Sirc, Problems of Economic Resposibility
Source: Essay in Toward Liberty: Essays in Honor of Ludwig von Mises on the Occasion of his 90th Birthday, September 29, 1971, vol. 1, ed. F.A. Hayek, Henry Hazlitt, Leonrad R. Read, Gustavo Velasco, and F.A. Harper (Menlo Park: Institute for Humane Studies, 1971).
Problems of Economic Responsibility and Initiative Re-emerging in Eastern Europe by Ljubo Sirc
The problem of economic responsibility in large corporations is being intensely discussed in the Western market economies, but there the direct consequences of mistaken decisions fall, in the final instance, on the owners of shares. The question is, therefore, posed, but it goes less deeply than in East European economies where it remains unresolved in principle.
Here the impact of economic responsibility on economic development has become obvious only with the gradual transition of some East European economies from centralised planning towards decentralised markets although in a planned framework. As long ago as 1959, a Yugoslav economist, the late professor of the University of Zagreb, Mijo Mirkovic, underlined the pivotal role of responsibility. In his work Introduction to the Economic Policy of the FPR of Yugoslavia1 , published in Croat, he wrote in conclusion: “A mistake by the capitalist is immediately passed on to him. Therefore, he is very careful not to take decisions which are not in accordance with circumstances and possibilities. Under socialism that does not exist. Wrong decisions do not fall on those who are responsible for them. Most probably such a sense of responsibility will develop in the long run.” Certainly, Professor Mirkovic exaggerated the directness of consequences for the responsible in the limited company, but, seen from Eastern Europe, the consequences of economic responsibility appear rather clear-cut since the situation there has been so far entirely obscured. On the other hand, it should be stressed that, on the whole, responsibility is not a question of psychological development, but a result of institutional arrangements.
Responsibility under centralism
When all decisions are taken centrally, the responsibility can only lie with the central bodies who take them. A small number of persons is involved, so that personal economic responsibility is ruled out, since - almost by definition - individuals or the entire group do not possess sufficient personal belongings to compensate for the losses on the enormous sums involved. What remains is political or criminal responsibility. Those having taken the wrong decisions can be demoted or sent to prison.
But it is difficult to apportion either kind of responsibility between the Central Committee and government who lay down the general lines, the Planning Commission which works them out in detail, possibly the Parliament which adopts the plan, and finally the executive organs. What usually happened was that, in the case of major blunders, somebody low in the hierarchy was punished - one can safely say as a scapegoat.
These punishments were so erratic that their main result was to deter people from decision making altogether and encourage them to refer even the most trivial problems up the ladder of authority till they reached somebody with a sufficiently strong political backing not to be afraid of the prosecutor. People that high up were hardly ever called to account for economic mistakes, except as a pretext, but perished in internal struggles for power, if they perished at all. Although at the moment “responsibility” ranks high among the slogans in the first half of 1967, the Yugoslav paper Borba came out against political “responsibility” for communist leaders who mismanaged the project of a central gas distributing system for the whole of Slovenia at Velenje which was finally dropped with the loss of very large resources. Be that as it may, we have it on the authority of Viktor Novozhilov that, as the experience of centuries shows, fear is a less effective incentive for production than economic or moral interest.2
However, even if fear were less whimsical, it could be applied, under a centralised command economy, only to technical and hardly to economic mistakes. An economic decision about what to produce or how to produce it can be shown to be wrong when it does not pay, which can be measured only if prices are flexible and active, which they are not. Without doubt a centrally administered system can pursue aims different from those of a pure market system, but then the execution of the appropriate operations has to be centrally supervised under imposition of political or criminal responsibility, or the lower echelons must be guided by prices which are fixed by the government as planning indicators, which should make economic responsibility possible. It must be underlined that prices in this sense were hardly used in East European countries, as their planning authorities normally relied entirely on quantitative indicators. In principle, a government could partly guide even a market economy by fixing certain prices, without abolishing economic responsibility.
Furthermore, it is only the profitability of existing enterprises that can be compared with each other, whereas the potential profitability of enterprises which the authorities have not thought of, is as important. These enterprises would alter the profitability of existing enterprises, but they have been left out of plans because there is only one decision-making body or group of bodies with the result of lower efficiency throughout the economy. This loss can be remedied only if there are other centres of decision-making, in other words if there is competition.
True, there has always been local initiative, but it was severely circumscribed on the same hierarchical basis as at the centre, so that local decision-making bodies could also overlook important lines of production.
