Why Socialism Fails – Part 1

Ken Olson, co-founder of Digital Equipment Corp, said in 1977, “There is no reason anyone would want a computer in their home.” Even very smart people sometimes make statements which, in retrospect, are proven to be ridiculously mistaken. Technology is hard to predict, partly because innovation which drives its evolution is by definition unpredictable. Those foolhardy enough to make predictions about technology get generally ridiculed years later when everyone knows what no one knew before. Hindsight is awesomely accurate while foresight often misses the barn, leave alone the target painted on it.

That leads us to two fun facts. Fun Fact #1: humans are limited beings. Our rationality is bounded and so is our knowledge. Not being omniscient and infinitely rational, at best we can only guess at what is to come in a world which is immensely complicated, big, messy and dynamic.

Fun Fact #2: we are always making predictions, whether or not we speak them out loud and are quoted in the press. Every decision we make involves making predictions and our expectations about the future dictate our choices. The outcome of what we end up choosing reveals whether the predictions were good or not. The laughter of the gods — and even mere mortals — rings loudly when the seemingly wise and powerful make predictions.

The quality of our predictions and our choices, great and small, determine how successful we are. The errors we make in our small predictions are hardly noticeable although their effects may accumulate over time and eventually get us into trouble. The errors of large predictions we are sometimes forced to make — our choice of career, spouse, house — can ruin us. Just because it is human to err does not impose an obligation on the universe to be forgiving.

Make bad predictions and you are literally out of business. Digital Equipment Corp (DEC) used to be a successful computer company. Most readers of this piece have probably never heard of it. Never mind the details of how it disappeared, one thing you can say for sure is that its management made wrong judgement calls. They, people like Ken Olson quoted above, misjudged what the market needed and what was to come.

From being “a major American company in the computer industry and a leading vendor of computer systems, software and peripherals from the 1960s to the 1990s”, it vanished without a trace. It was acquired by Compaq in 1998, which in turn was engulfed and devoured by Hewlett-Packard in 2002. (How long HP will survive is another prediction that you make at your own peril.)

Make somewhat consistently large and correct predictions, and you can become fabulously wealthy. That’s the Warren Buffet way. But the probability of success is negligibly small and not many travelers are found on that road to riches. Just do the arithmetic. Make 10 successive large predictions with probability of success 0.1, and the overall success rate drops down to one in 10 billion.

Conversely, the probability of failure adds up (in a manner of speaking since we actually have to do multiplication for conditional probabilities) the more predictions one makes about events that are not independent, until failure become virtually certain. The major lesson then is to avoid having to make too many large predictions. The trick is to keep in mind the first fun fact — that both our knowledge and rationality is bounded.

The universe is always poised at the edge of forever, with the great god Shiva as the Nataraja dancing the Tandava, the dance of creation and destruction. In the more limited world of economics and commerce, coming at the realization from a different domain Schumpeter also pointed to it. Corporations come into existence and they go out of existence in a dance of creative destruction. The success of new corporations depends on the failure of old corporations.

The universe persists and evolves because its component subsystems are impermanent and expendable. Any attempt at preventing change is misguided and costly because of its ultimate futility. The flexibility of a system is a function of how quickly it can adjust to changing environments by changing its components.

Our inability to foresee the future and make correct predictions are the result of our bounded rationality and knowledge. Whether we live in a deterministic universe or not, we just don’t know enough, and even if we did have all the relevant information at hand, our bounded rationality would not allow us to process that information to make long-term predictions.

So what are we to do? We have to work with what we know. We, each one of us, have local knowledge. That knowledge is temporally and spatially local. You know what happened in your immediate past and in your neighborhood. The further away an event is from you in time and space, the less your know about it and with less certainty.

No one of us knows it all but the total information needed is spread out among all the participants. The dispersed information gets aggregated and each participant in the system takes the relevant bit, combines it with the local knowledge and makes its own predictions.

The socialist system depends on what is called the “social planner.” The social planner supposedly has all the information needed to make correct long-term predictions about the future and make the choices for the entire system. This places information requirements and rationality requirements that are impossible for humans. The probability that they will make the right predictions and choices is zero.

The wealth and poverty of nations depends on its people understanding this universal truth. This is the core of the argument which supports why socialism fails and why the market-liberal order succeeds. Socialism strives to maintain the status quo, and that goes against the very nature of the universe. It resists change, it fights evolution, it fears novelty and innovation. For innovation always leads to change and change leads to diversity. Diversity leads to inequality. That’s the law and it has operated right from the beginning of the universe. What started off as an homogeneous collection of fundamental particles has evolved into a diversity of objects and entities. Diversity and novelty are coincident with growth and development.

The market-liberal system does not impose unrealistic demands on the participants. It says, “Do what you think is in your best interest. Your incentive is that if you make the right choices, you will be rewarded. Otherwise, you lose. But don’t worry. You have only to make very small decisions. You will be able to continually make course corrections as you go along. You will learn from your mistakes and figure out how to get things done better. You are the master of your own destiny and no one will tell you what you have to do. No one will command you to follow his dictates. You are a free person.”

The market-liberal system works because it recognizes basic nature of the universe and works with it, not against it.

Socialism fails everywhere to deliver the goods. India’s story is just a special instance of a general story. But socialism has an appeal to a large number of people. Let me stress that: not all people, only a large number of people. Who are these and what is its special appeal is the subject of a later post.

It’s all karma, neh?

Author: Atanu Dey

Economist. View all posts by Atanu Dey