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It may sound strange, but it is true. In the final analysis, this fact is what brought communism down. It wasn’t Ronald Regan’s master plan to force the USSR to spend itself into oblivion. It wasn’t pope’s John Paul II’s support of Polish union Solidarity. It wasn’t communist repressive regime or incompetent economic management. It was something much more basic and critical to communist theory: communists can’t count.

What do we mean by the idea that they can’t count? Simple, they can’t count profit and loses.  It is not that they can’t do math, it is that they lack the numbers for doing math.

In a communist system, the government owns all the production means. In essence, the government owns all factories, trains, roads, trucks, mines, stores, farms, etc. The idea being that if the governments owns everything, and the people are the representation of the government, then the people owns everything. Therefore, no worker can be “oppressed” by “capitalists”.  Never mind that the government was nothing but a collection of oligarchs. That’s an entirely different discussion.

However, there was a tiny flaw in the plan. If the government owned everything, that meant that the government had to:

  1. Plan what is it going to be produced and in which quantities
  2. Decide how much to pay workers

The problem with this is that the government cannot read minds. Therefore, the government cannot determine what people want or at what price. Therefore, the communist economic system cannot know if a product is economically viable or not. If it cannot know this, then it cannot make efficient economic decisions as to what to produce, in which quantities and at what price. Which means that the communist economic system systematically mis-allocates capital. This is the true source of failure in the communist economic system. They are blind.

In economic terms, a free market is a mechanism to efficiently allocate capital. What does this mean? It means that a company takes a risk by producing goods and services which it intends to sell to the public. They take a risk because they don’t know if the product will sell or at what price. They enter the market and the market decides if the product is OK and if the price is OK.

If either of those elements are not OK and cannot be fixed, then the product is not sold and the company will discontinue it. The market told the company that people don’t want that product.

Similarly, if the product is sold, the quantity sold and the price will tell the company how much more to produce and at what cost. In essence, the market is telling the company how much the people want the product.

Any product can be sold at a sufficiently low price. We know that. The question is, is that price above or below manufacturing costs? If it is below, it is not economically viable. If it is above, it is.

In a free market, you can perform this calculation because the market gives you both numbers. Your suppliers are charging you a price for your raw materials and you know how much you are paying your employees and spending on facilities. You can calculate your costs.

In addition, the retail price is telling you how much can you sell the product at. One number minus the other gives you the profit margin. If it is positive, the product has been accepted. If it is negative, it has not.

This number, the profit margin, it is the most important number in human history. It is telling you if people want a product or not. This number is telling you if your product is enhancing the standards of living of people, at a price that the world can afford!

Without this knowledge, it is impossible to know if you should expand production or shut it down. This is precisely the number communists did not have. They arbitrarily decided wages and retail prices. There was no way to calculate if a product was enhancing the quality of life at a price that the communist production system could afford.

Why do we talk about affordability? Simple. If you keep manufacturing products that may be good but you are selling them below manufacturing costs, you are wasting manufacturing resources from other areas.

Let’s say that in a communist system you want to manufacture iPhones. You have decided that each citizen must have at least one iPhone. These phones are expensive to manufacture, but “for the good of the people” you will sell them below manufacturing costs. This means that many manufacturing facilities will have to be build and staffed to manufacture iPhone parts and then assemble them. These manufacturing facilities will need machinery, raw materials and people. As we allocate machinery, raw materials and people to these plants, we are preventing other plants from having them. Therefore, houses won’t be built. Bridges won’t be built. Tractors won’t be built, and so on.

We are taking scarce resources and re-directing them from one manufacturing process to another.  For one to be successful, the other must fail. However, we are doing this arbitrarily. We don’t really know if people actually want to have one iPhone each but not houses, tractors and bridges. We don’t really know if the quality of life of our citizens will be enhanced or not. People have no way of communicating this information to us. The free market is not operating and therefore there is no way to determine preferences.

And why are preferences important? Because satisfying preferences is what the market is all about. A successful economy is so because it satisfies preferences. An un-successful economy is so because it ignores people’s preferences.

This is only the first step. As products are bought by people at above manufacturing costs, this profit margin in turn fuels other manufacturing processes, creating new products and services. These ones, in turn, will satisfy other preferences creating more profit margins, which will be re-invested; and so forth.

People’s preferences matters because it is the very engine of economies. It’s what gets the ball rolling in a snowball effect. Or, if you want to be fancy, positive feedback. The more successful products you have, the faster an economy grows. The faster the growth, the richer the people. The richer the people, the higher the standards of living.

Communists can’t do this because all their numbers are arbitrary. They simply lack the means of calculating and therefore knowing what are people’s preferences and if they can afford them. It is not that communist economies where all bad or that communists could not manufacture goods. That is ridiculous. The truth is that they were incredibly inefficient, but this inefficiency was not a management issue, but a basic principle of communism. It is something that cannot be fixed because it is a direct consequence of what communist philosophy demands. Communism is an inherently and severely flawed system, even from the theoretical point of view.

Yes, it is that simple!

In summary, what brought down the communists is that communists can’t count.

So, next time somebody tells you about communism, you can enlighten them about why it failed. Next time somebody tells you about “managing” a free market, you can tell them why this concept is pure idiocy.

Now you know. It is up to you to enlighten others. Or not. Your choice.

Note: please see the Glossary if you are unfamiliar with certain words.

 

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