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So all right then – if the importance of property rights and economic incentives is so self-evident, then (to return to our topic of the Soviet Union) why did the communists still manage to mess things up so badly? After all, it’s not like they were just unable to recognize the reality of the situation; after their early failures, the Soviets were all too aware of the incentive problems they faced – hence why they ended up resorting to mass coercion and oppression in order to “motivate” their workforce. But even after deploying these tactics, their outcomes continued to disappoint. So why did their supposedly efficient state-run economic system, even with its added “incentives” for workers and everything, still produce such abysmal results? Well, as Acemoglu and Robinson already briefly touched on, it turns out that the incentive problem isn’t the only thing that can go wrong when your economy is forced to operate entirely on the basis of what the government dictates. Scott Alexander summarizes a more in-depth explanation given by Francis Spufford in his book Red Plenty:

The classic [explanation for why communism fails] is that during communism no one wants to work hard. They do as little as they can get away with, then slack off because they don’t reap the rewards of their own labor.

[…]

But […] in certain cases, Russians were very well-incentivized by things like “We will kill you unless you meet the production target”. Later, when the state became less murder-happy, the threat of death faded to threats of demotions, ruined careers, and transfer to backwater provinces. And there were equal incentives, in the form of promotion or transfer to a desirable location such as Moscow, for overperformance. There were even monetary bonuses, although money bought a lot less than it did in capitalist countries and was universally considered inferior to status in terms of purchasing power. Yes, there were Goodhart’s Law type issues going on – if you’re being judged per product, better produce ten million defective products than 9,999,999 excellent products – but that wasn’t the crux of the problem.

Red Plenty presented the problem with the Soviet economy primarily as one of allocation. You could have a perfectly good factory that could be producing lots of useful things if only you had one extra eensy-weensy part, but unless the higher-ups had allocated you that part, you were out of luck. If that part happened to break, getting a new one would depend on how much clout you (and your superiors) pulled versus how much clout other people who wanted parts (and their superiors) held.

The book illustrated this reality with a series of stories (I’m not sure how many of these were true, versus useful dramatizations). In one, a pig farmer in Siberia needed wood in order to build sties for his pigs so they wouldn’t freeze – if they froze, he would fail to meet his production target and his career would be ruined. The government, which mostly dealt with pig farming in more temperate areas, hadn’t accounted for this and so hadn’t allocated him any wood, and he didn’t have enough clout with officials to request some. A factory nearby had extra wood they weren’t using and were going to burn because it was too much trouble to figure out how to get it back to the government for re-allocation. The farmer bought the wood from the factory in an under-the-table deal. He was caught, which usually wouldn’t have been a problem because everybody did this sort of thing and it was kind of the “smoking marijuana while white” of Soviet offenses. But at that particular moment the Party higher-ups in the area wanted to make an example of someone in order to look like they were on top of their game to their higher-ups. The pig farmer was sentenced to years of hard labor.

A tire factory had been assigned a tire-making machine that could make 100,000 tires a year, but the government had gotten confused and assigned them a production quota of 150,000 tires a year. The factory leaders were stuck, because if they tried to correct the government they would look like they were challenging their superiors and get in trouble, but if they failed to meet the impossible quota, they would all get demoted and their careers would come to an end. They learned that the tire-making-machine-making company had recently invented a new model that really could make 150,000 tires a year. In the spirit of Chen Sheng, they decided that since the penalty for missing their quota was something terrible and the penalty for sabotage was also something terrible, they might as well take their chances and destroy their own machinery in the hopes the government sent them the new improved machine as a replacement. To their delight, the government believed their story about an “accident” and allotted them a new tire-making machine. However, the tire-making-machine-making company had decided to cancel production of their new model. You see, the new model, although more powerful, weighed less than the old machine, and the government was measuring their production by kilogram of machine. So it was easier for them to just continue making the old less powerful machine. The tire factory was allocated another machine that could only make 100,000 tires a year and was back in the same quandary they’d started with.

It’s easy to see how all of these problems could have been solved (or would never have come up) in a capitalist economy, with its use of prices set by supply and demand as an allocation mechanism. And it’s easy to see how thoroughly the Soviet economy was sabotaging itself by avoiding such prices.

[…]

The Soviets had originally been inspired by [a] fear of economics going out of control, abandoning the human beings whose lives it was supposed to improve. In capitalist countries, people existed for the sake of the economy, but under Soviet communism, the economy was going to exist only for the sake of the people.

(accidental Russian reversal: the best kind of Russian reversal!)

And instead, they ended up taking “people existing for the sake of the economy” to entirely new and tragic extremes, people being sent to the gulags or killed because they didn’t meet the targets for some product nobody wanted that was listed on a Five-Year Plan. Spoiling good raw materials for the sake of being able to tell Party bosses and the world “Look at us! We are doing Industry!” Moloch had done some weird judo move on the Soviets’ attempt to destroy him, and he had ended up stronger than ever.

If there’s one thing the Soviet government did have, it was power. It was running a command economy, after all, and that meant that whatever the Soviet government ordered to be done, that’s what would be done. The problem, though, was that despite being practically all-powerful within its borders, the Soviet government was not all-knowing – so for all its power, there was never even the remotest chance that it would be capable of wielding that power in such a way as to achieve the impossible aim of accurately determining and fulfilling the needs of literally every single citizen and enterprise across every inch of its territory, in real time, on a perpetual 24/7 basis. To even imagine that it could do such a thing was to utterly fail to comprehend just how complex and multifaceted an economy of millions of people actually is, and how constantly those people’s needs are shifting and changing. Regardless of how powerful it might have been, then, the Soviet government’s notions for a planned economy were doomed from the start.

