Why Did Communism Fail? #2 – Absence Of The Market

The main reasons why Communism failed was that it could not provide a decent standard of living for its people. This was because the absence of a market meant Communism was enormously wasteful with resources. The system was notable for its crippling inefficiencies and gross mismanagement. Despite having some of the highest levels of investment, they had some of the lowest returns. This was due to the absence of market forces and signals, the primacy of political influences and a lack of accountability.

The free market has many flaws as I regularly discuss on this blog. However, it has some advantages (though they are often exaggerated) which make it essential to an economy. The most important of which is that it can send signals. If you try selling shoes and no one buys them, this is the market signalling that you should switch to something else. This is signal is not perfect and in some cases can be seriously flawed, but in general it works. The problem with Communism is that it abolishes the market’s ability to signal. Consumers had very little choice so they would buy the shoes even if they hated them. Thus there was no way to know what was a good or a bad investment. Factories would be built and products made even if no one wanted them. Rising prices is a way for the market to signal that there is high demand for a good. But if prices are fixed by the state, then there is no way to know what is or is not in demand.


The second problem with removing a market is that there is no longer a way to punish inefficiency and reward competence. In a capitalist system inefficient producers go bankrupt (this is a rough rule of thumb that holds best at the extreme) whereas under Communism a factory can be extremely inefficient and continue in business. It was possible to make poor quality goods and people would still have to buy it. The state would cover all losses and credit was easily available. Thus there was no incentive to take risks on changing production structure or shaking up the system. It was easier to just continue with the old ways of wasting resources.

Instead decisions were made for political reasons. Managers and administrators were chosen not based on their knowledge of economics or proven competence but rather based on political loyalty. It was preferable to have a group of inept loyalist than successful dissidents who may undermine your position. As there was no market guidance as to where best to invest, political connections were most important. The focus was then on what best benefited the party elite rather than what benefited the economy. Hence huge statues to political leaders dominated poorly constructed buildings that lay empty. If success was determined for political rather than economic reasons, then praising the leader became more important that being economically efficient.

Due to the political structure and without a market, decision makers were unaccountable. There was no way to punish failure or incompetence. The lack of transparency meant large amounts of money could not be accounted for. In this climate corruption flourished. Communist countries were notoriously corrupt and their leaders completely unaccountable. As a firm could sustain any amount of losses, disappearing money wasn’t a problem. Inefficient firms dominated by nepotism and corruption couldn’t be driven from the market and sold just as much as more efficient firms. Political connections and bribery determined where resources went even if it was harmful for the economy.

At the core of the economic failure of Communism was the abolition of the free market. Many countries can prosper with heavy regulations, high taxes or state intervention, but all cases where the market itself was abolished have failed. Without a market there is no way to accurately make economic decisions, to maximise economic efficiency or to use resources in the best way. Central planning fails as an alternative as it lacks sufficient accurate information and is open to political manipulation and corruption. By abolishing the market, Communists hoped to protect the economy from cycles of boom-and-bust. Instead they condemned the economy to stagnation.


Filed under Economics

19 responses to “Why Did Communism Fail? #2 – Absence Of The Market

  1. cumbrianirish

    What about the wastefulness and inefficiency of the banking system and generally in corporate capitalism?

  2. “Instead decisions were made for political reasons. Managers and administrators were chosen not based on their knowledge of economics or proven competence but rather based on political loyalty.” Applies to more than marketing, one of the dangers now facing America. Moreover, the media makes a fight game between political views and worsens divisions.

  3. Good post! The failures of present-day American capitalism do not make the old Soviet command economy a good system, nor vice versa.
    I highly recommend a book, RED PLENTY by Francis Spufford, which is a highly sympathetic account of attempts to reform the Soviet system during the Khrushchev era and why it failed.

  4. As I shared from fff.org before on my blog Robert, the (free) market is a beautiful thing…It is always correct and is moral. http://rightfromyaad.wordpress.com/2013/04/19/the-market-is-a-beautiful-thing/

    • I’m trying to drive a middle course between the extremes of Communism and Libertarianism. The market is neither perfectly evil or perfectly correct and moral. There are numerous cases of it failing, such as right now. It would be a shame if you misunderstood my critique of Communism as a justification to run to the other extreme.

