The Suntory and Toyota International Centres for Economics and Related Disciplines
On the Theory of the Centrally Administered Economy: An Analysis of the German
Experiment. Part I
Author(s): Walter Eucken and T. W. Hutchison
Source: Economica, New Series, Vol. 15, No. 58 (May, 1948), pp. 79-100
Published by: Wiley on behalf of The London School of Economics and Political Science and
The Suntory and Toyota International Centres for Economics and Related Disciplines
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I948]
On the Theory of the Centrally
Administered Economy: An Analysis
of the German Experiment:
PART I
By WALTER EUCKEN
(Translated by T. W. HUTCHISON)
INTRODUCTION
i. AFTER 1936 the German economy came more and more under
central direction and administration. This was not the result of a
conscious effort of policy to create a new form of economic organisation.
It was rather a result produced accidentally. It was the full-employment
policy which started the movement, and it was the implementation
of this policy which led step by step towards a centrally administered
economy (" Zentralverwaltungswirtschaft ").
In I932-3 the full-employment policy began with public works,
expansion of credit, a cheap money policy, and a pegging of the exchange
rate. As this policy threatened to bring a sharp rise in prices, a general
price-freeze was ordered in 1936. Germany-like many other countries
since then-entered upon a period of " repressed inflation ". Prices
ceased to give expression to the scarcity of goods and services on the
markets. This state of affairs gave rise to the creation of a central
administrative apparatus to direct the economy, to supervise foreign
trade, to allocate the most important raw materials such as coal, iron
and cement, to weigh up priorities, distribute licences and so on. This
was the beginning. With the growing danger of war, and with its actual
outbreak, the measures of central administration and direction played
an increasingly important role in the economy. It was necessary
to concentrate productive resources on armaments and to force up the
rate of investment. There was the growing pressure of an expanded
but immobilised supply of money. So more and more branches of
production, and even the distribution of labour supplies and consumers'
goods, came under the orders of the central planning authorities.
It was not that the whole everyday economic life of the country was
controlled by the central administration through the direction of
labour, production orders, compulsory deliveries, rationing and so on.
On the contrary, important markets remained free for a long time.
Only in recent years did barter develop on a large scale, when the
German people not only got their rations of bread, potatoes, or meat,
from the central authorities, but tried to obtain food and other consumers'
goods by barter, or grew vegetables and potatoes for
79
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8o ECONOMICA [MAY
themselves. Then different forms of economic organisation were combined
together. But since I938 it was one of these forms which
dominated, that of the centrally administered economy.
The following pages are concerned almost exclusively with this
element in the German economic system (" Wirtschaftsordnung "), and
not with the very important problems of money and barter which
arose in the course of this interesting episode. An economic order
in reality is always made up of a combination of different pure
forms. We are only concerned here with one of these. A centrally
administered economy is not to be confused with one where all
property is collectively owned. Certainly, central administration
and direction of an economy can be combined with collective ownership
of property, as, for example, in Russia since I928. But this combination
is not necessary. The interesting point is that in Germany
the means of production remained predominantly in private ownership,
and farms and factories alike continued to belong mainly to private
individuals and companies. But the private owners could only dispose
over their means of production to a limited extent. There was widespread
requisitioning of industrial stocks, which were only released
for definite purposes consistent with the central plan. We can say,
in fact, that for the economic process as a whole, it was not the plans
and actions of individual businesses and households that were decisive,
but the plans and orders of the central authorities.
2. What questions do we want to put about the German experiment?
In our case, a question which has been much discussed, and which has
shown itself to be a fruitful one: are the same economic " laws "
valid in the centrally administered economy as in the exchange
economy ?
Economists have given two fundamentally different answers to this
question. J. S. Mill spoke of " the very different laws " which held for
the competitive as compared with the collectivist economy. Similarly
also Dietzel.' In contrast with these " dualists ", the " monists
hold that the economic processes of an exchange and of a collectivist
economy-two concepts usually not at all precisely defined-are
essentially similar. This was the view of Wieser, Pareto, and especially
Barone. The point of view of these writers has been widely accepted,
and on the whole the monists predominate.
