Back to the USSR?

26. January, 2009

Last week we've seen some new ideas on how to get us out of this economic crisis. Most prominently, Ilmars Rimšēvičs, the Central Bank governor, said that Latvia must be run as a firm, [we] should be making decisions what to produce, where to invest…. I humbly disagree.

At the moment, Latvian economy is not run like a firm and that, in my opinion, is a very good thing. However, some twenty years ago it was run like a firm. I am speaking about the time when it was Soviet Socialist Republic of Latvia (or something like that). The Soviet Union was a centrally-planned economy and Gosplan ran it as one would run a firm. That’s what centrally-planning does: some central planning board makes decisions what to produce, where to invest, what are the priority industries, etc. Apparently, I should explain why this is a bad idea.

First, there is a lot of theoretical arguments why central planning does not work well. Any economics textbooks would tell you that maximum economic efficiency is achieved decisions about what to produce are left to decentralized markets, and not to the government. Friedrich von Hayek, a famous economist, explained why decentralized markets would outperform centrally-planned economies in his classic article The Use of Knowledge in Society. That article was written back in 1945. In about the same time Hayek has also published his book The Road to Serdom, in which he rather accurately predicted the paths of socialism, Soviet Union, and Nazi Germany. I am not going to delve into the details of his arguments here, but Hayek earned a Nobel Prize in economics in 1974. That should speak for itself.

You don’t believe economic theories? Then look at empirical evidence! Consider the example of Korea, which in 1950 was divided into a country with a Stalinist centrally-planned economy (North Korea) and a country with largely market-based economic institutions (South Korea). So we can look at the results of a half a century long experiment in central planning vs markets . See the table below (from Alex Tabarrok).

In Latvian here

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