Defining Ideas

The Destructive Consequences Of Socialism

Saturday, November 3, 2018
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In the early 1980s, when I was a senior economist at President Reagan’s Council of Economic Advisers (CEA), we put out one publication annually for the public: The Economic Report of the President. The rest of the time, we spent our time analyzing and arguing about economic policy. So, for example, as the senior economist for energy from 1983 to 1984, I argued against re-imposing price controls on oil and gasoline, for allowing Alaskan oil to be sold to foreigners, and against increasing the stringency of the fuel economy standards for cars and trucks.

But with the all-pervasiveness of the web, it was only natural that at some point, CEA economists would want to bring their economic thinking to the public without waiting for the annual report. Former President Obama’s CEA economists published reports on the web a fair amount in his second term. And President Trump’s CEA economists followed suit. Their latest is a fact-filled, well-footnoted report published last week, titled “The Opportunity Costs of Socialism.” Why now? Probably because over half of Democrats have a positive view of socialism, and economists have a lot to say about socialism. The tone is calmly passionate, yet academic in the best sense of the word. I challenge anyone to read it open-mindedly and conclude that socialism, whether extreme or moderate, is a good economic system.

In section after section, the authors analyze both the failure of extreme socialism a la Mao, Stalin, and Castro, less extreme socialism (Venezuela), and still less extreme socialism (the Nordic countries.) They also quantify what would happen to tax rates, real GDP, and standards of living in the United States if we were to adopt enhanced socialist policies, particularly in health care.

But the CEA economists don’t just rely on empirical economic models. They also use good economic reasoning to point out the basic problem with socialism: bad incentives. Following Milton and Rose Friedman, they note four ways people can spend money: (1) spend their own money on themselves, (2) spend their own money on others, (3) spend someone else’s money on themselves, and (4) spend someone else’s money on others. The fourth way accounts for most government spending. The authors note a huge problem: the spenders don’t economize (they’re spending other people’s money) and they don’t seek the highest value (they’re spending on others.) For that reason, socialism and government spending generally are very wasteful.

They use this basic spending framework to criticize the idea, which has become popular on the American left, of Medicare for All. They quote New York Times economics columnist Paul Krugman’s statement that under Medicare for All, “most people would gain more from the elimination of insurance premiums than they would lose from the tax hike.” The authors point out that Krugman fails to mention “any of the economic problems with spending someone else’s money on someone else.” (italics added)

That criticism might account for Krugman’s calling the report “amazingly dishonest.” Krugman claims the report is “basically saying that if you favor Medicare for All, you’re Mao Zedong.” Not true. The authors note upfront that “Present-day socialists do not want the dictatorship or state brutality that often coincided with the most extreme cases of socialism.” Who’s dishonest?

It’s easy to show that our mixed economy in the United States performs way better than the horrible socialist economies of Lenin’s and Stalin’s Soviet Union, of Chairman Mao’s Communist China, and of Fidel Castro’s Cuba.

For that reason, you might think that such a demonstration is unnecessary. But they point out that in 1989, U.S. Nobel Prize winners Paul Samuelson, who won in 1971, and William Nordhaus, who won this year, wrote that “the Soviet economy is proof that, contrary to what many skeptics had earlier believed, a socialist command economy can function and even thrive.” If it’s worthwhile to correct the fuzzy thinking of two leading American economists, it’s definitely worthwhile to point it out to the American public, many of whom learned economics from the textbook in which that quote appeared.

The report’s section on Cuban agricultural production is devastating. After Castro took over in 1959, he nationalized 70 percent of farmland. The result? Between 1957-58, the period before Castro, and 1963-64, by which time the nationalization had been done, the production of beef, pork, poultry, eggs, milk, corn, rice, root vegetables malanga and yucca, and potatoes all fell by a double digit, and typically a high double-digit, percentage. Output of their biggest crop, sugar, fell by 35 percent. Why didn’t Cubans starve? The Soviet Union bailed them out. The CEA report notes that Puerto Rico and Cuba had relative equal national incomes in 1950 but, by 2000, Cuba’s national income relative to Puerto Rico’s had fallen by almost two thirds.

The report also notes the grim statistics of Soviet agricultural production in the early 1930s when Stalin wiped out millions of Ukrainians, a fact covered up by the infamous Walter Duranty of the New York Times. It also tells us that Mao’s Great Leap Forward from 1958 to 1962 included a policy of collectivization of agriculture, one of whose features was no remuneration for effort on farms. The result? Per capita agricultural production fell by double-digit percentages and 45 million Chinese people died during the famine of 1959 to 1961. Incentives to produce lead to more production, and the absence of such incentives kills production—and people. 

The CEA report even contains a small section analyzing the ways that Hugo Chavez wreaked havoc on Venezuela’s economy. Although Venezuela’s government had nationalized the oil industry in 1976, the state-owned petroleum company, PDVSA, was run fairly well. (This is not reported in the CEA report but is, nevertheless, useful in understanding what happened next.) But in the late 1990s, Chavez skimmed PDVSA’s revenue to fund government transfers and skimped on reinvesting in the industry. The authors have a graph showing Venezuela’s oil production falling by about half over the last 20 years, while Canada’s production of similar oil has almost doubled over the same time. Also, in 2017, Venezuela’s government owned 526 government enterprises, up from 74 in 2001, and it imposes price controls on basic goods like flour and aspirin. Of course, price controls have done what price controls do, namely reduce and even destroy the incentive to produce the goods whose prices are controlled. In recent years, the CEA notes, about 2 million people have emigrated from Venezuela. Relative to population, that would be like 20 million people leaving the United States.

