Central Planning Illusions: Comparing the Soviet Union to China

June 6, 2012

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Seemingly at odds with modern day Krugman, the Princeton Professor dismantles the central planning model in this 1994 paper. At the time, politicians and the population at large were alarmed at the rapid ascent of the Asian Tigers and their central planning model.

The leaders of those nations did not share our faith in free markets or unlimited civil liberties. They asserted with increasing self-confidence that their system was superior: societies that accepted strong, even authoritarian governments and were willing to limit individual liberties in the interest of the common good, take charge of their economies, and sacrifice short-run consumer interests for the sake of long-run growth would eventually outperform the increasingly chaotic societies of the West. And a growing minority of Western intellectuals agreed.

Unconcerned, Krugman made the analogy to the Soviet Union’s growth 30 years earlier:

Stalinist planners had moved millions of workers from farms to cities, pushed millions of women into the labor force and millions of men into longer hours, pursued massive programs of education, and above all plowed an ever-growing proportion of the country’s industrial output back into the construction of new factories.

However, the lack of productivity growth hinted at the subsequent collapse in the Soviet Union’s growth rate. The dearth of innovation, with freedom, basic rule of law, and property rights as a prerequisite, meant once the labor pool had been exhausted, depreciation on the fixed assets would inevitably exceed the output from each unit of labor.

Economic growth that is based on expansion of inputs, rather than on growth in output per unit of input, is inevitable subject to diminishing returns. It was simply not possible for the Soviet economies to sustain the rates of growth of labor force participation, average education levels, and above all the physical capital stock that had prevailed in previous years. Communist growth would predictably slow down, perhaps drastically.

This same narrative can be applied to China today, whose growth model is based on commandeering vast pools of labor to move into cities, build fixed assets, and work long hours. An arbitrary rule of law squeezes out innovation in the private sector for the benefit of state controlled companies. The one-child policy is creating a shortage of laborers, the fixed asset overbuild has misallocated capital on a massive scale, and the environment has been wrecked.

The Asian Tigers deserve credit; following the Asian Flu, many reformed, granted their people more freedom, eventually allowing the private sector to compete with the state sector and internationally. Perhaps China will do the same, but it may take a crisis to force a change given the vested interests.

Further Reading: The Myth of Asia’s Miracle

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