Who is right ? Is the fundamental logic of economic action really
the same in the commercial as in the socialist society, as Schumpeter
has recently held ?2 Or, are these two quite different worlds ? This
is much more than a purely academic question. In the economic life
of this century both methods of direction are being applied, that of the
exchange economy and that of the centrally administered economy.
1 J. S. Mill: Logic, Book 6, Chapter IO, para. 3. H. Dietzel: Theoretiscbe Sozial5konomik,
I895, p. 85 ff.
2 Barone, in Giornale degli Economisti, o908; Pareto, Manuel, p. 362 ff.; and Schumpeter,
Capitalismn, Socialism and Democracy, 1942, Chapter i6.
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1948] THEORY OF THE CENTRALLY ADMINISTERED ECONOMY 8I
The history of our time offers for our analysis, as to our forefathers it di
not, many experiments in the central administration of economic life.
We are dealing with this one experiment. Can we understand the economic
phenomena of the twentieth century if we approach them with
a single unified theoretical apparatus created for the analysis of the
exchange economy ? Or is it necessary to work out a special theory
of the centrally administered economy to do justice to economic reality ?
Wieser and Barone had no knowledge of such definite examples as
we have. Of course, historical cases of a predominantly centrally
administered economic order are numerous, for example those
of Egypt or of the Incas. But economic processes in our modern
industrial age are so much more complex and comprehensive, and the
tasks of direction so much more difficult, that these older examples
are of secondary interest. Economists today have material before
them quite unknown to their predecessors.
Our analysis of the German experiment was undertaken just at the
moment when this experiment was coming to its close. The direction
of the economy by central administration broke down in I946-47.
Procedures and forms pertaining to monetary and barter economies,
and to an economy of self-sufficient household units, began to spread.
But this investigation is not a historical one; nor is it an obituary notice.
Our aim rather is to get a grasp of the general principles which German
experiences can teach. It is agreed that the direction of economic
life by a central administration came about in Germany mainly for
purposes of war. Frequently improvisations had to suffice, instead
of the long-term planning possible in peace. What is simply a
peculiarity of war conditions must not be attributed to the centrally
administered economy.
THE ECONOMIC PROCESS AS A WHOLE
I
HoW A CENTRAL ADMINISTRATION WORKS
The study of the organisation of an exchange economy begins with
the procedures of individual firms or households, let us say, in a
leather factory. It is ascertained that the firm bases its plans on price
and cost calculations, that is, on the relation of the prices of the products
to the prices of the factors of production. This is what is decisive
in guiding production. In this way each firm controls, in its own
sphere, a fraction of the economic process, and the process as a whole
is controlled by means of prices.
The study of a firm in a centrally administered economic orderfor
example during the German experiment-leads to quite another
conclusion. Our leather factory produces on the orders of the Leather
Control Office. This " Control Office ", "Department " or " Planning
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8z ECONOMICA [MAY
Branch" (" Fachabteilung " or " Planstelle ") allocates raw hides and
auxiliary materials. It gives the firm its instructions to produce, and
disposes of the leather it produces. For knowledge as to how the
plans are formed by which the economy is guided in a centrally
administered system, we must go to these control offices. There were
"Controls " for textiles, clothing, glass, pottery, iron and so on.
How did this central direction work out ?
In four stages:
First, there was the collection of statistical material for which the
Controller would have at his disposal a Statistical Section. This
primary importance of statistics is a characteristic of the centrally
administered economy. The statisticians tried to assemble for the
planning authorities all the important data necessary: thus, for
example, equipment, storage capacity, the need for storage space, the
needs for coal and electricity, the production and import of raw materials,
the production and uses of, for example, leather, textiles or other
raw materials and other products. From this statistical material
a quantitative balance-sheet was obtained which put the supplies
against the consumption for the preceding year, half year, or quarter.
