Incentives of agency theory – Incentives in Planned Economies

We must distinguish between the Soviet practice and the theory of planning devel- oped in the Western countries. As explained by Berliner (1976),

In the early years of the Soviet period there was some hope that socialist society could count on the spirit of public service as a sufficient motiva- tion for economic activity. With the intense industrialization drive of the thirties, however, that hope was gradually abandoned. In a historic dec- laration in 1931, Stalin renounced the egalitarian wage ethic that had obliterated “any difference between skilled and unskilled work, between heavy and light work” (401).

Following his biting denunciation of “equality mongering,” there evolved a new policy in which personal “material incentives”—primarily money incomes— became the major instrument for motivating economic activity.

In the Soviet Union, a general set of managerial incentive structures devel- oped during the thirties and lasted for three decades. In this classical period, the managers’ incomes comprised a salary, a basic bonus, and the Enterprise Fund. This incentive structure had many defects (problems with new products, no proper incentives for cost minimization, ratchet effect, etc.). It was criticized and under constant evolution. With the passing of Stalin, the discussion became more intense and quite open with the 1962 Liberman paper in the Pravda and culminated in the 1965 Reform. Among Soviet specialists in the Western world, a literature studying in detail the new Soviet incentive structure developed.

In the famous socialist controversy of the thirties, incentives were largely over- looked. Lange (1936) perceived no problem with imposing rules to managers:

The decisions of the managers of production are no longer guided by the aim to maximize profit. Instead, there are certain rules imposed on them by the Central Planning Board which aim at satisfying consumers’ preferences in the best way possible.

One rule must impose on each production plant the choice of the combi- nation of factors of production and the scale of output which minimizes the average cost of production.

The second rule replaces the free entry of firms into an industry or their exodus from it. This leads to an equality of average cost and the price of the product.

—Lange (1936, p. 62)

Lerner (1934) pointed out the difficulty arising with a small number of firms having increasing returns to scale and reformulated the rules as: Every producer must produce whatever he is producing at the least total cost, and a producer shall produce any output or any increment of output that can be sold for an amount equal to or greater than the marginal cost of that output or increment of output.26 Even in 1967, Lange did not see any problem of incentives in the working of the socialist economy:

Were I to rewrite my essay today my task would be much simpler. My answer to Hayek and Robbins would be: so what’s the trouble? Let us put the simultaneous equations on an electronic computer and we shall obtain the solution in less than a second. The market process with its cumbersome tâtonnements appears old fashioned.27

—Lange (1967, p. 158)

It is therefore not surprising that the voluminous mathematical theory of iterative planning developed in the sixties did not pay any attention to incen-tives.  Such a concern appeared only marginally in Drèze and de la Vallée Poussin (1971), where truthful reporting of private characteristics was shown to be a maximin strategy in a planning procedure for public goods. In 1974 Weitz- man, who had participated in the development of the iterative planning literature, made a direct criticism of the implicit idea that planning with prices was good for incentives:

It seems to me that a careful examination of the mechanisms of succes- sive approximation planning shows that there is no principal informa- tional difference between iteratively finding an optimum by having the center name prices while the firm responds with quantities, or by having the center assign quantities while the firm reveals costs or marginal costs.

—Weitzman (1974, p. 478)

Considering an explicit planning problem with asymmetric information, Weitzman compared price mechanisms and quantity mechanisms. This will be the point of departure of the more general approach in terms of nonlinear prices by Spence (1977). From then on, planning procedures were more systematically studied from the point of view of incentives. However, by then, the lack of interest for iterative planning was fairly general.

Source: Laffont Jean-Jacques, Martimort David (2002), The Theory of Incentives: The Principal-Agent Model, Princeton University Press.

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