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The Economics of Planning
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Introduction to Planning
It is common for economists to conclude (too
quickly) that the experience of the old USSR
has shown that planning generated poor
economic results.
But at the same time we point to some large
corporations as efficient institutions.
But large corporations are run by plans.
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“Islands in a Sea of Markets
Think of the
boundaries of a
corporation as the
external markets
where it buys its
labor, materials,
and sells its
output. The
corporation is a
plan that allocates
this labor &
materials to
produce an output
for sale to the
outside market.
The Sea ofCapital Markets
LaborMarket Sea
The BayOf Materials
CEO
Finance Dept
ProductionPersonel
OutputMarket Ocean
Marketing
Dept.Purchasing
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“Islands in a Sea of Markets”
Dr. H. thinks of Singapore as a large corporation (one with strong penalties for bad behavior).
What are the differences between a planned economy and a large corporation?
Performance Measures
Mechanisms for replacing management
Ownership
Incentives
Bankruptcy
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Planning in the Old USSR and PRC
According to Marxist/Leninist Thought:
No market prices
No financial markets
No trade with capitalist countries
No private property
How is it decided what will be produced without the
guidance of prices?
What production methods will be used?
How is it decided which consumers get the output?
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The Plan ~ Input Output Tables
TECHNICAL COEFFICIENTS: For every sector of
the economy it is determined how much of each
input is needed to produce one unit of output. In the
example below, it takes .7 units of labor to produce
one unit of Agric., and it takes .1 units of Services to
produce one unit of Heavy Ind.
Agric Heavy Ind. Light Ind. Services
Agric .1 0 .3 0
Heavy Ind. .1 .3 .1 0
Light Ind 0 0 .2 0
Services .1 .1 .2 .1
Labor .7 .6 .2 .9
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Output Targets
Planners set target output levels for each sector.
Unlike the example below, it was common for
planners to emphasize high output targets for the
“Heavy Industry” sector. According to the goals of
the planners, the development of heavy industry in
the urban sector was viewed as a first step toward
rapid economic growth. Very large steel factories
were often observed in planned economies.
Agri Heavy Ind. Light Ind. Service
Target Output 250 150 400 200
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“Material Balance”
With these data, the planner can then allocate
inputs to each sector of the economy.
The target for the “Agri” sector is 250 units of
output, it takes .1 units of “Heavy Ind” inputs to
produce one unit of “Agri”, and so .1x250=25
units of Heavy Ind. Is sent to the Agri sector.
Agri Heavy
Ind.
Light Ind. Service Cons. Total Use
Agri. 25 0 120 0 105 250
Heavy Ind. 25 45 40 0 40 150
Light Ind. 0 0 80 0 320 400
Services 25 15 80 20 60 200
Labor 90 180 525
Total Output 250 150 400 200
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“Material Balance”
How much labor will be sent to the “Agri.” sector?
Agri Heavy
Ind.
Light Ind. Service Cons. Total Use
Agri. 25 0 120 0 105 250
Heavy Ind. 25 45 40 0 40 150
Light Ind. 0 0 80 0 320 400
Services 25 15 80 20 60 200
Labor 90 180 525
Total Output 250 150 400 200
How much labor will be sent to the “Light Industry”
sector?
Note that while this is a simple calculation, the result
was often the mass, forced relocation of people.
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“Material Balance”
To get the amount available for consumers from
each sector, we take the output target and subtract
the amount that has been used up as inputs in the
other sectors.
250 units of “Agri” were produced, but 145 (25 +
120) were used as inputs in other sectors, so 105
units of “Agri” were left over for consumers.Agri Heavy
Ind.
Light Ind. Service Cons. Total Use
Agri. 25 0 120 0 105 250
Heavy Ind. 25 45 40 0 40 150
Light Ind. 0 0 80 0 320 400
Services 25 15 80 20 60 200
Labor 175 90 80 180 525
Total Output 250 150 400 200
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GDP Accounting
Agri Heavy Ind. Light Ind. Service Cons. Total Use
Agri. 25 0 120 0 105 250
Heavy Ind. 25 45 40 0 40 150
Light Ind. 0 0 80 0 320 400
Services 25 15 80 20 60 200
Labor 175 90 80 180 525 1000
Total
Output
250 150 400 200
The “size” of the economy was measured differently
in the planned economies than in the West. Using this
example, GDP according to the Western concept
would be 525, the amount of final goods available for
consumers. Under the Soviet system, GDP was
recorded as 1000 which includes output used up in the
process of production.