      • For this balancing act, why not have one standard (for example a minimum wage) for the whole world then? Why is it that some countries have different wages to others?

        Let’s use the case of the US….How can there be a legally mandated basic wage for the entire country? That’s ludicrous. The wages in deep rural Kansas or Alabama cannot be arbitrarily determined by some bureaucrat to be the same as the wage for another in Manhattan. They are operating in totally different market places. Freedom is moral and just. The market determines the price not some politician.

        Why do you say the market is failing? Because prices fall? Or an industry’s revenue declines and its product is less of a priority for a consumer? Is it the duty of govt to come to its rescue and prop it up? a la “Cash for Clunkers” and an auto bail out? What happened to the Horse and Buggy industry after the invention and mass production of the motor car?

        Where are you going to find the angels (as Friedman says) that will organize society for us through the force of laws… give us this balance? There is a right way and a wrong way. The compromise of a middle ground is evil and only serves the interest of political power.

        • I’m not quite sure what it is that you are trying to say. Of course wages are not the same all over the country which is why they are not. Alabama has a lower minimum wage than New York. You seem to think this is the moral outcome but why such someone get paid less for flipping burgers just because they live in Alabama?

          Its had to have a debate when you simply state ideology as fact. I mean how do I pull apart sentences like “The market determines the price not some politician.”?

          “Why do you say the market is failing?”
          Isn’t obvious? I mean surely you can see the mass unemployment and stagnant growth? You do remember when the economy nearly collapsed in 2008?

          Yes it is the role of the government to rescue the economy because no one else will and I’d rather not live through the 2nd Great Depression.

          “Where are you going to find the angels”
          Who said we need angels? To claim we need angels to run the government is as ridiculous as saying that capitalism requires angels. To boost the economy the government needs to spend money on infrastructure. You don’t need to be an angel or a genius to do this.

          “There is a right way and a wrong way. The compromise of a middle ground is evil and only serves the interest of political power.”
          Evil? Really? So we must choose between Communism and Anarchism and all middle ground is evil? Are you sure about that?

          • Sorry for the delay in my reply, as a physician my time is consumed by competing interests. In the US, there is a FEDERALLY MANDATED minimum wage…each state then sets a standard above that. But again, how can the wages in state capitals be the same as wages in rural and remote areas of the state? Secondly the Federally mandated minimum wage at a time in the 1960’s was higher (when inflation is accounted for) than it is today.

            As I have tried to tirelessly point out, political effort at fixing the market leads to larger problems down the road. You need to do a forensic dissection of economic history, even understanding what caused the Great Depression…and the US govt’s failures.

            Capitalism is all about freedom and protecting freedom. Any form of control will require Papal altruistic intent to make laws that serves the interest of millions. And we know how well the Holy Roman Empire turned out.

            What is Anarchism? Where is anyone who is about more freedom talking about anarchy? This is nothing but demagoguery from leftists. Of course govt is necessary, but let us limit their power and focus on things that only they alone can do. Security and justice being paramount.

            You may want to give up your liberty for your interests, but you cannot authorize the govt to take away mine, because of some notion of collective responsibility and collective ‘good’.

            I could direct you to some of Thomas Sowell and Walter Williams’ economic texts and teachings.

            • While there are wage differences across the country, these are not monumental. You claim the government makes things worse, but I disagree. I have studied the Great Depression and it was definitely not the governments fault. As with our current crisis it was the free market gone wild and out of control.

              Despite its name, the Holy Roman Empire wasn’t actually run by the Pope.

              You said the middle ground was evil, so I presumed you were on the extremes. I couldn’t think of anything more extreme than Communism and Anarchism.

              The whole debate over libertarianism boils down to whether you view us as individuals or members of society. If you think we have responsibilities as well as rights, then you understand the need for government.

              I’ve never heard of Walter Williams, but I cannot stand Thomas Sowell. He has got to be one of the most annoying and illiterate economists I know of.

  5. Ceannaire

    That article repeats could have been written by a Ronald Reagan speechwriter such is its relaince on “Reds Under the Bed” clichés and stereotypes that have been ten-a-penny in the history of socialism at the complete expense of analysis and fact.

