In a recent Free Thoughts podcast, Cato scholar Andrei Illarionov, former economic advisor of Vladimir Putin, brought up a peculiar aspect of the Soviet economic system that left his interviewers stunned. Speaking of his time studying economics in college, Illarionov stated, “Prices were not studied … Prices were forbidden.”1

Soviet economics did not allow for a proper price mechanism or for monetary calculation. The Soviet Union used a system of central planning called material balance planning, which balanced the total output of the economy with the total input, which would in theory allow for the most equitable distribution of resources and eliminate waste. The Soviet experience, marked by chronic shortages and stagnation, was an utter failure. This article will examine the Soviet material balance system and its shortcomings from an Austrian perspective, including the contemporary observations of economists Ludwig von Mises and F.A. Hayek.

The Soviet government, in accordance with the principles of state socialism,2owned and controlled all industry in the country. The economy was managed by Gosplan, a central planning agency that set levels of production, wages, and prices. For Soviet ideologues, Gosplan would replace the free market, maximizing efficiency in production and allowing for the more equitable distribution of goods and services. To accomplish this task, Gosplan utilized a system of material balances.

Eliminate Waste? Hardly

Gosplan began using material balance planning to manage the economy shortly after Josef Stalin came to power. Utilizing a vast bureaucracy, Gosplan would estimate public demand for goods and take in the considerations of high-ranking government officials to determine the total output of a commodity for an entire year. Central planners would then draw up balance sheets for each commodity outlining the total output of the commodity and the total input required to produce the desired output. Material balance planning “worked” by getting all balance sheets to balance simultaneously, a Herculean task considering Gosplan made balance sheets for nearly twenty thousand different commodities. The thinking went that by accounting for all resources with a central agency, Gosplan could eliminate waste and ensure that every resource could be fully utilized.3 The second step involved Gosplan negotiating with regional administrations and plant managers to determine what would be produced where and what needed to be done to ensure that production goals were met. It was here that many of the problems with material balance planning began to manifest.

In 1920, over a decade prior to the implementation of material balance planning and not three years after the Bolsheviks first seized power, Ludwig von Mises authored “Economic Calculation in the Socialist Commonwealth,” which served as the foundation for his longer book, Socialism. In it, Mises identified two major flaws with socialist planning: the absence of money as a means of calculation and exchange and, consequently, the inability of the socialist system to properly allocate capital goods.4 With production levels already set by Gosplan, there were no markets for determining supply and demand, and therefore no prices. While money did exist in the Soviet Union as a medium of exchange for consumption goods, workers were paid according to the “value” of their labor rather than at a wage determined by the market. While the use of a monetary medium for consumption goods was more efficient than Mises’s hypothetical example of exchanging “coupons” and calculation in kind, the fundamental problem was the same.5 Since money only existed in the Soviet Union as an expression of labor, it could not be used to rationally judge the value of a good. As stated by Mises, “In a socialist commonwealth, which … finds it impossible to use money as an expression of the price of the factors of production (including labor), money can play no role in economic calculation.”6

Even in the absence of monetary calculation, however, Mises argued it would still be possible to have a system of exchange for consumption goods. Comrades could still barter with each other so that each might attain their maximum possible utility under the tight constraints of that system, and the Soviet use of money would allow for greater flexibility than envisioned by Mises. However, no such system existed for capital goods. Since the means of production were controlled by the state, Mises argued, capital goods could only be transferred internally. In the Soviet Union, when Gosplan misallocated capital goods to enterprises, enterprises would often barter with each other so that each had the capital goods they needed to best meet their respective production quotas.7 But since the state owned all capital goods, exchanges between enterprises were essentially just a relocation of state property. As predicted by Mises, this left Gosplan unable to determine whether production was efficient or inefficient. Whereas the manager of a private enterprise could gauge efficiency in terms of profit, a Soviet planner could only measure efficiency by the predicted ratio of total input to total output.