The statistics had to follow precise orders with regard both to
their collection and treatment. They formed the foundation for
the planning itself which was the second stage of the process. This
consisted of drawing up programmes for requirements and supplies,
and for the means by which the two were to be balanced.
It is an essential point that the figures planned for requirements
had their source only partially in the demands of the higher authorities,
who would be requiring for purposes of armaments, or investment
in general, particular quantities of iron, machinery, leather, etc.
Another part originated with other users (" Bedarfstrager "), that is,
mostly other control offices. Thus for example, leather would be ordered
by the Shoe Control, or the Machinery Control, while the Leather
Control ordered tanning materials, oils, fats, coal and so forth from
the control offices responsible. Requirements always came in to the
particular planning branch or control office collectively, or in aggregates
(" gebiindelt "). It is important that at this very early stage in drawing
up the plan, standardisation of goods became a necessity. Determining
the leather requirements, for example, of the Shoe Control was all the
more difficult the greater the variety of types of shoe in production.
Central planning requires standardisation.
After the centrally administered economy had been working some
time, the planning offices often used the figures for earlier planning
periods, which could be ascertained with precision. The figures were
intended for thefuture planned quantities, but were taken over without
further scrutiny from previous plans. There was a danger here that the
necessary consistency with the facts of the present position might
be lacking. For this reason the central authorities higher up, for
example in the Ministry of Economics, often had occasion to warn
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1948] THEORY OF THE CENTRALLY ADMINISTERED ECONOMY 83
against the exuberance of the statisticianis. For example, it was on
one occasion explained that: " However much planning may require
a statistical basis, it must never be forgotten that statistics can only
relate to the past. The outward form which planning assumes, that is,
balances of figures, is not the essence of planning, which is rather an
active shaping of the future." Incidentally, the calculating of needs
per head of the population was held of small significance, as it took no
account of local and occupational differences.
With regard to supplies, the principal item apart from imports and
drawing on stocks, was, of course, production. Here the principle
was laid down that production had to be es'timated on the basis of the
narrowest bottleneck. For instance, equipment and raw materials
might be ample, but if it was coal or labour that was in short supply,
it was in accordance with these that plans had to be drawn up. As
bottlenecks were constantly shifting, the basis of the plan had constantly
to be altered. The real art of this sort of central planning lay in
recognising promptly where the bottleneck was to be expected next.
Over the balancing of requirements against supplies, long battles
were necessary, and we shall be dealing with these repeatedly later on.
The many single control offices fought for allocations of more coal, or
transport, or labour. On the other side, the requirements of each " consuming
" party, every one trying to get hold of as much leather, textiles
or petrol as possible, had to be cut down. The attempt would be made
first at the level of the individual Control Office, by lengthy negotiations,
to get the different " consumers " to moderate their demands. But
the higher authorities took a hand from the start. They did so, in the
first place, by fixing grades of priority, and secondly, by giving the
decision in cases of conflict.
As an instance for the fixing of priority rankings, the petrol arrangements
may be taken. First, in November, i94p, it was ordered that
petrol was to be used only for war purposes in the strict sense.
Allocations were to be made on the basis of the following priorities:
i. For providing the population with food and fuel.
2. For clearing railway stations and docks.
3. For maintaining agricultural production.
4. For sanitary organisation and the police.
5. For firms on important war work and for the building plans of
the Plenipotentiary Authority for Special Problems of
Chemical Production.
6. For providing for the armaments and other production decisive
to the war effort.
7. For providing for the building plans of other industries decisive
for the war effort.
For the valuing and directing of the stream of goods the grading of
needs in this way was essential, and the individual control offices had
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84 ECONOMICA [MAY
to proceed accordingly. If no agreement was arrived at, let us say,
as to how much coal the Leather Control should get, the Minister of
Economics himself had to decide.
The results of this procedure were set down in a Budget or
Balance Sheet ("Mengenbilanz"), for a quarter or half a year, or
for a whole year, according to the peculiarities of each process
of production. Here is an outline of one of these Budgets:
OUTLINE BUDGET.
