All Commentary
Wednesday, May 1, 1991

Transforming the Command Economies

Dr. Sennholz heads the Department of Economics at Grove City College in Pennsylvania.

To transform a Communist system into a market order is like trying to reform a person suffering from alcoholism or drug addiction. The addict, knowing little of healthful living, has developed a multitude of physical and psychological deficiencies and dependencies. When he finally musters the strength for reform, he soon suffers the symptoms of withdrawal such as weakness, trembling, and mental depression. The discomfort and pain then cause him to return to his addiction.

Despite all the talk about transformation to a market order, progress is lacking almost completely in the Soviet Union and is limited rather narrowly in the satellite countries such as Poland, Czechoslovakia, Hungary, Romania, and Bulgaria. Although most Communist leaders solemnly acknowledge that an eventual systemic change is necessary, they are afraid of many aspects of the market order of which they know so little. In particular, they are fearful of mass unemployment and other forms of “exploitation of the weak and poor” which, they are convinced, are clear results of capitalism. This fear is echoed by a diverse chorus of ex-Communists, socialists, social democrats, and erstwhile central planners who, despite theft free market rhetoric, are addicted to the old order.

President Gorbachev and his followers are deploring the “extremely high costs” of transforming the command economies. They are warning of the economic crashes and disruptions that “radical restructuring” is said to bring about. They point with alarm at Poland’s gross national product which is reported to have declined by 16 percent since an economic reform program was initiated in January 1990; unemployment is said to have risen to one million, and goods prices allegedly outpaced wages by 35 percent. Wherever they look, they seek and find reasons or excuses for delaying and temporizing.

In reality, the costs and pains of transition are minimal provided the transformation is swift and comprehensive. When man is free to improve his well-being he does so without delay, even on the first day of reform. He does so in Budapest as well as in Moscow. Every 1990 reform that actually set him free, therefore, immediately improved his economic condition—no matter what the statisticians want us to believe.

The economic data that the Eastern European governments are so quick to release are flawed for a number of reasons. They rest on the spurious statistics of output and income of the prior command system which are compared with the real levels of productivity in the fledgling market order. Poland’s 16 percent decline in GNP is calculated from pre-reform Communist statistics that were greatly overstated. After all, economic command systems, lacking the guidance of market valuation and pricing, always operate in the dark, unable to compare the value of input with the value of output. Their production staff sties include much physical but valueless output, such as clothing no one can wear or food no one can eat. Similarly, since the statistics of command production have to meet quantitative norms rather than produce valuable items for the market, they fail to allow for inferior product quality. And finally, Communist statistics are frequently based on faulty reporting—the embellishment of data to meet or exceed the expected quotas. The central authorities then further “improve” the faulty data for propaganda purposes.

Before Communist East Germany was reunited with West Germany, its per-capita GNP was reported at 88 percent of that of West Germany. Recent estimates suggest that the Communist figure was overstated by more than 50 percent. If this rate of overstatement holds true also in Communist Poland, the reported 16 percent decline in GNP since the inauguration of reform may actually signal a significant rise in production and income.

The unemployment statistics that frighten the reformers are equally misleading. They compare the rates of unemployment that become visible today with the make-work, featherbedding, and pay-without-work unemployment that is hidden in all political command systems. They reveal the truth that heretofore was hidden behind the veil of Communist fiction and probably indicate real improvement in productive employment.

Finally, the post-reform inflation that is laid on the doorsteps of the market order is completely misplaced. It actually springs from the hidden inflationary practices of the command regimes. When goods prices are set free after many years of command pricing, they immediately adjust to the true state of affairs. Soaring prices promptly remove the money “overhang” left by the previous system, solve the goods shortage that constitutes a money surplus, and eliminate the long queues of people waiting patiently to buy a few shabby items. The inflation the reformers lament clearly is the inevitable consequence of command policies.

Price inflation may also be the undesirable result of current money creation and credit expansion. The reformers, most of whom are ex-Communists and socialists, continue to wield complete control over their country’s money and banking structure. For one reason or another they indulge in massive deficit spending which they easilyfinance through the issue of large quantities of monopolistic legal-tender money. The subsequent rise in goods prices is foreseeable and unavoidable. Yet the reformers are quick to place the blame for the rise on the private-property individual-enterprise system.

Reform is a test of beliefs. It must be preceeded by a profound acceptance of the values and principles of the market order. Otherwise, all efforts will be futile, and the new social and economic edifice will be built on the shifting sands of the command system.

Frye Steps of Reform

To transform a Communist economy to a private-property economy is a formidable but tractable undertaking. The tractability requires five steps of reform that need to be taken simultaneously or in short order:

1) The Communist regime must relinquish direct and indirect control over the people’s money and credit. The central bank that issues monopolistic legal-tender money must be abolished or, at least, be prevented from engaging in inflationary practices.

2) The regime must relinquish all manifestations of control over the capital market. Therefore, it must exert budgetary discipline and abstain from draining and mutilating the capital market.

3) All price, wage, and rent regulations, which are really people controls, must be abolished so that consumers rather than politicians and officials determine the mode of production and rewards. Free prices must be permitted to restore the link between consumers and producers and allocate income according to costs and productivity.

4) All means of production now owned or controlled by the regime must be privatized forthwith. They may be returned to the individuals and their heirs from whom they were seized or, if no heirs can be found, be distributed among the workers who use them. The new owners, in turn, must be free to sell their shares in the capital market

5) To link the transforming economy to the world economy and to international competition, all import and export restrictions must be lifted and the people be permitted to exchange their goods and services with people everywhere.

To focus on one or another of these steps and exclude the rest is to invite failure and disappointment. It may even lend strength and support to the enemies of reform who would love to repair their power of command and restore the old system. All five steps need to be taken simultaneously or in short order so that the market order emerges unhampered and unimpaired and is permitted to function efficiently.

Omitting a single step may jeopardize the reform. The money monopoly in the hands of government is likely to lead to soaring inflation and monetary disintegration. Continuing control over the capital market may permit government to engage in massive capital consumption, to exhaust and deplete the market, and cause economic stagnation and decline. Price, wage, and rent controls would prevent the readjustment of production to consumer choices and preferences. Government ownership of the means of production would continue to breed inefficiency and corruption and protect officials and servants from the fresh air of competition. It would deprive the people of competent services and burden taxpayers with the losses incurred by the public enterprises. Finally, continuation of export and import restrictions would deprive the people of the tremendous advantages that flow from the international division of labor.

A move toward reform is simply the result of ideas of reform taking hold on the mind. Such ideas are burgeoning throughout the Communist world, no matter what the detractors may do to stifle them. Many mistakes are likely to be made on the road to individual freedom and the private-property order. Yet mistakes provide opportunities for learning and lessons in wisdom.

  • Hans F. Sennholz (1922-2007) was Ludwig von Mises' first PhD student in the United States. He taught economics at Grove City College, 1956–1992, having been hired as department chair upon arrival. After he retired, he became president of the Foundation for Economic Education, 1992–1997.