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Economic CalculationYesterday we published the Austrian Economic view about economic calculations (see Austrian Economics For Dummies - Economic Calculation). The summary of it is simple. Money allows us to compare different items which would otherwise not be comparable (e.g. apples and oranges). Money does so through the market assigning prices to those items. Those prices represent something along the line of the "average" value that people assign to those items. We can perform this comparison because we can compare the equivalent value in terms of money of apples and oranges. This is so because value is subjective and without a free market we would not be able to have an estimate of the value of each item in terms of money. The problem is that value is always subjective and perpetually changing. If the value is determined by one person, this will be highly unreliable, however, if the value is determined by a market with thousands of people, this value is far more reliable. With this value at hand, we can perform all kinds of calculations (i.e. estimates) as to what we really want, and how much do we want to spend in this or that good or service and how do we spend our money more efficiently. This works for people buying goods or services and it also works for companies manufacturing goods or providing services. The allocation of resources is made efficient by the information that prices provide because they are telling us what it is that people want and how much would it cost to provide it.

COMMUNISM

Now let's take a look at what happens under communism. In this political system all means of production (goods and services) belong to the state. Although there is money and it is used as a means of exchange, this money does not determine prices because prices are set by planners who decide what will be manufactured and at which price it will be sold. In other words, in a communist system prices contain no information as to the desires of people. As such it is impossible to know what it is that people want. Additionally, it is impossible to know how much it is costing to manufacture what people want. But if we can't know this, then we can't allocate resources efficiently.

In a communist system it is possible to use other means to try to figure out what it is that people want, for example the velocity at which items are sold or the volume of sold items. This could be used for consumer goods. For manufacturing goods (i.e. those goods used in production) this is much more difficult because manufacturing quotas need to be planned. Although it is possible to cascade down the desires of people from consumer goods to manufacturing goods, this process is quite inefficient.

There are many other ways in which in a communist system it would be possible to obtain some estimate of people's desires and manufacturing costs and as a matter of fact this is exactly what communists did. The problem is that any other means of so estimating which excludes free market prices, has a much greater error in it and is much slower.

Free market prices are instantaneous and ever adapting to new circumstances. Prices can be monitored at near real-time. As a matter of fact many retailers do so; the most obvious ones are the supermarkets. Other types of monitoring can be attempted but they will be slow, irresponsive and hard to track. This is precisely why communist economies work but are so inefficient as planning is not based on real costs representing real wishes of people but on guessed costs representing the guesses of bureaucrats and political leaders. In a communist system planning represents the political will of the leadership, which is to say a political reality and not a "real" reality. Now, if planning is based on something that it is not real, how much error do you think it will contain? Quite a lot!

SOCIALISM

Introduction

Socialism is communism-light. In this sense the economic idea behind socialism is to take forcefully (i.e. tax) the so-called "rich" people and give to the poor. This is, to re-distribute wealth by force. Socialism is sort of a dual-personality schizophrenic. On one hand it acknowledges that some type of managed market (not a free one) must exist to produce goods and services and, more importantly, profits. On the other hand, socialism hates markets and does it utmost to tax them to the limit. Obviously such a system brings with itself the seeds of its own destruction because it will be invariably biased towards what it likes (i.e. taxing) and against what it hates (free markets). The problem is that one cannot exist without the other. But this is a lengthy discussion which is out of topic for this article. Let's get back on track.

Under socialism there are actually three markets; the free market, the managed market and the communist production system which sort-of co-exist at the same time.

Free market

A free market exists under socialism under two forms. The most obvious one is the cash market and the less obvious is what idiotic bureaucrats call the "black" market. Basically any and all transactions that are not limited or interfered with by the government must be considered true free markets. In these free markets prices truly represent the will of the people.

Managed market

Managed markets are all markets that were previously truly free (i.e. not interfered with) and are now operating under limiting government rules. Many of these markets do retain some of their free market properties (e.g. real estate prices) and many markets do not (e.g. many foods or health care prices). All of them are interfered with through taxation which is to say that they are all being affected by artificial costs which will artificially alter their prices. In these markets prices represent a hybrid between the will of the people and the "political goals" (i.e. fiction) of politicians.

Communist production system

In many socialist countries entire segments of a market are entirely planned, directed and controlled by governments. All the means of production are in government hands. As such all prices are determined by central planners. Examples of such segments are fully socialized medicine, public schools, police services and so on. In those segments the price of services provide no information whatsoever as to people's will.

Conclusion

The efficiency of a socialist system is inversely proportional to the degree of government interference in free markets. This degree directly affects prices and therefore it directly affect the information that those prices convey. Therefore economic planners (e.g. in companies) get information with a higher error content than in a free market. Thus, it is much more likely that their plans will contain higher errors. But higher planning errors imply less efficient resource allocation and this implies more inefficient productive processes. It is for this reason that there are no two identical socialist countries, because their degree of interference in free markets is different (see for example Socialism Indices, particularly the Incompetence Socialist Index).

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

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