September 22, 2003 by AK
The Ventilator debates an investment banker’s article on the Chinese economy. I don’t have a password to WSJ Online, so I only have access to the bits that the Ventilator quotes. (Thanks to Cinderella Bloggerfeller for the link.)
All of that discussion is worth reading if you are interested in the workings of un-free markets and the concept of value itself. I would not align myself with either economist; they both have good points. Value is a fundamental, complex concept that sounds deceptively simple. (The Russian language does not have an adequate word for most of its economic and financial senses; “great value” is impossible to translate.) To put it roughly, the market value of a good in a free market economy is… well, its market value. It’s a tautology. In contrast, the value of a good in a centrally planned economy is what the central planner says it is. In-between there lies a multitude of mixed economies.
But it’s not that simple. Value is a function of many variables: preferences, market structure, government regulation, etc. By definition, the “market value” of anything is tied to a specific market or economy. Suppose the government taxes polluting cars heavily, or the same taxing effect is achieved through litigation, — destroying cars could suddenly become a value-adding activity. You cannot take the price set of economy A, apply it to economy B, and conclude that B is value-destroying.
Still, the Ventilator claims,
Soviet factories received perfectly adequate raw supplies (steel, energy, water, etc.) and turned them into a final product that was worth less than the market price of the materials: refrigerators that broke down immediately, cars that wouldn’t start in winter, clothes that itched and looked ugly.
That may be right, but what market price is this? A price that would have prevailed if the Soviet economy had been opened up under certain conditions? (Those conditions, such as industry ownership structure, taxes, tariffs, etc., would have to be specified, too.) Suppose so; suppose those prices would have made most factories bankrupt; would it mean that “the collapse of Russian industry and the release of the raw materials it used to consume to sell them at market prices on the world market improved the economic welfare of all Russians”? In theory, it should improve the average welfare, but Pareto domination is by no means assured. Moreover, the distributional consequences of such a drastic liberalization would have been disastrous, especially if ownership of those raw materials were closely held by an oligarchic clique. And to some degree, it was disastrous. Moreove, this is what the author foresees for the Chinese state-owned sectors.
The Soviet system was not designed with a view to opening it up to external or internal competition. But suppose now the economy had been liberalized only internally; that some unsurmountable physical obstacle had prevented free trade between the former Union and the world beyong the patterns of the Communist era. Would that have made producers of bad cars go bust? Not necessarily. Ladas would still be value-added goods.
The story of the former Union’s transition has episodes from both scenarios and is complicated by unpleasant legacies such as the huge military-industrial sector. With the government once the only buyer, and the illiquidity of most products, it is exceptionally hard to value military output. Plus, much of the economy rested on production chains or simple production networks, which I believe added unpleasant side effects to the transition (see Blanchard and Kremer’s 1997 paper, Disorganization).
Only freely set market price will tell us whether a particular stage of the productive process adds value or subtracts it. Centrally planned economies lack this mechanism and do not, in principle, know what is their total economic output. They can count the cars, the airplanes, and the coats that their factories produce, but they do not know whether anyone would actually buy them.
This is correct and to the point — something one should never forget. But this logic also shows that there was no way at all to compare Soviet economic growth with that of the West. Industrial production numbers were poor indicators, and applying US prices to Soviet products, even with appropriate, albeit arbitrary, discounts, making the Soviet economy value-subtracting (possibly), would be a methodological mistake: GDP is a measure of value added, and value is market-specific and economy-specific.
But isn’t it how PPP-adjusted GDP is calculated? Roughly speaking, yes; but PPP-based GDP had better be used as an indicator of quality of life. It is quality of life that can always be compared meaningfully, although not necessarily quantified; isn’t the point of economic growth to improve it, after all?
Now let’s have some fun for a change.
According to Marx and his epigones, the amount of labor used in producing a good determined the value of the good. It is astonishing how such an obviously wrong idea became widely accepted. Under the Marxist theory of value, increasing labor productivity is irrelevant. On the contrary, negative productivity could be mistaken for economic growth. Take an example of a worker whose job is to take a sledgehammer and dent every car rolling off the production line. According to Communist theory, this is by definition a value-adding activity, because the worker is adding his labor to the product. You may laugh, but much of the activity in Communist factories fell into this category. I know, I worked in them.
This is what got Cinderella Bloggerfeller laughing; I completed my laughing course a while ago. The amount of waste in the system was enormous and heartbreaking, but it would be better understood not in terms of value, but in terms of resource allocation or factor use. I don’t know what Marx has to do with it; this straw man of the labor theory of value belongs to what I think official Soviet economists branded as “vulgar Marxism”. “Labor theory of value” originated long before Marx. In general, there is nothing wrong about distinguishing, along with Adam Smith, between the labor value and the market value of a good. The trouble begins when you start to assert that the labor value should really be the measure of all things — that is, you take a normative approach. But again, Soviet and Chinese bosses’ love for labor hours has less to do with Marx than with keeping those working-class bastards busy. The right shortcut to Marx would be not to his theory of value but to his recognition of an “Asian mode of production”.
One last point that may help understand the Soviet system. Picture the Soviet Union as a humongous corporation. The country is one monster of a company town; all citizens are employees; party secretaries are human resources managers; export sales are sales; imports are costs; rouble prices are transfer prices, etc. It’s amazing how far one can go in pursuing this analogy: a lengthy article, if not a book, is guaranteed.