on Liberty - June 1995 - Posted on February 13, 2002
by Mark J. Perry
Socialism is the Big Lie of the
twentieth century. While it promised prosperity, equality, and security,
it delivered poverty, misery, and tyranny. Equality was achieved only in
the sense that everyone was equal in his or her misery.
In the same way that a Ponzi scheme or chain letter initially succeeds but
eventually collapses, socialism may show early signs of success. But any
accomplishments quickly fade as the fundamental deficiencies of central
planning emerge. It is the initial illusion of success that gives
government intervention its pernicious, seductive appeal. In the long run,
socialism has always proven to be a formula for tyranny and misery.
A pyramid scheme is ultimately unsustainable because it is based on faulty
principles. Likewise, collectivism is unsustainable in the long run
because it is a flawed theory. Socialism does not work because it is not
consistent with fundamental principles of human behavior. The failure of
socialism in countries around the world can be traced to one critical
defect: it is a system that ignores incentives.
In a capitalist economy, incentives are of the utmost importance. Market
prices, the profit-and-loss system of accounting, and private property
rights provide an efficient, interrelated system of incentives to guide
and direct economic behavior. Capitalism is based on the theory that
Under socialism, incentives either play a minimal role or are ignored
totally. A centrally planned economy without market prices or profits,
where property is owned by the state, is a system without an effective
incentive mechanism to direct economic activity. By failing to emphasize
incentives, socialism is a theory inconsistent with human nature and is
therefore doomed to fail. Socialism is based on the theory that incentives
In a radio debate several months ago with a Marxist professor from the
University of Minnesota, I pointed out the obvious failures of socialism
around the world in Cuba, Eastern Europe, and China. At the time of our
debate, Haitian refugees were risking their lives trying to get to Florida
in homemade boats. Why was it, I asked him, that people were fleeing Haiti
and traveling almost 500 miles by ocean to get to the "evil
capitalist empire" when they were only 50 miles from the
"workers' paradise" of Cuba?
The Marxist admitted that many "socialist" countries around the
world were failing. However, according to him, the reason for failure is
not that socialism is deficient, but that the socialist economies are not
practicing "pure" socialism. The perfect version of socialism
would work; it is just the imperfect socialism that doesn't work. Marxists
like to compare a theoretically perfect version of socialism with
practical, imperfect capitalism which allows them to claim that socialism
is superior to capitalism.
If perfection really were an available option, the choice of economic and
political systems would be irrelevant. In a world with perfect beings and
infinite abundance, any economic or political system--socialism,
capitalism, fascism, or communism--would work perfectly.
However, the choice of economic and political institutions is crucial in
an imperfect universe with imperfect beings and limited resources. In a
world of scarcity it is essential for an economic system to be based on a
clear incentive structure to promote economic efficiency. The real choice
we face is between imperfect capitalism and imperfect socialism. Given
that choice, the evidence of history overwhelmingly favors capitalism as
the greatest wealth-producing economic system available.
The strength of capitalism can be attributed to an incentive structure
based upon the three Ps: (1) prices determined by market forces, (2) a
profit-and-loss system of accounting and (3) private property rights. The
failure of socialism can be traced to its neglect of these three
The price system in a market economy guides economic activity so
flawlessly that most people don't appreciate its importance. Market prices
transmit information about relative scarcity and then efficiently
coordinate economic activity. The economic content of prices provides
incentives that promote economic efficiency.
For example, when the OPEC cartel restricted the supply of oil in the
1970s, oil prices rose dramatically. The higher prices for oil and
gasoline transmitted valuable information to both buyers and sellers.
Consumers received a strong, clear message about the scarcity of oil by
the higher prices at the pump and were forced to change their behavior
dramatically. People reacted to the scarcity by driving less, carpooling
more, taking public transportation, and buying smaller cars. Producers
reacted to the higher price by increasing their efforts at exploration for
more oil. In addition, higher oil prices gave producers an incentive to
explore and develop alternative fuel and energy sources.
The information transmitted by higher oil prices provided the appropriate
incentive structure to both buyers and sellers. Buyers increased their
effort to conserve a now more precious resource and sellers increased
their effort to find more of this now scarcer resource.
The only alternative to a market price is a controlled or fixed price
which always transmits misleading information about relative scarcity.
Inappropriate behavior results from a controlled price because false
information has been transmitted by an artificial, non-market price.
Look at what happened during the 1970s when U.S. gas prices were
controlled. Long lines developed at service stations all over the country
because the price for gasoline was kept artificially low by government
fiat. The full impact of scarcity was not accurately conveyed. As Milton
Friedman pointed out at the time, we could have eliminated the lines at
the pump in one day by allowing the price to rise to clear the market.
From our experience with price controls on gasoline and the long lines at
the pump and general inconvenience, we get an insight into what happens
under socialism where every price in the economy is controlled. The
collapse of socialism is due in part to the chaos and inefficiency that
result from artificial prices. The information content of a controlled
price is always distorted. This in turn distorts the incentives mechanism
of prices under socialism. Administered prices are always either too high
or too low, which then creates constant shortages and surpluses. Market
prices are the only way to transmit information that will create the
incentives to ensure economic efficiency.
