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Lecture 2. Economic systems; How the Soviet economy was supposed to work

Lecture 2. Economic systems; How the Soviet economy was supposed to work. Today’s class. Structure of the course Hayek’s paper How the Soviet-type economies were supposed to work - outline of the central planning process;

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Lecture 2. Economic systems; How the Soviet economy was supposed to work

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  1. Lecture 2. Economic systems; How the Soviet economy was supposed to work

  2. Today’s class • Structure of the course • Hayek’s paper • How the Soviet-type economies were supposed to work - outline of the central planning process; - difficulties with idealized central planning and their consequences

  3. Structure of the course • Overview of the workings of a Soviet-type system • Difficulties of partial reforms • Systemic reforms: • Price liberalization & financial stabilization • Privatization (major topic) • Reform of government (major topic) • Assessment and current performance

  4. Hayek’s paper • misconception about the economic problem of society (If we have all relevant info and if we start from a given system of preferences the problem of the best use of resources is the one of pure logic) • Main economic problem: how to make use of knowledge that is not given to any one mind

  5. Hayek’s paper (cont.) • It’s not whether planning is necessary, but whether planning should be done centrally by one authority or if it should be divided among many individuals • Hayek’s claim: The relative efficiency of the economy depends on which system would make better use of existing knowledge dispersed among individuals

  6. Hayek’s paper (cont.) • Scientific knowledge vs. tacit knowledge and knowledge of local circumstances • The importance of change • The miracle of the price system • Problems with Hayek’s arguments?

  7. Soviet-type central planning in theory • Leaders: Set main targets • Planners: Produce initial roughly balanced and highly aggregated feasible plan • Planners: Allocate aggregated targets and inputs to economic branch ministries • Ministries: Allocate less aggregated targets and inputs to enterprises • Enterprises: Disaggregate targets and inputs • Enterprises: Send adjustments back to ministries

  8. Soviet-type central planning in theory (cont.) • Ministries aggregate adjustments made by enterprises and send back to planners adjusted aggregated targets • Planners try to adjust the plan to eliminate imbalances and send the new targets and inputs back to ministries • Iterations continue till a balanced plan is produced

  9. Problems with idealized planning process • Incentives? (disregard for now) • Problem: How are the initial targets developed? • Consequence: “Wrong” and perhaps infeasible targets are set

  10. Problems with idealized planning process (cont.) • Problem: How do planners, ministries, enterprises decide how to produce things? • Consequence: “Wrong” production processes are used • Also: How to structure the incentives correctly?

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