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Planning and the Labor Theory of Value
Agri Heavy Ind. Light Ind. Service Cons. Total Use
Agri. 25 0 120 0 105 250
Heavy Ind. 25 45 40 0 40 150
Light Ind. 0 0 80 0 320 400
Services 25 15 80 20 60 200
Labor 175 90 80 180 525 1000
Total
Output
250 150 400 200
First note the total quantity of labor we have in this
economy; 525 units of labor.
Second, notice the total amount of goods available
for consumption: 525.
Finally, smile since the planning document is
consistent with Marxist thought!
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Planning “Successes”
Compared to market processes, planning has the
potential to move resources more quickly to attain
social goals. (The planners chose the goals.)
Provision of public goods like clean water and mosquito
abatement.
Building a steel industry and other large scale projects.
“Giganticism” was a noted feature of planned
economies.
Provision of certain kinds of scientific research which
private market firms could not profitably supply.
Military action
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Planning “Failures”
Asymmetric Information
Suppose the central planner has honest
intentions to serve society.
She needs information from factory
managers to help her set the “technical
coefficients”, “output targets”, and input
allocations for next year’s plan.
But she cannot tell which of the factory
managers are telling her the truth.
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Planning “Failures”
Asymmetric Information
Factory managers have an incentive to provide
inaccurate information to the planners.
They provide higher estimates for the technical
coefficients in an effort to get more inputs.
They produce less than their quota noting that their
quota needs to be lowered for next years’ plan.
They produce their quota of 100 kilos of bricks, but the
bricks are of a quality that is difficult to observe by the
planners (The bricks are too large.)
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Planning Failures ~ Game Problems
The factory managers thinks about the planners’ response to the failure of his factory to meet their output quota.
The planners’ could close the factory or the planner could give the factory more inputs (or lower the output quota).
The “Nash Equilibrium” was often that the manager would not reach the quota and the planner would give them more resources.
This result has been called the “Soft Budget Constraint” (Kornai).
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Children overspend their weekly allowance knowing that Mom will give them movie money to get them out of the house on Saturday afternoon.
Contractors have “cost overruns” knowing that once started, the payer will have high switching costs to terminate this contract and start with another.
Governments sometimes provide bailouts for failing firms.
Games concerning “soft budget constraints”
are not just a feature of planned economies.
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Planning Failures ~ Shortages
Planned economies are often noted for
shortages, especially for consumer goods.
As noted, the factory managers’ had the
incentive to produce as little as possible
with as many resources as possible.
Due to the “soft budget constraint”
demand for resources was high, but the
supply of goods was low.
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Planning Failures ~ Shortages
Planners set prices
for accounting
reasons.
They had an
incentive to set
prices below the
market equilibrium
price.
Planner were then in
a position to profit
personally from the
black market 1 2 3 4 5 6
100
200
300
400
500
600
Price
Quantity
Supply (from plan)
Demand
Black Market Price
Planners' Price
Shortage
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Planning Failures ~ Technological
Change
Factory managers were often in a position to note changes in technique which would increase efficiency.
If the technological change was one that would require less labor, the factory manager would lose workers in next year’s plan.
If the technological change required more capital, the manager may be “rewarded” with new machines in next year’s plan.
The incentive structure biased the direction of technological change.
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Planning Failures ~ The Allocation
of New Investment
The rate of savings in the former USSR was very high (>40%).
Planners were in the position to allocate these substantial savings to new investment.
How did planners decide on which new investment to undertake? (Note: in markets this is done by private investors searching for new profit opportunities.)
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Planning Failures Restricted Rights
to Exit from Chinese Collectives
Before 1956 farmers could chose to join a collective. If dissatisfied with the outcome, the farmer could exit the collective and farm independently
Starting around 1957 collective participation was mandatory and exit was not allowed.
How would this change the incentives for the cooperative managers?