Supplies. Consumption.
i. Home Production i. Home Consumption (arranged
2. Additions from Occupied according to uses)
Territories z. Needs of occupied territories
3. Imports: 3. Exports
I-3 Total of Current Supplies I-3 Current consumption
4. From stocks 4. Additions to stocks
I-4 Total supplies I-4 Total consumption
Under heading i on the right (home consumpti
out in detail how much, say, leather, had been fixed for the armed
forces, for agriculture, for machinery, for shoes, and so on.
That is what the plans of the centrally administered economy
looked like. They consisted of a long series of interlocking budgets
of one control authority after the other. The controls for coal, iron,
electricity, petrol, leather, textiles, and so on, set out their budgets which
together made up the plan as a whole. But the fitting together of the
detailed programmes was brought about through the general directions
(e.g., priority rankings), of the higher authorities, and through their
actual intervention in many particular cases. Thus, although the
control officers carried out and worked out the programmes, they
were dependent on, and subordinate to, the ministries and other
central offices. That was how the planning process was unified.
The third stage was the issuing of production orders to individual
firms. The production of the firms was fixed in terms of quantities
for particular periods of time, and with regard to varieties and qualities.
Requisitioned raw materials were released to the individual factories
for their production, and orders for the disposal of the resulting product
were issued. The very difficult task of working out production orders
for individual firms was often carried out through industrial organisations
like the " Reichsgruppe Industrie ", cartels, associations, etc.
Experts had to be used who were at the same time highly interested
parties, and, similarly, organisations which were private pressuregroups.
We shall be returning, also, to this subject.
Fourthly, and finally, there was the check-up on results. Firms
were obliged continuously, either quarterly, monthly, or even daily,
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I948] THEORY OF THE CENTRALLY ADMINISTERED ECONOMY 85
to report their stocks and production, and the control offices had continually
to be checking that the actual figures and the 'programmed'
figures agreed. Shortfalls might be traceable either to particular
firms, or to the non-arrival of allotted raw materials, or through labour
being drawn off by other control offices, and so forth.
In any case, the heads of the control offices had to intervene. So
the carrying out of the plans was accompanied by continual negotiations
and running battles. In the end another factor would intervene in this
checking up on the plans. The plans were naturally often being carried
through months, or even a year, after their original working out.
Meanwhile the data had altered, for instance, with regard to coal
supplies. It was then necessary to revise the plans and production
orders.
This was how the four interconnected stages proceeded and were
continually repeated. Other centrally administered economies
might proceed in a similar way or in a different way. What is the
economic significance of this procedure ?
II
THE DIRECTING MECHANISM
Let us consider for a moment a small, closed, self-sufficient, household
economy (" Eigenwirtschaft "), a community of thirty people, who
produce for themselves everything they consume, and are under the
authority of a single individual. The task of directing such an economy
would be as follows: the director day by day has to decide how thef actors
of production shall be combined, where each worker is to work, who on
the potato field, who in the forest, and what tools each shall have at his
disposal. At the same time he has to decide as to the use of the land,
buildings, livestock, and transport. He has to decide also the timestructure
of production, that is, as to investment and savings. This is only
possible if the director is clear the whole time as to the importance of
different requirements, and how much each unit of the factors of production
can contribute, in each different use, to satisfy the community's
needs. All these valuations are interdependent. If, for example, the
director decides to build a bridge, that is, to invest, then all values are
altered. Each unit of the means of production, an hour's work on the
potato field, or in the forest or the stables, gets a different relative
significance and a general shifting may prove necessary.
Economic calculations run in three directions. The planner
constantly examines how far the factors of production in their previous
use and occupation have actually met the needs of the community.
These cost calculations relating to the past are the basis of the plans
for thefuture. Plans for the future are tentatively built up from past
experience, the task being to meet existing scarcities, or those expected
in the near or distant future. Economic calculation therefore, is made
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86 ECONOMICA [MAY
up out of examination of the past and projection into the future, with
attention to the present. Each individual unit of consumers' goods
and means of production is allotted its niche in the economic cosmos
by the plans of the directing authority.
