Why did socialist economies fail? The role of factor inputs reconsidered

Dr Alex Klein

by Tamás Vonyó and Alexander Klein, discussion paper KDPE 1708, April 2017.

Non-technical summary

The role of institutions features prominently in comparative studies of economic development. Eastern Europe after 1945 provides a textbook case, where relative decline in income per head and productivity has been linked to institutional failure. The inefficiency of central planning compared to the market economy is well established both theoretically and empirically. The socialist system, it has been argued, was relatively successful in mobilizing resources but stifled innovation and entrepreneurship. Planned economies thus achieved ‘a satisfactory productivity performance in the era of mass production, but could not adapt to the requirements of flexible production technology’ (Broadberry and Klein 2011, p. 37). Effective in the phase of extensive growth, socialist economies slowed down abruptly as investment reached diminishing returns, which contributed to their collapse in the 1980s. While Eastern European countries seem to have maintained high rates of labor participation and very high levels of investment in  physical  capital,  they  were  shown  to  have  become  increasingly  inefficient  compared  to  western market economies in their use of production factors and intermediate inputs.

This paper does not challenge the view that the planned economy was inefficient, but the above characterization  of  the  socialist  growth  experience  is  out  of  date.  As  the  literature  review  will demonstrate,  the  majority of  previous  studies  found that the last  decades  of  communism  witnessed sharply diminishing, during the 1980s often negative, rates of productivity growth. The inefficiency of the socialist system was manifested in productivity failure. We consider these results biased by the inconsistent use of data on output and factor inputs. Researchers benefited from revised data on national income that yielded substantially lower rates of economic growth than what government statistics had suggested, but they have still used official data on capital formation, or estimated capital stock from official investment data. Under central planning, investment statistics are just as difficult to trust as national accounts. We will show that socialist economies invested considerably less in physical capital than previously claimed. Likewise, official employment figures overstate the growth of labour input as average work hours declined from the 1960s onward. We suggest a much larger role for factor inputs and a smaller one for productivity in the relative decline of Eastern Europe, especially in the 1980s, than what earlier interpretations advocated. We reveal fundamental differences between the growth experience of small socialist countries and what we know about the Soviet economy in the same period.

You can download the complete paper here.