In economics, this problem the Soviets faced is known (straightforwardly enough) as the knowledge problem. As the Wikipedia article summarizes:

The local knowledge problem is the argument that the data required for rational economic planning are distributed among individual actors and thus unavoidably exist outside the knowledge of a central authority.

Friedrich Hayek described this distributed local knowledge as such:

Today it is almost heresy to suggest that scientific knowledge is not the sum of all knowledge. But a little reflection will show that there is beyond question a body of very important but unorganized knowledge which cannot possibly be called scientific in the sense of knowledge of general rules: the knowledge of the particular circumstances of time and place. It is with respect to this that practically every individual has some advantage over all others because he possesses unique information of which beneficial use might be made, but of which use can be made only if the decisions depending on it are left to him or are made with his active cooperation. We need to remember only how much we have to learn in any occupation after we have completed our theoretical training, how big a part of our working life we spend learning particular jobs, and how valuable an asset in all walks of life is knowledge of people, of local conditions, and of special circumstances. To know of and put to use a machine not fully employed, or somebody’s skill which could be better utilized, or to be aware of a surplus stock which can be drawn upon during an interruption of supplies, is socially quite as useful as the knowledge of better alternative techniques. And the shipper who earns his living from using otherwise empty or half-filled journeys of tramp-steamers, or the estate agent whose whole knowledge is almost exclusively one of temporary opportunities, or the arbitrageur who gains from local differences of commodity prices, are all performing eminently useful functions based on special knowledge of circumstances of the fleeting moment not known to others.

Because while incomplete this distributed knowledge is essential to economic planning, its necessity is cited as evidence in support of the argument that economic planning must be performed in a similarly distributed fashion by individual actors. In other words, economic planning by a central actor (e.g. a government bureaucracy or a central bank) necessarily lacks this information because, as Hayek observed, statistical aggregates cannot accurately account for the universe of local knowledge:

One reason why economists are increasingly apt to forget about the constant small changes which make up the whole economic picture is probably their growing preoccupation with statistical aggregates, which show a very much greater stability than the movements of the detail. The comparative stability of the aggregates cannot, however, be accounted for—as the statisticians occasionally seem to be inclined to do—by the “law of large numbers” or the mutual compensation of random changes. The number of elements with which we have to deal is not large enough for such accidental forces to produce stability. The continuous flow of goods and services is maintained by constant deliberate adjustments, by new dispositions made every day in the light of circumstances not known the day before, by B stepping in at once when A fails to deliver. Even the large and highly mechanized plant keeps going largely because of an environment upon which it can draw for all sorts of unexpected needs; tiles for its roof, stationery for its forms, and all the thousand and one kinds of equipment in which it cannot be self-contained and which the plans for the operation of the plant require to be readily available in the market.

As such, the local knowledge problem is a microeconomic counterargument to macroeconomic arguments that favor central planning and regulation of economic activity.

Eric A. Posner and E. Glen Weyl sum it up this way:

Ludwig von Mises and Friedrich Hayek […] pointed out the flaw in central planning: those who undertake it lack the information and analytical capacity to make the best allocative decisions. People’s valuations are private information; the genius of the market is its capacity for disseminating this information from consumers to producers through the price system. Central planning, in contrast, results in massive misallocation of resources—the production of goods no one wanted—that was characteristic of real-world socialist economies like that of the Soviet Union. Moreover, centralization of the economy opened the way to political abuse, which Hayek memorably called the “road to serfdom.”

Now, obviously, none of this is to say that producers in the private sector always necessarily make perfect decisions themselves. In fact, privately-owned firms fail all the time; it’s one of the defining features of the free market. What distinguishes these failures from the failures of central government planning, though, is that they’re actually a part of the market’s normal process of allocating goods and services – which is to say, they’re just another market signal. If a firm produces goods or services that people don’t actually want, that’s just a cue for those customers to take their business elsewhere. But by contrast, when a communist government fails in its process of allocating goods and services, it doesn’t just serve as a helpful signal to customers to look elsewhere for their needs – it means that those needs don’t get fulfilled at all. As Tim Harford writes:

In the [private sector,] mistakes, certainly, will be made—perhaps more frequently than under central planning. But the mistakes stay small; in market economies we call them “experiments.” If venture capitalists back them, they do not expect many to succeed. When they succeed, they make some people rich and bring innovation to the whole economy. When they fail—which is more often than not—some people will go bankrupt, but nobody will die. Only command economies can promote experimentation on such a fatally extravagant scale and suppress informed criticism. (Mao [whose misguided central planning in China led to grain shortages that killed millions] was not alone. The Soviet president, Nikita Khrushchev, made a similar mistake following a visit to the United States, when he ordered Soviet fields to be replanted with the corn he had seen growing in Iowa. The failure was a catastrophe.) It is worth remembering that market failures, while sometimes serious, are never as tragic as the worst failures of governments like Mao’s.

Sadly, these kinds of allocation-failure horror stories are a consistent staple in the history of communism. Every time another government decides to adopt a communist ideology, its leaders insist that they will succeed where all the other attempts have failed – because unlike those other governments, which were plagued by incompetence and corruption, their new brand of communism will put the people’s needs first, and will serve them in a rigorous, systematic way that uses the best economic expertise available. And yet, every single time, these communist leaders discover that, as it turns out, single-handedly micromanaging an entire economy requires a level of knowledge and understanding that is so impossibly all-encompassing that no single organization or government entity could conceivably reach it, regardless of how pure its intentions were. And so ultimately, like clockwork, the citizens of these countries suffer the consequences – often in the form of mass death from starvation and other all-too-preventable causes.

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