With division of labour, and an economy of many millions of people,
there is a corresponding task. But in this case the direction will not
be set by calculations by the individual. Rather, the task will be
to find the form of organisation for economic life best suited to a satisfactory
direction of the economic process from the point of view of the needs
of the community.
The particular solution to the problem of direction which the centrally
administered economy in Germany arrived at, had two essential characteristics.
(i), Planning and direction were based on round aggregate
valuations without individual values or calculations of marginal cost.
(z), As economic calculation had no compelling force behind it, this
method of direction was able to survive for a long time.
(i) (a) To take the first of these two points: the offices of the central
administration worked with aggregate valuations derived from the
calculations of the statisticians.
Who made these valuations ? In the first place they were proposed
by the sectional control offices. In our example, the Leather Control
proposed to distribute leather among different users (e.g., the armed
forces, footwear, industrial purposes), according to the users' own
valuations. After negotiations with the "consumers", alterations
would be made; that is, an attempt would be made to bring the
valuations of the Leather Control into equilibrium with those of the
" consuming " control offices. The dealings were always in mass
quantities. Values were not given to single units but were calculated
for total quantities, perhaps for five or eight thousand tons at a time.
These aggregate valuations, and thereby the direction by the control
office of the factors of production and of consumers' goods, were supported
by the fixing of priority gradings by the higher central authorities
which we have just referred to. But these priority grades were always
ineffective. They were too crude, and the individual grades were made
up of too many different kinds of needs. (For example, Grade three,
" petrol for maintaining agricultural production".) Secondly, these
gradings took insufficient account of the decreasing importance of
particular types of need as they came to be satisfied. Finally, they
took no account of the supply position with regard to complementary
goods. A decree of the Central Planning Office of December, I94z4,
deals with this very clearly: "The problems of directing production
by the crude process of priority grades become more and more difficult
as scarcities increase. Unimportant production must not merely be
slowed down, but stopped altogether. To fix an order of priority for important
production in accordance simply with the nature of the product
must lead to serious mistakes and misdirection, if the supply position
of the consumer is not taken into account. The provision of single
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i948] THEORY OF THE CENTRALLY ADMINISTERED ECONOMY 87
screws, which may be all that is needed to complete some agricultural
machinery, may be much more important than supplying the same
screws to a tank factory, which has a much higher priority, but which
will need the screws only some. months ahead. The various levels of
need, in conditions of general shortage, cannot be dealt with by priority
orders. Particularly with the present strain on all the means of production,
all offices responsible for directing production must maintain
a close scrutiny, to ensure that each item as it is produced is directed
to the right destination. I lay it down that the time has come to
enforce the principle : ' Planning instead of Priorities ' I decree that
with effect from January Ist, I945, all priority rankings lapse."
If particular sectional controls were unable to agree about aggregate
values, the decision had to be made higher up by central authorities.
This is clearly shown in a decree of I942: " Every effort is to be made
by the sectional controls, in agreement with the consuming organisation,
to fit requirements to productive possibilities. Only in exceptional
cases, when a decision of this kind is not possible, may it be referred
to the Ministry concerned. If the planning office and the consuming
organisation are not under the authority of the same Ministry, the
decision must be made by a common superior authority."
No values could be reckoned in individual detailed quantities.
Decisions had to be made daily about single tons of iron or copper, or
about individual workers. Where and for what purpose were these factors
to be used ? What value had they in each of the many various
possible uses ? Where and how were they to be used for the maximum
satisfaction of needs ? These questions could not be answered by such
round aggregate valuations. If there were IOOO cbm. of wood to be
disposed of, this would be distributed in round quantities for fuel,
mining, artificial silk and so on, without any full consideration
being possible with regard to particular qualities.
(b) Some sort of cost calculation did find a place in the set up.
But this cost accounting was also of a ' round' aggregate kind.
