What Should Direct Our Economy: The Invisible Hand or the Iron Fist?

You probably heard: a recent poll found that nearly half of American millennials would rather live under socialism than capitalism. To anyone old enough to remember the horrors of central planning, this should come as a shock. The fact that an economic system responsible for more than one hundred million deaths is increasingly popular suggests that something has gone horribly wrong.

One problem is education. The same study found that most men and women your age simply do not know what socialism is. Socialism, properly understood, is not some romantic conception of “equality.” It is the state ownership of property, the government management of the economy.

However, this resurgent popularity of socialism is not merely a misunderstanding. Many are honestly skeptical of the ability of markets to solve societal problems. Trusting the “invisible hand” of the market to alleviate economic need is just not realistic to some. Instead, they see a problem and an obvious, immediate solution—government action.

But can the government really manage the economy? The historical record loudly answers “No!” Central planning has resulted in failure everywhere it has been tried. This is because the government lacks both the knowledge and the incentive to manage an economy efficiently.

Markets are dynamic in satisfying what consumers’ want because they function as vast information networks. Trusting the invisible hand to direct resources efficiently is not placing blind faith in the power of markets but instead a realistic appreciation of the limits of experts.

Modern economies are astonishingly complex. Millions of people each make thousands of decisions about the goods they purchase, the jobs they work, and the investments they make. These decisions are guided by prices, profits, and loss. Prices help guide people and businesses toward the best use of their efforts and resources. Businesses that satisfy consumers are rewarded with profits. But if businesses don’t satisfy customers, they suffer losses and will be forced to close.

Government programs function nothing like this. Failing programs don’t go bankrupt. In a centrally planned economy, there is no such feedback on what works and what doesn’t. Bureaucrats, not individual businesses and consumers, decide what is produced and how. The Soviet Union, for example, produced the greatest quantity of shoes in the world, but of the worst quality and style. As Scott Shane explains in Dismantling Utopia:

The problem with shoes, it turned out, was not an absolute shortage. It was a far more subtle malfunction. The comfort, the fit, the design, and the size mix of Soviet shoes were so out of sync with what people needed and wanted that they were willing to stand in line for hours to buy the occasional pair, usually imported, that they liked.

Government planning fails because there is no efficient guide to direct resources toward what consumers want. This is as true for healthcare as it is for shoes. Without prices, it is impossible to coordinate economic activity.

It is true that markets fail in some cases. But governments rarely fare any better, and often make things worse. For example, a 2006 Brookings Institution study found that regulations that were supposed to correct market failures have “cost the U.S. economy hundreds of billions of dollars a year.”

Policymakers’ good intentions don’t necessarily lead to good outcomes. A recent study on Seattle’s minimum-wage law highlights this old truth. Supporters of the city’s new $15 minimum wage believed that workers would get a pay raise. What they failed to see, however, was that employers who could not afford the pay increase had to cut their workers’ hours by nearly 10 percent to make ends meet. Overall, the average low-wage worker in the city lost $125 per month, while thousands more lost their jobs altogether.

When governments intervene, the cure is often worse than the disease. Not only are problems  exacerbated in the short term; market solutions are preempted from developing in the long run. The provision of government flood insurance is one such example. As Chris Edwards of the Cato Institute has written:

The federal government began providing flood insurance in 1968 because it thought that private companies would not provide it. Over the years, the federal program has built up a large debt and created distortions. Meanwhile, insurance companies have made advances over the decades … such that private flood insurance would probably work today. But the existence of the subsidized federal program has blocked it from developing.

Left free to experiment, entrepreneurs and businesses are guided by prices, profits, and loss to satisfy consumers—and to solve societal problems in the process. The more successfully enterprises serve consumers, the more they are rewarded. If they provide no benefits, they fall by the wayside and resources are reallocated to enterprises that do create value. Socialism, the government control of industry, fails because it lacks the incentives to make these adjustments.

After the misery and poverty that central planning has wrought over the past century, it is important to recognize the severe limits of what government intervention can achieve. Whenever governments try to control natural interactions among people, there are often unintended negative consequences. At best, it results in corruption and inefficiency. At worst, there is widespread death and destruction. It is well past time to give up on the idea that the government can manage our lives.

Socialist economic planning is no match for the free market. 

Originally published by the Intercollegiate Studies Institute.