Knowledge and Power

In addition to Mises’s criticisms, there were knowledge problems and public choice considerations as well. Gosplan, removed from the day-to-day operations of factories, farms, mines, and the like and often spurred on by the unrealistic expectations of government officials, would come up with plans that required enterprises to do as much as they could with as little as possible. While the negotiating phase helped alleviate this problem a little, many enterprises ultimately failed to meet production goals due to lack of resources.

As stated earlier, Gosplan also set wages. While many services were provided directly by the government, Soviet citizens still received wages they could spend at their discretion, typically on retail goods. Instead of paying workers wages determined by the market, Gosplan relied on Marxist principles regarding the value of labor to determine a fair wage. Wages to workers would be given directly through Gosbank, the Soviet Union’s central and only bank, who provided enterprises with cash while debiting their accounts.8 Gosbank played a role in nearly every financial transaction which occurred in the Soviet Union, which allowed it to monitor enterprises closely and ensure that Gosplan’s plan was being followed properly.

Prices of retail goods were determined in a similar fashion. Gosplan, knowing the total amount of money going towards wages and therefore the amount of money available for consumption, would take that amount and set it equal to the value of all the goods that were to be produced that year according to their plan. From there, Gosplan could set the price of every good, again typically relying on the labor theory of value, the sum total of which would add up to the total of workers’ wages. In this way, Gosplan kept rigid prices that ideally reflected the value of the labor required to produce it. Again, all transactions went through Gosbank.

Here, the Soviet Union encountered another problem predicted by Mises. In a society where money only existed as representative units of labor, it could not be used to make rational calculations. For Mises, economic calculation based on the labor theory of value faced two main problems. The first problem was rigidity of labor’s value and how it failed to reflect “material factors of production.” Similar to his criticism that state control of the means of production prevented rational decision-making, Mises argued that changes in technology, the availability of resources and commodities, and the efficiency of production could not be accounted for in units of labor.9 A Soviet miner might receive a wage for his labor, but the value of his labor would not be reflected in the mined ore transferred to a steel mill, nor would a steel worker’s labor be reflected in the raw steel transferred to a factory. The end result was prices that did not reflect the total amount of labor that went into a given good. The prices of retail goods in the Soviet Union depended on crude estimations by Gosplan that did not reflect the costs, labor or otherwise, of production. Gosplan simply saw it as another balance sheet, with total wages on one side and the total “value” of retail goods on the other.

The second problem observed by Mises was the inequality of different types of labor. Labor, as observed by both Marx and Mises, could be physical or mental, skilled or unskilled. While Marx believed that “complex labor,” could be reduced to and thought of in terms of “simple labor,” Mises was unconvinced. In a capitalist system with monetary exchange, it was possible to measure the value of one type of labor relative to another type. Where labor existed as the only unit of exchange, the value of labor could only be measured in terms of the value of other labor, which meant, “Calculation in terms of labor would have to set up an arbitrary proportion for the substitution of complex labor by simple labor.”10 As such, Gosplan’s assignment of wages were a far cry from the original labor theory of value. If anything, wages reflected Soviet policy priorities more than they did the value of labor. Gosplan used higher wages as a means to encourage the growth of certain industries or migration to places like Siberia.

Simply from an administrative perspective, managing the economy in its entirety was difficult to pull off. From unrealistic production goals imposed on enterprises to frequent gaps and inconsistencies in execution, balancing every balance sheet simultaneously meant that one enterprise failing to meet its production quota would unbalance every other balance sheet. Gosplan had failsafes in place to address this problem, but they were rarely sufficient. With restrictions on currency and Gosbank monitoring every financial transaction, individual enterprises would often find themselves in a situation where they could not meet their output with the given input and had no means to remedy the situation, which led to the bartering system mentioned earlier.