What about the so-called success stories in the Nordic countries: Denmark, Finland, Iceland, Norway, and Sweden? The CEA notes that although they have single-payer, universal-coverage health insurance and government spending is about half of GDP versus 38 percent in the United States, none of those countries’ governments imposes a single-payer scheme on the entire nation. Moreover, none has policies that are advocated by today’s Americans who identify as socialists: high corporate taxes, heavy regulation of business, a government monopoly of K-12 schools and colleges, or health care that is “free,” that is, zero-price to the patient.

The CEA notes two major facts about Nordic tax policy that would probably come as a surprise to American socialists. First, because of the disincentives for production caused by high marginal tax rates on corporations and individuals in the 1970s and 1980s, the Nordic countries reduced their tax rates—on corporations and individuals—by between 20 and 30 percentage points.

Second, unlike in the United States, the highest marginal tax rates on individuals kick in at relatively modest income levels. The top U.S. federal income tax applies to income that is eight times the average wage. The top tax rate in Nordic countries, by contrast, applies to income that is only 1.5 times the average wage. That, along with heavy value-added taxes, means that the higher tax bite in Nordic countries is due to a broader base rather than high taxes on “the rich.”

In short, the Nordic tax systems are less “progressive” than ours. U.S. socialist Bernie Sanders claims that he wants the United States to emulate Scandinavia. That would mean driving U.S. tax rates on the middle class well above the levels we have now. I wouldn’t be surprised if Sanders has done so little investigation that he doesn’t know even that basic fact.

Still, as noted above, the Nordic countries are more heavily taxed than we are. But they are just as well off, right? Not quite. The CEA writes, “The average real GDP per capita in the U.S. is about 20 percent above the averages in Denmark, Finland, Iceland, and Sweden.” What about Norway? If you strip out the Norwegian government’s large revenue from oil, we are well above Norway also.

The authors also point to a problem with comparing Nordic GDP per capita to ours: the treatment of child care. A much larger percent of child care in the United States is done in the home, typically by parents, and is, therefore, not counted in GDP. By contrast, here’s how the late economist Sherwin Rosen characterized Swedish child care: “[A] large fraction of women work in the public sector to take care of the children of other women who work in the public sector.” Rosen asked, “[H]ow much additional real output comes of it?”

One of the strongest, and most relevant, sections of the report is its analysis of Medicare for All (M4A). They don’t take on a straw man; M4A plans have 141 members of Congress as sponsors. Two such bills currently before Congress would make it illegal for a private business to sell health insurance and for a private employer to offer health insurance to his employees. They also would make it illegal, a la Canada, to charge patients even a penny for covered medical services. With a zero price, estimates the CEA, increased health care usage would increase federal spending on health care by $440 billion in 2022. Then, with government spending making up for the $1,470 billion that would have been spent on private health insurance and the $460 billion that would have been privately paid for out-of-pocket expenses, they estimate that total health care spending by the feds in 2022 would be $2,370 billion higher. That’s a whopping 9.7 percent of GDP. In the absence of other spending cuts, that increase would cause federal government spending to increase by almost half. They estimate that to fund that spending, tax rates would have to increase by 14 percentage points at all income levels. These tax rates would make the economy smaller than otherwise because of the added disincentive to be productive. The net result: households would spend 19 percent less on non-health items.

And what would we get in return for these much higher taxes? Worse health care. They document how the U.S. system, with a larger private health-care sector than in most countries, has been a driver of innovation. With total government control of health-care spending, innovation would decrease. Also, with no deductibles and copayments, people would go to the doctor for minor ailments. The government would likely respond by rationing, “reallocating healthcare from high-value uses to low-value ones.”

Although the CEA does a great job of analyzing socialized medicine, it would have done an even better job if it had brought the same skepticism to our two major socialized health-care schemes: Medicare and Medicaid. Also, you don’t need to be a fan of government medical care to realize how badly the current U.S. system is distorted by the tax code and heavy regulation on both the demand and supply sides, something on which the CEA report is completely silent. My guess is that they didn’t want, for obvious political reasons, to tread in that dangerous territory.

The report’s authors seem to have a tin ear in their understanding of Friedrich Hayek’s classic 1945 article, “The Use of Knowledge in Society.” They see his point being about the unintended consequences that follow from delivering goods or services at below-market prices. Although Hayek would have agreed with that point, that is not what his article is about. Hayek’s contribution was more fundamental point: central planners sorely lack the information needed to plan an economy well because such information resides in the brains of the millions of participants in the economy.

All in all, though, the report is an excellent overview of the destructive effects of various degrees of socialist policy. It’s a keeper.

David R. Henderson is a research fellow with the Hoover Institution. He is also a professor of economics at the Naval Postgraduate School in Monterey, California.