Responsibility under decentralisation
The shortcomings enumerated above were undoubtedly among reasons which prompted the change to decentralisation in some communist countries. Decentralisation means that at least a part of decision-making is shifted from the centre and from local authorities to the enterprise, i. e. production units.
It turned out that the only rational, although not perfect, criterion was profitability based on goods produced and sold, not on goods produced and added to unsaleable stockpiles. It also proved that incentives, paid to managers or workers, had to be based on profitability. Under centralism, there had been a system of material stimulation but based on various technical indicators, which led to the most incredible distortions of production.3
This kind of decentralisation certainly improves the situation, but still leaves us with some unresolved questions. Whoever is put in charge of an existing factory, be they managers or workers councils as in Yugoslavia, can be responsible for current production exclusively because they have obviously had nothing to do with the original decision to found the production unit. This being so, the fixed capital should not be handed down to the new management at historical book prices possibly multiplied by some factor to take account of inflation. It is patent injustice if the management has to pay interest on the full grossed-up cost value of capital instead of on the value derived from future proceeds, or better proceeds as expected at the moment of the take-over. If the current value, based on discounted proceeds, is lower than inflated initial cost of investment, this is the fault of the original investor, but not of present management. In Yugoslavia, this has already led to frustration and a feeling of injustice, while other communist countries will run into similar problems when the system gets underway.
More than that, the value of capital should be, if justice is to be preserved, adjusted to the circumstances every time a new team takes over the management, particularly as all countries foresee ploughing back which can be profitable or unprofitable; if the present value is higher than the initial value, this is the merit of the former management; if it is lower, it is its fault. It is not clear how this distinction can be taken into consideration in a system of social ownership.
It would seem that, according to the system now in force or planned to be introduced, both managers and workers are placed in an economically favourable or unfavourable position by appointments which have little to do with economics. They are placed in charge of an enterprise by a political body which can do it for political reasons or for nepotism, or elected by workers who were themselves employed for no strictly economic reasons. It is true that a capitalist owner can also hire and fire for non-economic reasons, at least if the trade-unions do not intervene, but if he does, the economic consequences of his irrational behaviour will be reflected in a fall of his capital value.
Under social ownership, there is no such close link between capital and person or persons who should bear the ultimate responsibility. For the planning authorities which have taken the decision on the establishment of a production unit and the corresponding investment, there is no economic responsibility. On the other hand, anybody, manager or worker, can take a decision or participate in making a decision today, and then escape any ill-effect for himself by leaving the enterprise in question the next day to find another job; in fact, there is high probability, particularly for managers, that they will be, as a matter of course, transferred to some other post in a few years at the latest. A case described in a Yugoslav publication4 is an illustration in point: one director offered to borrow at the interest rate of 17 per cent; when asked how he could hope to pay interest and repay the loan at this rate, he said that what mattered to him was to secure the credit; repayment was not his concern since he would no longer be in charge of the enterprise when it became due. Under social ownership, there is thus no ultimate responsibility except the community's.
Professor Ronald Meek wrote a letter to The Times,5 some years ago, wondering whether nationalised enterprises in Britain should be asked to maximise returns on capital invested rather than returns on some other factor, in particular on labour employed. Theoretically, an enterprise should not maximise returns on any factor - these returns should be considered costs - but profits tout court. In practice this turns out to be maximisation of returns on capital because equity capital receives the residual of the total enterprise revenue and the good or bad working of an enterprise is reflected in the rise or fall of its capital value. The incomes of employees will not be reduced and, if the worst comes to the worst, in a fully employed economy they are able to leave and find employment elsewhere.
Even if responsibility for current decisions could be separated from responsibility for the original decision on founding the enterprise, there would be considerable differences in degree to which various members of the enterprise could be held responsible for the economic results of current decisions. This is particularly important in the case of workers' management where the entire personnel is supposed to manage and be responsible for management, but it is important also in other more limited cases; witness The Resolution of the Central Committee of the Hungarian Socialist Workers Party concerning the Reform of the Economic Mechanism of May 1966 which states: “Supplements to wages from the profits made by the enterprise, or more precisely from its profit-sharing fund, should represent a larger part in the total income of persons whose efforts can have a greater influence on the profitability of the enterprise.”