    First, up, “stagnation”; the Soviet economy was in a state of continuous economic growth from the end of the Second World War until the mid 1980s, which was when Gorbachev started dismantling the socialist system, and, unsurprisingly, it thereby fell apart. Continuous economic growth for forty years isn’t stagnation. Unlike capitalist countries, it avoided busts and recessions. No economist has ever found a way by which capitalism can avoid boom and bust trade cycles.

    Secondly, you contrast the centrally-planned Soviet model with an idealised and innaccurate version of the market economy. In theory, prices may well be an accurate way of transmitting information, but this ignores the tendency of monopolies and cartels to grow in captialist economies, which deprives citizens of choice and vitiates the conventional arguments in favour of prices. Do you think the prices of Microsoft products are an accurate reflection of their use to consumers? There can be all kinds of reasons why prices may be fixed; in the 1970s, the capitalist world was brought to its knees by the Oil Crisis caused by OPEC deciding to hike prices just to teach the West a lesson for supporting Israel. These monopolistic and oligopolistic tendencies within capitalism further mean that capitalist economies actually come more and more to resemble the “centrally planned” economies you try to contrast them with, with key economic decisions being made in the boardroom of a small number of corporations as opposed to by the interplay of consumers with markets.

    Thirdly, you claim that the socialist economies were “inefficient”. This is also untrue even by the metric of neoclassical economics, as some time ago the “Journal of Economic Perspectives” did a study on the comparative efficiencies of the socialist economies as compared to the capitalist Western economies and arrived at the conclusion that by every single neoclassical indicator the former were more efficient or as efficient as the latter.

    Finally, you refer to corruption. Whilst it is true that it was an issue, you give no explanation as to why it was more so in socialist than capitalist countries. Corruption has increased massively in the former Soviet republics since independence. Whatever petty corruption there may have existed in the Warsaw Pact states, I can think of no examples so flagrant and high-level as how Charles Haughey was bought off by rich businessmen in the 80s, such as when he was bribed by Ben Dunne to secure a better tax deal for him; as how just recently in the United States a gun law was defeated by senators almost all of whom had received donations from gun companies.

    • Its funny you compare me to Ronald Regan when all my friends think I’m a socialist (I’m a social democrat).

      “the Soviet economy was in a state of continuous economic growth”
      Officially yes, but the official statistics were wildly exaggerated. The economy literally did not grow after 1980. Even before then it had slowed down enormously and had greatly fallen behind the West. Also this was a growth in the quantity of goods in the economy, what is not measured is the exceptionally poor quality of the goods.

      On your second point let me be clear that I am no free marketeer. The market is nowhere near as efficient as its adherents claim and it has flaws (as I regularly discuss on the blog). It can on occasion resemble oligopoly. However, it is better than central planning.It does provide some benefits as I discussed in the post.

      I’d like to see the study that claimed that socialism was more efficient, all the academic work I have seen have said the opposite.

      Corruption was rampant under Communism as there were no checks or balances. Without a free press scandals could not be reported and officials could not be held to account. It also means we cannot compare current corruption scandals with the past as most of them were swept under the carpet.

      • Ceannaire

        Here is the study I was referring to: http://jdeanicite.typepad.com/files/murrell-economics-and-socialism.pdf.

        Newspapers were in actual fact inundated with reports of corruption and abuse of power, and these were regularly acted upon, none of which is to say that the situation would not have been better had the society been freer, but the picture is more complex than the Reaganesque caricature (and I was comparing your writings on this particular subject to Reagan, not in general). But anyway, if it’s not possible to compare corruption there with capitalist economies then it’s not very fair to use it as a criticism of socialism’s failures vis-á-vis capitalism.

  6. Thank you, Robert. Your words apply so well to energy efficiency programs in the US that I would like to lift a few sentences (with proper attribution, of course) to use in a blog/white paper about what to change. I knew there were parallels, but the fact that whole paragraphs could be used in an argument to reform programs, simply by replacing the word ‘communism’ is stunning.

    Thank you for your beautiful and insightful writing. It’s funny, I have a strong faith and I love your thinking… life is funny, isn’t it?

    • Robert, this is a gift. Thank you!! So many gems it’s hard to choose a favorite, so I’ll randomly grab one:
      “By abolishing the market, Communists hoped to protect the economy from cycles of boom-and-bust. Instead they condemned the economy to stagnation.”

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