How much does the use of markets as a decentralized social planning mechanism for economic life matter? How much richer are we because we live in a market economy rather than in a command-and-control bureaucratic economy?
We are fortunate–if that is the word–to be able to answer this question because the twentieth century provided us with a natural experiment in the form of High Stalinist central planning. Karl Marx, you see, completely missed the utility of markets as devices for providing decision makers with proper incentives and for achieving allocative efficiency. (Why he missed this is, I think, a result of his crazy metaphysics of value, but I won’t go there today.) He saw markets only as surplus extraction devices–ways to quickly and fully separate the powerless from the value that they had created and that ought to have been theirs.
So when the Communists took over, they followed Marx and said: “we don’t want no stinking markets in our economies.” This naturally raised the question of how they were then to coordinate economic activity. And they hit on the clever plan of attempting to reproduce the Rathenau-Ludendorff Imperial German war economy of World War I. And they did so.
In 1989, the Iron Curtain came down, and we could see what a difference it made as we could examine levels of material well-being on both sides of the Curtain. This is as close to a perfect natural experiment as anyone could wish: the Iron Curtain’s location was determined by where Stalin’s and Mao’s and Giap’s armies marched–which is as exogenous to other determinants of economic well-being as anyone could wish.
Here are the results:
Material Well-Being in 1991: Matched Countries on Both Sides of the Iron Curtain
Eschewing markets robs you of between 80% and 90% of your potential economic productivity.
Now you can argue that the difference in human well-being is less than this gap in material wealth. Cuba, after all, has a high life expectancy and a low level of inequality.
Or you can argue that the difference in human well-being is much, much greater than this gap in material wealth:
Put me down on the much, much greater side of the argument.