Why Is the Quality of Goods under Central Planning So Bad?

Why is the average quality of consumer goods so bad under central planning? For a peak behind the (literal) curtain, see this fascinating video:

“Because socialism” is no answer to the quality of goods under socialism. That’s not an analysis. What mechanisms under socialism lead systematically to this thoroughly documented outcome?

To grasp the full significance of the problem, recognize that production will be inefficient absent profit and loss signals. Planners will produce output with inputs that have more valuable alternative uses. Can we say anything systematic about the resulting inefficiency?

Yes—in the 1990’s, scholars asked why prices under central planning tended to yield shortages almost exclusively. It’s not obvious why. If prices are chosen randomly by planners, then some ought to yield shortages, and others ought to yield surpluses—but surpluses of consumer goods were far rarer than shortages.

Why? Soviet bureaucrats weren’t residual claimants—they couldn’t keep profits, and they didn’t bear losses. Consequently, they sought profits by pricing goods below their market-clearing levels and then collecting bribes from consumers who were faced with shortage conditions.

That explains “non-random prices,” but what about quality? Why is there a tendency toward lower quality instead of quality, which is sometimes “too low” and sometimes “too high”?

First, it’s obviously true that quality can either be “too high” or “too low.” If every single car produced in an economy were a Ferrari, the average quality of cars would be higher—but most consumers would be unable to afford a car. An economy could always produce higher-quality goods by simply producing fewer goods overall. Similarly, if every car were a deathtrap, consumer preferences would likewise be frustrated. Profit and loss signals help producers locate that golden mean of quality (or safety).

As for the empirical evidence about quality in centrally-planned systems, Yoram Barzel quotes Janos Kornai—an authoritative scholar on centrally-planned economies (i.e., “shortage economies”)—regarding typical product quality in such contexts. Kornai writes, “...the command economy is only capable of issuing output instructions in terms of aggregate indicators; the fine distinctions of quality cannot be centrally prescribed.” 

So, there’s a tendency toward low prices and low quality in centrally-planned economies.

It turns out that Barzel’s leveraging of Kornai comes from an (apparently) unpublished manuscript that offers a novel theory—and one distinct from Kornai’s—of low quality under central planning. Unsurprisingly, Barzel roots his logic firmly in the logic of property rights reasoning.

Barzel:

In market economies, private producers’ reputation backs their high quality commodities or commodity attributes. I argue that given the suppression of profits in planned economies, planners undersupplied quality because they were unable to create the appropriate incentives needed to deploy reputation for guaranteeing it.

Buyers use objective criteria to evaluate some of the commodity attributes they purchase, and subjective criteria to evaluate others. In market economies, state-enforced contracts are usually used to guarantee attributes evaluated by objective criteria. When an attribute falls short of the contractual specifications, buyers can demonstrate that fact. In case of dispute, the courts can assess the loss and award the buyers the appropriate compensation for overpaying for the product. Buyers that evaluate attributes subjectively know how they feel about them, but they cannot objectively document such sensations. Therefore, such attributes cannot be contractually stipulated and guaranteed effectively. Market sellers, however, can use their reputation to guarantee the subjectively evaluated attributes. My basic argument is that under government production, which includes state-planned production, commodities and services will consist almost entirely of the contractually guaranteed attributes. These commodities will not be provided with much reputational attributes, which accounts for the low quality of commodities produced by governments.

Notice how these insights hinge on goods being thought of as bundles of attributes. Some of those attributes can be “guaranteed” contractually; others are “guaranteed” relationally. However, relational guarantees depend on their being a residual claimant of those attributes. Thus, when those attributes are the ones we associate with “quality,” they get under-supplied in a system (socialism) where there are no residual claimants to the provision of those attributes. 

This article was adapted from “Why is the Quality of Goods under Central Planning So Bad?” originally appearing on Marginalia. You can read it here.