23 Things They Don't Tell You about Capitalism

by Ha-Joon Chang

we are still living in planned economies

  What they tell you

  The limits of economic planning have been resoundingly demonstrated by the fall of communism. In complex modern economies, planning is neither possible nor desirable. Only decentralized decisions through the market mechanism, based on individuals and firms being always on the lookout for a profitable opportunity, are capable of sustaining a complex modern economy. We should do away with the delusion that we can plan anything in this complex and ever-changing world. The less planning there is, the better.

  What they don’t tell you

  Capitalist economies are in large part planned. Governments in capitalist economies practise planning too, albeit on a more limited basis than under communist central planning. All of them finance a significant share of investment in R&D and infrastructure. Most of them plan a significant chunk of the economy through the planning of the activities of state-owned enterprises. Many capitalist governments plan the future shape of individual industrial sectors through sectoral industrial policy or even that of the national economy through indicative planning. More importantly, modern capitalist economies are made up of large, hierarchical corporations that plan their activities in great detail, even across national borders. Therefore, the question is not whether you plan or not. It is about planning the right things at the right levels.

  Upper Volta with rockets

  In the 1970s, many Western diplomats called the Soviet Union ‘Upper Volta with rockets’. What an insult – that is, to Upper Volta (renamed Burkina Faso in 1984), which was being branded the quintessential poor country, when it wasn’t even near the bottom of the world poverty league. The nickname, however, succinctly summarized what was wrong with the Soviet economy.

  Here was a country that could send men into space but had people queuing up for basic foodstuffs such as bread and sugar. The country had no problem churning out intercontinental ballistic missiles and nuclear submarines, but could not manufacture a decent TV. It is reported that in the 1980s the second-biggest cause of fires in Moscow was – believe it or not – exploding TVs. The top Russian scientists were as inventive as their counterparts in capitalist countries, but the rest of the country did not seem able to live up to the same standard. What was going on?

  In pursuit of the communist vision of a classless society based on collective ownership of the ‘means of production’ (e.g., machines, factory buildings, roads), the Soviet Union and its communist allies aimed for full employment and a high degree of equality. Since no one was allowed to own any means of production, virtually all enterprises were run by professional managers (with minor exceptions such as small restaurants and hairdressers), preventing the emergence of visionary entrepreneurs, like Henry Ford or Bill Gates. Given the political commitment to high equality, there was a clear cap on how much a business manager, however successful, could get. This meant that there was only a limited incentive for business managers to turn the advanced technologies that the system was clearly capable of producing into products that consumers actually wanted. The policy of full employment at all costs meant that managers could not use the ultimate threat – that of sacking – to discipline workers. This contributed to sloppy work and absenteeism; when he was trying to reform the Soviet economy, Gorbachev frequently spoke of the problem of labour discipline.

  Of course, all this did not mean that no one in communist countries was motivated to work hard or to run a good business. Even in capitalist economies, we don’t do things just for the money (see Thing 5), but communist countries relied, with some success, much more on the less selfish sides of human nature. Especially in the early days of communism, there was a lot of idealism about building a new society. In the Soviet Union, there was also a huge surge of patriotism during and shortly after the Second World War. In all communist countries there were many dedicated managers and workers who did things well out of professionalism and self-respect. Moreover, by the 1960s, the ideal egalitarianism of early communism had given way to realism and performance-related pay had become the norm, mitigating (although by no means eliminating) the incentive problem.

  Despite this, the system still failed to function well because of the inefficiency of the communist central planning system, which was supposed to be a more efficient alternative to the market system.

  The communist justification of central planning was based on some quite sound logic. Karl Marx and his followers argued that the fundamental problem with capitalism was the contradiction between the social nature of the production process and the private nature of ownership of the means of production. With economic development – or the development of productive forces, in Marxist jargon – the division of labour between firms develops further and as a result the firms become increasingly more dependent on each other – or the social nature of the production process is intensified. However, despite the growing interdependence among firms, the Marxists argued, ownership of the firms firmly remains in separate private hands, making it impossible to coordinate the actions of those interdependent firms. Of course, price changes ensure that there is some ex post coordination of firm decisions, but its extent is limited and the imbalance between demand and supply, created by such (in non-Marxist terms) ‘coordination failures’, accumulates into periodic economic crises. During an economic crisis, the argument went, a lot of valuable resources are wasted. Many unsold products are thrown away, machines that used to produce now-unwanted things are scrapped, and workers who are capable and willing to work are laid off due to the lack of demand. With the development of capitalism, the Marxists predicted, this systemic contradiction would become larger and consequently economic crises would become more and more violent, finally bringing the whole system down.