A Static World

The Soviet Union’s doing away with prices was one of its many downfalls. However, there was an even bigger problem with the Soviet Union’s abandonment of the price mechanism. A central planning board simply could not account for the day-to-day preferences of millions of individuals, nor could it respond to fluctuations in demand. This problem was addressed by F.A. Hayek in his 1945 essay, The Use of Knowledge in Society, where he responded to arguments made by market socialists that a central planning board could effectively set prices. The planners at Gosplan, however, were far from market socialists and did not even attempt to mimic a free market. Prices and production were set at the beginning of every year, where they would remain rigid until the next year. As prices in the Soviet Union were largely arbitrary, market forces like demand could only affect Gosplan’s production levels. In other words, Gosplan would estimate the demand for a good, order production to meet the necessary supply, and then set prices completely independent of that good’s scarcity or demand. And all this was before taking into account Hayek’s observations about central planning and insufficient knowledge.

Even with the myriad resources at its disposal, Gosplan found itself utterly unable to predict demand. Since output was predetermined on an annual basis, when retailers ran out of a good for a specified year, there was simply no more to go around. Likewise, since prices were fixed by Gosplan, retailers couldn’t lower prices to encourage consumers to buy more of a product they had in excess or raise prices on a product that was in short supply but widely demanded. Chronic surpluses and shortages came to define the Soviet economic experience.11

Gosplan learned to deal with surpluses quickly enough. They would inventory the surplus good or commodity and then simply reduce production the next year. Shortages were another matter. Food, household appliances, and nearly every consumer good was in short supply at some time or another. There were even shortages of toilet paper, which led to the Russian political expression “you can’t wipe your ass with a TV.”12 These shortages were only further exacerbated when the Soviet government decided that expanding the military or winning the space race were higher priorities.

The Soviet Union’s doing away with prices was one of its many downfalls. While the Soviet economy grew under material balance planning, the growth was inefficient, largely a result of forced industrialization and better technology, and often came at the expense of consumer welfare. Should Gosplan decide to gear production toward non-retail goods such as tanks and weapons, then Soviet citizens would simply have to do without. Mises’s predictions about the impossibility of rational economic calculation in a socialist system proved true with the Soviet experience serving as a testament to their validity. In the end, a world without prices would be a terrible place to live.

Andrei Illarionov, interview by Trevor Burrus and Matthew Feeney, Free Thoughts, podcast audio, May 26, 2017. ↩ State socialism, in Marxist-Leninist thought, was the second stage in the process toward true communism. The first step was state capitalism, as Vladimir Lenin believed, like Marx did, that capitalism necessarily had to precede socialism. State capitalism, as envisioned by Lenin, allowed for the creation of a proletariat with government experts serving as a surrogate for the bourgeoisie. State socialism, or state ownership of the means of production, would follow. Finally, the third step was communism, summarized by Marx as “from each according to his ability, to each according to his need.” In the third step, everything would be owned by the community as a whole. Marxists often criticize Stalin for implementing state socialism before the creation of a real proletariat. ↩ Michael Manove and Martin L. Weitzman, “Aggregation for Material Balances,” Journal of Comparative Economics 2, (1978): 1. ↩ Referred to by Mises as “goods of a higher order.” ↩ Ludwig von Mises, Economic Calculation in the Socialist Commonwealth(Auburn, AL: Ludwig von Mises Institute, 1990), 3-4. At the time of Mises’s writing, a socialist system had yet to be fully implemented, as the Soviet Union, then the world’s only communist country, still considered itself to be a “capitalist” country (see footnote 2). Mises, therefore, had to speculate as to what form exchange for consumer goods might take, based on the writings of contemporary socialist economists. Mises hypothesized about both a system where laborers would be given coupons they could redeem for certain consumer goods and a system of calculation-in-kind, where the value of a good is expressed only in relation to other goods. Neither of these systems were adopted by the Soviet Union. ↩ Ibid, 21. ↩ Heinz Kohler, “Soviet Central Planning,” Vassar College. ↩ Ibid. ↩ Mises, 27. ↩ Ibid, 30. ↩ The “shortage economies” of communist nations have been written about extensively by Hungarian economist Janos Kornai. Kornai’s most notable work on the subject was his 1980 book, The Economics of Shortage. ↩ Grant Brisbee, “A field guide to pooping in the Soviet Union,” SB Nation.

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This piece first ran at Libertarianism.org