The relative efficiencies of market and planned economies.

• Author: Moroney, John R.

The advantage to efficiencies of the decentralization of decisions and of individual responsibility is even greater, perhaps, than the nineteenth century supposed; and the reaction against the appeal to self interest may have gone too far . . . The authoritarian state systems of today seem to solve the problem of unemployment at the expense of efficiency and freedom. John Maynard Keynes [16, 380-81]

. . . it was not the possibility of planning as such which has been questioned . . . ., but the possibility of successful planning. . . . What we should anticipate is that output, where the use of available resources was determined by some central authority, would be lower than if the price mechanism of a market operated freely under otherwise similar circumstances. Friedrich A. Hayek [11, 203-04]

1. Introduction

   Are planned economies systematically more or less productive than market economies? This question provoked heated intellectual debate since the time of Hayek [11], Keynes [16], Lange [19], Lange and Taylor [20] and Lerner [22]. The collapse of the communist systems of East Europe since 1989 closed the debate: planned economies were without doubt less efficient in utilizing economic resources than market economies. But how much less efficient? This question is of obvious scientific interest, but it has not been answered.

   Some work addressing the broad question of comparative efficiency has been done by Bergson [4; 5; 6], Mater [25; 26], Moroney [28], and others. All indicate comparatively lower efficiency in planned economies. But none addresses the question "by how much?" Our contribution here is to answer this question using a novel methodology. We estimate aggregate frontier production functions for two groups of countries: 7 centrally-planned economies in East Europe and 17 predominantly market economies in West Europe.

   Estimating frontier production functions enables two types of comparisons that have not before been possible. First, we can compare the overall efficiencies of East European countries relative to West European countries. We find that, overall, the planned economies were about three-fourths as efficient as the market economies. Second, we can compare relative economic efficiencies among countries within East Europe. Here we find moderate variation, with all 7 countries operating within 70% to 83% of the aggregate East European frontier.

2. Brief History of the Debate

   The argument favoring central planning is that competitive markets are unstable, leading to swings of overinvestment in some sectors and underinvestment in others, thereby generating a wasteful use of resources. Such waste could in principle be avoided by central planning of production, prices and resource allocation.

   Hayek [11; 12], Mises [27] and other proponents of market systems acknowledged the theoretical possibility of rational centralized price setting and resource allocation. But they reasoned that the stupendous volume of information required for centrally directed resource allocation is impracticable. No central authority could assimilate it, much less act on it. Instead, they forcibly argue that prices set in decentralized markets prompt greater overall economic efficiency.

   The computational feasibility of centralized resource allocation in a flexible price setup was later analyzed formally by Arrow and Hurwicz [1] and Malinvaud [24]. And the strictly technical feasibility of allocating resources without either market or accounting prices was demonstrated by Heal [13; 14]. But as Heal readily acknowledges, the information requirements on the part of the Central Planning Board and of plant managers are more stringent than in either the Arrow-Hurwicz or Malinvaud models.

   The collapse of the centralized economic systems of East Europe since 1989 shows the serious flaws that plagued them. And the fact that real per capita incomes grew much faster in West Europe than in East Europe after World War II also signifies productivity advantages of decentralization.(1)

   Bergson [4; 5] found four planned economies to be generally less efficient than seven market economies in their use of capital and agricultural land in 1975. Moroney [28] found seven East European planned economies to use capital and energy generally less efficiently than seventeen West European market economies during the 1978-1980 period. Both Bergson and Moroney used ordinary least squares to estimate a constant-returns-to-scale Cobb-Douglas production function, with a dummy variable to identify the planned economies. Neither Bergson nor Moroney could address the degree of technical inefficiency among the economies of Eastern Europe. We do so here.

   Our objective is to estimate stochastic production frontiers. We identify the separate production frontiers of the two types of economies, and position different countries in East Europe relative to their own frontier. We use Moroney's data, which comprise a 24 x 3 panel of 17 market and seven planned economies over the three year period 1978-1980. Countries are listed in Table III. They include three of Bergson's four planned economies plus four others, and five of Bergson's seven market economies plus twelve others. These panel data enable us to exploit econometric techniques unavailable to Bergson and Moroney. We use maximum likelihood techniques to construct a stochastic production frontier, relative to which the "firm effects" provide country-specific measures of productive efficiency. The model allows for the possibility of neutral and non-neutral (in the sense of Hicks) differences in technical efficiency between the groups of countries.

   We test the hypothesis that there is no systematic difference in performance across the two economic systems. If the hypothesis is rejected, and if the market economies are systematically more productive, then the Bergson-Moroney hypothesis is both confirmed and quantified to a degree that heretofore has not been possible. We do find systemic differences. We find a large gap in technical efficiency between the two systems. The lower efficiency of the centrally-planned economies was present a full decade before the turmoil that rent them politically and economically. The differences we find in economic efficiency are in no way ascribable to the disruptions encountered during "the transition." These countries have deteriorated sharply since their political disintegration. The reasons for their economic collapse during the transition are a very different matter from the reasons for lower efficiency when central planning was intact.(2) We focus...