer)
dubula dubula (shoot shoot)
aw dubul’ibhunu (shoot the Boer)
dubula dubula (shoot shoot)

Malema has demanded the expropriation of land and assets from whites without compensation and has praised the Zimbabwean model. Yet Malema, though there is clear evidence of his popularity amongst some of the population, was convicted of “hate speech” and expelled from the ANC. Zuma rushed to distance himself and the party from such class and has yet to reach for his machine gun since becoming president. Despite many anxieties and increasing inequality so far populism seems only a distant threat in South Africa.