  In contrast, under central planning, the Marxist argued, all means of production are owned by the whole of society and as a result the activities of interdependent production units can be coordinated ex ante through a unified plan. As any potential coordination failure is resolved before it happens, the economy does not have to go through those periodic crises in order to balance supply and demand. Under central planning, the economy will produce only exactly what is needed. No resource will lie idle at any time, since there will be no economic crisis. Therefore, the central planning system, it was argued, will manage the economy much more efficiently than the market system.

  That, at least, was the theory. Unfortunately, central planning did not work very well in practice. The main problem was that of complexity. The Marxists may have been right in thinking that the development in productive forces, by increasing interdependence among different segments of capital, makes it more necessary to plan centrally. However, they failed to recognize that it also makes the economy more complex, making it more difficult to plan centrally.

  Central planning worked well when the targets were relatively simple and clear, as seen in the success of early Soviet industrialization, where the main task was to produce a relatively small number of key products in large quantities (steel, tractors, wheat, potatoes, etc.). However, as the economy developed, central planning became increasingly difficult, with a growing number of (actual and potential) diverse products. Of course, with economic development, the ability to plan also increased thanks to improvements in managerial skills, mathematical techniques of planning and computers. However, the increase in the ability to plan was not sufficient to deal with the increase in the complexity of the economy.

  One obvious solution was to limit the variety of products, but that created huge consumer dissatisfaction. Moreover, even with reduced varieties, the economy was still too complex to plan. Many unwanted things were produced and remained unsold, while there were shortages of other things, resulting in the ubiquitous queues. By the time communism started unravelling in the 1980s, there was so much cynicism about the system that was increasingly incapable of delivering its promises that the joke was that in the communist countries, ‘we pretend to work and they pretend to pay us’.

  No
wonder central planning was abandoned across the board when the ruling communist parties were ousted across the Soviet bloc, following the fall of the Berlin Wall. Even countries such as China and Vietnam, which ostensibly maintained communism, have gradually abandoned central planning, although their states still hold high degrees of control over the economy. So, we all now live in market economies (well, unless you live in North Korea or Cuba). Planning is gone. Or is it?

  There is planning and there is planning

  The fact that communism has disappeared for all practical purposes does not mean that planning has ceased to exist. Governments in capitalist economies also plan, albeit not in the same comprehensive way that the central planning authorities in communist countries did.

  Even in a capitalist economy, there are situations – a war, for example – in which central planning is more effective. For example, during the Second World War, the economies of the major capitalist belligerents, the US, the UK and Germany, were all centrally planned in everything but name.

  But, more importantly, many capitalist countries have successfully used what is known as ‘indicative planning’. This is planning that involves the government in a capitalist country setting some broad targets concerning key economic variables (e.g., investments in strategic industries, infrastructure development, exports) and working with, not against, the private sector to achieve them. Unlike under central planning, these targets are not legally binding; hence the adjective ‘indicative’. However, the government will do its best to achieve them by mobilizing various carrots (e.g., subsidies, granting of monopoly rights) and sticks (e.g., regulations, influence through state-owned banks) at its disposal.

  France had great success in promoting investment and technological innovation through indicative planning in the 1950s and 60s, thereby overtaking the British economy as Europe’s second industrial power. Other European countries, such as Finland, Norway and Austria, also successfully used indicative planning to upgrade their economies between the 1950s and the 1970s. The East Asian miracle economies of Japan, Korea and Taiwan used indicative planning too between the 1950s and the 1980s. This is not to say that all indicative planning exercises have been successful; in India, for example, it has not. Nevertheless, the European and East Asian examples show that planning in certain forms is not incompatible with capitalism and may even promote capitalist development very well.

  Moreover, even when they do not explicitly plan the entire economy, even in an indicative way, governments in most capitalist economies make and implement plans for certain key activities, which can have economy-wide implications (see Thing 12).

  Most capitalist governments plan and shape the future of some key industries through what is known as ‘sectoral industrial policy’. The European and East Asian countries which practised indicative planning all also practised active sectoral industrial policy. Even countries that have not practised indicative planning, such as Sweden and Germany, have practised sectoral industrial policy.

  In most capitalist countries, the government owns, and often also operates, a sizeable chunk of the national economy through state-owned enterprises (SOEs). SOEs are frequently found in the key infrastructure sectors (e.g., railways, roads, ports, airports) or essential services (e.g., water, electricity, postal service), but also exist in manufacturing or finance (more stories about SOEs can be found in the chapter ‘Man Exploits Man’ of my book Bad Samaritans). The share of SOEs in national output could be as high as 20 per cent-plus, in the case of Singapore, or as low as 1 per cent, in the case of the US, but the international average is around 10 per cent. As the government plans the activities of SOEs, this means that a significant part of the average capitalist economy is directly planned. When we consider the fact that SOEs usually operate in sectors with disproportionate impacts on the rest of the economy, the indirect effect of planning through SOEs is even greater than what is suggested by the share of SOEs in national output.