When the Petrol or Leather Control made allocations to the different
" consuming " parties or sectional controls they were continually
comparing the services and foregone services which petrol and
leather in general rendered in different uses. Also, in cases of
conflict, when the responsible Ministry was asked for a decision,
say, as to how much leather was to go for shoes and how much for
machinery, the decision was made on a general cost comparison. Costs
were made after general considerations as to the aims of the economic
system. It would be considered whether these general aims would
be better served by using leather for workers' shoes or for machinery.
The services rendered in one direction to the overall plan were weighed
against those foregone in another direction. Thus, however generally
and imprecisely, there was some consideration of cost questions.
Certainly any calculation of marginal costs was impossible: for
example, in one province in 1945 there were I,OOO tons of iron to
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88 ECONOMICA [MAY
distribute. Iron was needed by all sorts of branches of the economy,
by handworkers, engineering, textiles, railways, repair works and so on.
How many tons should each particular branch of industry and each
firm receive.? Should the textile industry get 8o tons ? Or more ?
Or less ? A choice had to be made. Here also cost considerations
were weighed up. The services iron could render in this use and that
were compared. But the value of single tons used in one way or
another could not be calculated. So values were reckoned in round
aggregates, and distribution followed according to general estimates
of this kind.
(c) As has been explained, a comparison of realised and planned
figures would be made in order to compare actual production with
that planned. But there was no real economic accounting. The
quantities set out in the plans were compared with the quantities
actually used or produced by the firms. But whether the factors of
production were used economically, whether, that is, the planned cost
figures were rightly worked out or in need of amendment, could not be
deduced by comparing the planned and the actually realised figures.
A tile works for example would be allotted far more coal than it needed,
and this would be corrected only many months later. If the figures
of actual production agreed with those planned, then there were no
grounds for any correction. This comparison of planned and actual
figures afforded no possibility of approaching an optimum combination
of factors by trial and error. And the control offices realised
this.
2 (a) The compelling force of economic calculation: The price system
in an exchange economy is not merely a measure of scarcity or a
calculating apparatus (the efficiency of which, incidentally, we are not
concerned to judge here). The price system, rather, is a controlling
mechanism of compelling force. If costs exceed returns, the discrepancy
forces the firm in the long run to make a change or to close down.
To put it in another way, if price relationships are such that the prices
of the factors of production necessary for producing a good are
higher than the price obtainable for this good, then there must be a
change.
But in the centrally administered economy, valuations-themselves
arrived at in a different way-play a different role. For example:
during the war a silk-weaving factory was built at C. (Hanover). Even
from rough ' aggregate' valuations it was clear that this location was
unsuitable, and that the Crefeld silk-weaving factories could produce
much more cheaply. The consumption of iron, cement, machinery
and labour for the new factory in C. was unnecessary and a wrong
investment. This could have been ascertained even by a rough aggregate
value-cost comparison. The factors of production could have
served the needs of the plan better in a different use. Nevertheless
the decision to build was carried out. Personal considerations turned
the balance. In the exchange economy, the factory in C. would have
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1948] THEORY OF THE CENTRALLY ADMINISTERED ECONOMY 89
been condemned as a failure. In the centrally administered economy,
where there is no automatic process of selection, it could be built and
kept working. For these overall valuations have no compelling force
behind them. Economic science should pay more attention to this
peculiarity of economic calculation in a centrally administered econ
for it exercises a significant influence on the way in which the economic
process works out.
(b) How are these facts to be explained ? How is it that in the
centrally administered economy economic calculation exerts no
decisive force ? The purpose in calculating costs in a perfectly competitive
system is well known from the textbooks. Costs show what
values the factors of production could realise in an alternative use.
All sorts of needs, effectively backed by the purchasing power of
income-receivers, struggle for the versatile factors, and the decision
is made by price-cost calculations, in which costs represent forgone
utilities. Production must meet needs backed by purchasing power.