Profits and Losses
Socialism also collapsed because of its failure to operate under a
competitive, profit-and-loss system of accounting. A profit system is an
effective monitoring mechanism which continually evaluates the economic
performance of every business enterprise. The firms that are the most
efficient and most successful at serving the public interest are rewarded
with profits. Firms that operate inefficiently and fail to serve the
public interest are penalized with losses.
By rewarding success and penalizing failure, the profit system provides a
strong disciplinary mechanism which continually redirects resources away
from weak, failing, and inefficient firms toward those firms which are the
most efficient and successful at serving the public. A competitive profit
system ensures a constant reoptimization of resources and moves the
economy toward greater levels of efficiency. Unsuccessful firms cannot
escape the strong discipline of the marketplace under a profit/loss
system. Competition forces companies to serve the public interest or
suffer the consequences.
Under central planning, there is no profit-and-loss system of accounting
to accurately measure the success or failure of various programs. Without
profits, there is no way to discipline firms that fail to serve the public
interest and no way to reward firms that do. There is no efficient way to
determine which programs should be expanded and which ones should be
contracted or terminated.
Without competition, centrally planned economies do not have an effective
incentive structure to coordinate economic activity. Without incentives
the results are a spiraling cycle of poverty and misery. Instead of
continually reallocating resources towards greater efficiency, socialism
falls into a vortex of inefficiency and failure.
Private Property Rights
A third fatal defect of socialism is its blatant disregard for the role of
private property rights in creating incentives that foster economic growth
and development. The failure of socialism around the world is a
"tragedy of commons" on a global scale.
The "tragedy of the commons" refers to the British experience of
the sixteenth century when certain grazing lands were communally owned by
villages and were made available for public use. The land was quickly
overgrazed and eventually became worthless as villagers exploited the
communally owned resource.
When assets are publicly owned, there are no incentives in place to
encourage wise stewardship. While private property creates incentives for
conservation and the responsible use of property, public property
encourages irresponsibility and waste. If everyone owns an asset, people
act as if no one owns it. And when no one owns it, no one really takes
care of it. Public ownership encourages neglect and mismanagement.
Since socialism, by definition, is a system marked by the "common
ownership of the means of production," the failure of socialism is a
"tragedy of the commons" on a national scale. Much of the
economic stagnation of socialism can be traced to the failure to establish
and promote private property rights.
As Peruvian economist Hernando de Soto remarked, you can travel in rural
communities around the world and you will hear dogs barking, because even
dogs understand property rights. It is only statist governments that have
failed to understand property rights. Socialist countries are just now
starting to recognize the importance of private property as they privatize
assets and property in Eastern Europe.
Without the incentives of market prices, profit-and-loss accounting, and
well-defined property rights, socialist economies stagnate and wither. The
economic atrophy that occurs under socialism is a direct consequence of
its neglect of economic incentives.
No bounty of natural resources can ever compensate a country for its lack
of an efficient system of incentives. Russia, for example, is one of the
world's wealthiest countries in terms of natural resources; it has some of
the world's largest reserves of oil, natural gas, diamonds, and gold. Its
valuable farm land, lakes, rivers, and streams stretch across a land area
that encompasses 11 time zones. Yet Russia remains poor. Natural resources
are helpful, but the ultimate resources of any country are the unlimited
resources of its people--human resources.
By their failure to foster, promote, and nurture the potential of their
people through incentive-enhancing institutions, centrally planned
economies deprive the human spirit of full development. Socialism fails
because it kills and destroys the human spirit--just ask the people
leaving Cuba in homemade rafts and boats.
As the former centrally planned economies move toward free markets,
capitalism, and democracy, they look to the United States for guidance and
support during the transition. With an unparalleled 250-year tradition of
open markets and limited government, the United States is uniquely
qualified to be the guiding light in the worldwide transition to freedom
We have an obligation to continue to provide a framework of free markets
and democracy for the global transition to freedom. Our responsibility to
the rest of the world is to continue to fight the seductiveness of statism
around the world and here at home. The seductive nature of statism
continues to tempt and lure us into the Barmecidal illusion that the
government can create wealth.
The temptress of socialism is constantly luring us with the offer:
"give up a little of your freedom and I will give you a little more
security." As the experience of this century has demonstrated, the
bargain is tempting but never pays off. We end up losing both our freedom
and our security.
Programs like socialized medicine, welfare, social security, and minimum
wage laws will continue to entice us because on the surface they appear to
be expedient and beneficial. Those programs, like all socialist programs,
will fail in the long run regardless of initial appearances. These
programs are part of the Big Lie of socialism because they ignore the
important role of incentives.
Socialism will remain a constant temptation. We must be vigilant in our
fight against socialism not only around the globe but also here in the
The failure of socialism inspired a worldwide renaissance of freedom and
liberty. For the first time in the history of the world, the day is coming
very soon when a majority of the people in the world will live in free
societies or societies rapidly moving towards freedom.
Capitalism will play a major role in the global revival of liberty and
prosperity because it nurtures the human spirit, inspires human
creativity, and promotes the spirit of enterprise. By providing a powerful
system of incentives that promote thrift, hard work, and efficiency,
capitalism creates wealth.
The main difference between capitalism and socialism is this: Capitalism