  Moreover, in all capitalist economies, the government plans the national technological future by funding a very high proportion (20–50 per cent) of research and development. Interestingly, the US is one of the most planned capitalist economies in this regard. Between the 1950s and the 1980s, the share of government funding in total R&D in the supposedly free-market US accounted for, depending on the year, between 47 per cent and 65 per cent, as against around 20 per cent in Japan and Korea and less than 40 per cent in several European countries (e.g., Belgium, Finland, Germany, Sweden).1 The ratio has come down since the 1990s, as military R&D funding was reduced with the end of the Cold War. However, even so, the share of government in R&D in the US is still higher than in many other capitalist economies. It is notable that most of the industries where the US has an international technological lead are the industries that have been receiving major government R&D funding through military programmes (e.g., computers, semiconductors, aircraft) and health projects (e.g., pharmaceuticals, biotechnology).

  Of course, since the 1980s the extent of government planning in most capitalist economies has declined, not least because of the rise of pro-market ideology during this period. Indicative planning has been phased out in most countries, including in the ones where it had been successful. In many, although not all, countries, privatization has resulted in a falling share of SOEs in national output and investment. The share of government funding in total R&D funding has also fallen in virtually all capitalist countries, although not by very much in most cases. However, I would argue, despite the relative decline of government planning in the recent period, there is still extensive, and increasing, planning in the capitalist economies. Why do I say that?

  To plan or not to plan – that is not the question

  Suppose that a new CEO arrived in a company and said: ‘I am a great believer in market forces. In this fast-changing world, we should not have a fixed strategy and should maintain maximum possible flexibility. So, from now on, everyone in this company is going to be guided by ever-changing market prices, and not by some rigid plan.’ What do you think would happen? Would his employees welcome a leader with a vision fit for the twenty-first century? Would the shareholders applaud his market-friendly approach and award him with a pay rise?

  He wouldn’t last a week. People would say he does not have leadership qualities. He would be accused of lacking the ‘vision thing’ (as George Bush Sr once put it). The top decision-maker, it would be pointed out, should be willing to shape the future of the company, rather than letting it just happen. Blindly following market signals, they would say, is not how you run a business.

  People would expect a new CEO to say something like: ‘This is where our company is today. That is where I want to take it in ten years’ time. In order to get there, we will develop new industries A, B and C, while winding down D and E. Our subsidiary in industry D will be sold off. We will shut down our subsidiary in industry E at home, but some production may be shifted to China. In order to develop our subsidiary in industry A, we will have to cross-subsidize it with the profits from existing businesses. In order to establish a presence in industry B, we have to go into strategic alliance with Kaisha Corporation of Japan, which may involve supplying it with some inputs that we produce at below-market prices. In order to expand our business in industry C, we will need to increase our R&D investment in the next five years. All this may mean the company as a whole making losses in the foreseeable future. If that is the case, so be it. Because that is the price we have to pay in order to have a brighter future.’ In other words, a CEO is expected to be a ‘man (or a woman) with a plan’.

  Businesses plan their activities – often down to the last detail. Indeed, that is where Marx got the idea of centrally planning the whole economy. When he talked about planning, there was in fact no real-life government that was practising planning. At the time, only firms planned. What Marx predicted was that the ‘rational’ planning approach of the capitalist firms would eventually prove superior to the wasteful anarchy of the mark
et and thus eventually be extended to the whole economy. To be sure, he criticized planning within the firm as despotism by capitalists, but he believed that, once private property was abolished and the capitalists eliminated, the rational elements of such despotism could be isolated and harnessed for the social good.

  With the development of capitalism, more and more areas of the economy have become dominated by large corporations. This means that the area of the capitalist economy that is covered by planning has in fact grown. To give you a concrete example, these days, depending on the estimate, between one third and one half of international trade consists of transfers among different units within transnational corporations.

  Herbert Simon, the 1978 Nobel laureate in economics who was a pioneer of the study of business organizations (see Thing 16), put this point succinctly in 1991 in ‘Organisations and Markets’, one of the last articles he wrote. If a Martian, with no preconceptions, came to Earth and observed our economy, Simon mused, would he conclude that Earthlings live in a market economy? No, Simon said, he would almost certainly have concluded that Earthlings live in an organizational economy in the sense that the bulk of earth’s economic activities is coordinated within the boundaries of firms (organizations), rather than through market transactions between those firms. If firms were represented by green and markets by red, Simon argued, the Martian would see ‘large green areas interconnected by red lines’, rather than ‘a network of red lines connecting green spots’.2 And we think planning is dead.

  Simon did not talk much about government planning, but if we add government planning, modern capitalist economies are even more planned than his Martian example suggests. Between the planning that is going on within corporations and various types of planning by the government, modern capitalist economies are planned to a very high degree. One interesting point that follows from these observations is that rich countries are more planned than poor countries, owing to the more widespread existence of large corporations and often more pervasive (albeit often less visible, on account of its more subtle approach) presence of the government.