The profits of an enterprise, in so far as linked to current decisions, largely depend on the correct assessment of the future development of demand. The right choice of technique which also helps to determine profits is a part of the original decision to invest at all, if not connected with ploughing back, i.e. the re-equipment or expansion of an existing factory. But assessment of future demand and the choice of technique can be intelligently considered only by management or even a part of management, while the rest of a factory's personnel has neither the expertise nor the information required to participate in this decision. To them profits or losses - which acquire more importance if connected with cuts in wages - seem to be the result of forces over which they have no control. Distributed profits are accepted as a gift from heaven, while losses are resented as an injustice. On the other hand, profits which can be distributed to all and everybody are as a rule far too small a part of their incomes to be a serious incentive to take an active part in the management of an enterprise.
While East European countries have at least begun to discuss problems of economic responsibility for current production decisions, there has not been, so far, much consideration of the question of economic initiative and responsibility for investment in new enterprises.
All reforming countries consider that existing enterprises should preserve a part of their profits for re-investment as a part of their responsibility. In Yugoslavia, the conclusion has even been reached that ploughing back is not always the best policy because profits as a confirmation of the validity of past decisions are not always the best guide to future directions of production. Therefore, Yugoslav enterprises are now allowed not only to deposit their surplus funds in banks but to invest them in other enterprises, although this presents considerable problems as it conflicts with the principle of self-management that an enterprise should not derive an income from another enterprise.
But even in Yugoslavia, the question of initiative of founding new enterprises has not been resolved. This initiative still remains in the hands of political bodies. The same is true of all other countries, which is paradoxical because one of the main reasons for decentralisation was the misallocation of resources in the past due to the fact that new investment was also then decided upon by political bodies whose decisions, it is claimed, were not economic but “political” or “subjective” under the impact of various pressure groups which were not concerned with economic results. Investment by political bodies can also be wrong because bodies are territorial and their decisions will, therefore, be limited to the area under their jurisdiction which can lead to wrong locations.
Most communist countries seem to be aware of this paradoxical situation because they are trying to shift initiative from political authorities to banks which are supposed to act exclusively on the basis of economic criteria, i.e. profitability. However, banks nowhere, least of all in capitalist countries, function as prime movers of new investment and certainly not as exclusive or predominant prime movers. The idea of founding a new enterprise usually comes from an individual or group of individuals, probably with some capital of their own, who then submit the project to a bank which backs them if it is satisfied that the project will be profitable. Banks can act as selectors but not as initiators on a large scale. If banks are charged with the overall responsibility for new investment, the behaviour of the bank apparatus in this respect will be probably indistinguishable from and no more efficient than the behaviour of political apparatus, in particular as in many cases the same people will be in charge of the banks who were previously in charge of political investment departments.
Of course, if a person or group of persons develops an idea, they can contact a political authority or a bank and submit their project to them, but will anybody listen to them if they do not have the necessary political connections? And will the individuals be interested in taking such an initiative and be possibly blamed in the event of failure, if it is no way certain that they personally will derive any advantage in the event of success?
To some extent, omissions by political bodies and banks regarding the foundation of new enterprises can be remedied by small enterprises run by individuals, which are now allowed in some communist countries. However, their activity is narrowly circumscribed, so that they cannot fill in more than a part of the gaps which are left - one can say by necessity - by the vast political or banking apparatus which cannot have a sufficient grasp of and cope with detailed needs and conditions.
The limited decentralisation in Eastern Europe has brought to the surface the problems connected with economic responsibility. In many respects, these problems are similar to those concerning the large Western corporations. But there are important differences:
- 1. Although in the case of big concerns the share-holders do not participate in the management, the consequences of their decision to buy their shares fall, in the last instance, on them - in Eastern Europe, there is not even such a limited responsibility.
- 2. In the West, there exists a multitude of smaller enterprises beside the big corporations and in these former the link between management and capital ownership is much closer, so that economic responsibility is far more direct - in Eastern Europe, there is no economic responsibility of any sort for investment decisions, except in the very small private workshops of marginal importance.
- 3. In the West, there is still the freedom of economic initiative, although it may have lost much of its importance in practice - in Eastern Europe, it does not exist in principle and is in practice limited to small private workshops.
- 4. In the West, hardly any enterprises have been established without any regard for economic criteria - in Eastern Europe, the so called “political” enterprises were almost the rule.
For these reasons, it is perhaps little useful to carry the comparison between the problems of enterprises in East and West very far.
Uvod u ekonomiku FNRJ, Zagreb 1959;
Quoted by Professor A. Nove in The Times of 27 June, 1967;
See Edward Lipinski, “Some Unsettled Problems of Planned Economy”, paper submitted to the CESES-seminar in Rapallo, 1967;
Ekonomska Politika FNRJ, proceedings of a seminar organised at the University of Belgrade, Belgrade 1957;
Published on 9th January, 1964.