Price and Free Market
A comparison between Soviet Union and Britain in the 1980s
It’s quite obvious that the British did not have as many resources as the Soviet Union; in fact, the British have not produced enough food to feed themselves in more than a century — yet the British had better living standards than people in the Soviet Union. How did this happen?
This question was shared by many others, including Mikhail Gorbachev, the last president of the Soviet Union. It was said that Gorbachev once asked the British Prime Minister Margaret Thatcher: “How do you see to it that people get food?” The real answer was, she didn’t — price did that.
Price’s primary role is guiding consumers and producers to effective decision making, and efficient allocation of resources and products. Price is the exact reflection of supply and demand. It tells producers when to increase and when to stop producing to avoid further losses based on what a consumer wants. Although the producers are only looking out for themselves, from the standpoint of the economy as a whole, the society is using its resources more efficiently because decisions are guided by price.
Price links together all individuals in a market economy: It plays a crucial role in determining how much resources get used and how the resulting products get transferred to millions of people. Without price coordinating everything in the market, including itself, the economy is seldom efficient.
Here’s why free market price is important: it’s the most efficient allocation of resources. In the era of government-directed economy of the Soviet Union, price was not allowed to perform that function, as prices were not set by supply and demand, but by central planners as they see fit. So what happens when the government raise the price too high? Here’s a description by two Soviet economists: Shmelev and Popov, of a situation where the government raised the purchase price of moleskin, which leads more hunters to get and sell them:
“State purchases increased, and now all the distribution centres are filled with these belts. Industry is unable to use them all, and they often rot in warehouses before they can be processed. The Ministry of Light Industry has already requested Goskomtsen twice to lower purchasing prices, but the ‘question has not been decided yet. And this is not surprising. Its members are too busy to decide. They have no time: beside setting prices on these pelts, they have to keep track of another 24 million items.”
The situation described above was also common to many other, if not all, goods in the Soviet Union during that time. This creates a huge problem where unsold goods are piling up and rotting in warehouses, while there are painful shortages of other goods that could have been produced with the same amount of energy and resources wasted on those overproduced and unsold goods
While the government telling people what to do might seem to be a more orderly way of controlling things, it’s way too overwhelming for a government to keep track of 24 million prices. It’s not that the Soviet central planners made particular mistakes that caused the problem. The most fundamental issue is that coordinating every price efficiently is just too much task for human beings. As the two Soviet economists — Shmelev and Popov wrote:
“No matter how much we wish to organize everything rationally, without waste, no matter how passionately we wish to lay the bricks of the economics structure tightly, with no chinks in the mortar, it is not yet within our power.”
Money talks, and people listen. Public reaction to any price change is always much faster than any central planning. It’s not that the Soviet central planners made particular mistakes. Human beings are going to make mistakes in any kind of economic system. The real question is, what kind of incentives are there to push them to correct their mistakes? With a market economy where price automatically shifts resources in accordance with the supply and demand in the market, the British producers, unlike the Soviet government, cannot have surplus or afford losses. The British produce and consume in perfect accordance to their market demand and supply, therefore were using their resources effectively, while the Soviet Union was wasting their resources due to its inefficiency and poor allocation of resources. Therefore, although the British had much less resources than the Soviet Union, it’s not surprising that they still had a better standard of living.