This is the compelling " must" of economic calculation. Through
the agency of cost calculation, it is effective needs which control the
productive process. Certainly, in monopolistic or oligopolistic markets
the directing power of the consumers is essentially prejudiced and
weakened.
In the centrally administered economy, there is quite another relationship
between needs and supplies. The tension between the two finds
no effective expression in the markets. Demand and supply for iron,
coal, and all other goods does not originate with different independent
economic individuals, each with his own plans. Rather, the fixing
of needs and the direction of production is in a single hand. The
planning authorities consequently proceed by first fixing the requirements
for coal, bread, houses, and so on, and then adjusting the
productive process to these needs by their aggregate valuations and
production orders. But they do not have to proceed like this. They
can also proceed subsequently by altering the consumption side of the
equation, which is then adjusted to the production side. Allocations
of textile goods can suddenly be cut or the construction of a new factory
halted. Consumers cannot control the central administration. All
economic power is concentrated in the central administration, which
is thus itself subject to no controlling mechanism.
Perhaps this may be regarded as a weak point in the centrally
administered economy. In fact, it is only a weak point if the maximum
satisfaction of needs is regarded as the purpose of production. The
absence of any compelling force in value and cost estimates is at the same
time a source of strength, for it makes full employment comparatively
simple to bring about. We shall return later to this point at greater
length. Furthermore, the political authority is able, in the centrally
administered economy, to shape developments in economic life in
accordance with its political objectives, regardless of cost calcula-
tions.
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90 ECONOMICA [MAY
III
THE ROLE OF PRICES
We shall study this question also from two points of view: (i) What
role did prices play in Germany ? and (2) What general lessons are
to be derived from German experience ?
(i) German economic policy was concerned as far as possible to
control the economic process by indirect methods. Here, for example,
is what an important decree had to say: " All planning must have
the aim of exercising the maximum directive effect on the economy
with the minimum of interference. Interventions are unnecessary
so long as individual firms voluntarily cooperate in the policy laid down
by the State, or where, from considerations of purely private selfinterest,
their actions correspond with the requirements of the nation."
On this principle, an attempt was made to avoid all direct control over
intermediate stages of the productive process. The central control
of weaving, for instance, made possible indirectly the control of
spinning.
From the efforts of the central authorities to control the economic
process indirectly, rather than by direct order, it was a short step to
attempting the use of prices, and this attempt was actually made.
A. In order to be able to use prices as an instrument for controlling
economic life, the Ministry of Economics and the Price Commissioner
endeavoured to unify and improve accounting and the calculations of
their profits by private firms. Particularly as deliveries for the armed
forces gained in importance, very precise instructions as to cost accounting
were issued. The economic calculation of many German firms was
markedly improved and unified at this time. At certain points too,
prices were used with success to achieve a combination of the factors
of production somewhat nearer to the optimum, for instance with
regard to the production of munitions for which no former prices
existed.
At first, in these cases, the costs of production of the individual firms
were calculated, and prices fixed accordingly for each individual firm
on the basis of its costs. Consequently, the firms had no interest in
working economically, for profits were a percentage of costs, and were
greater if costs were high than if they were low. Therefore, in 1940,
to induce firms to produce economically, another system of calculating
prices was introduced: on the delivery of the munitions a uniform
price was paid, reckoned in accordance with the costs of an average
enterprise. A stimulus was thus given to improved production methods
in order to make profits. This procedure was later much refined.
Particular achievements of this kind do not alter the fact that the
prices, as they existed, were inadequate for controlling economic life as a
whole. The current prices expressed the scarcity relationships of the
autumn of 1936. Any change had been prevented by the price freeze.
If the plans of the central authorities had envisaged meeting a
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1948] THEORY OF THE CENTRALLY ADMINISTERED ECONOMY 9I
requirement equal approximately to the earlier demand, then the prices
and price relationships would have remained serviceable longer. But the
opposite was the case: public works, and investment for armaments
purposes, brought about big discrepancies between the centrally planned
needs and the earlier demand curves. The prices fixed for iron, coal, tiles
and so forth, no longer expressed the relationship between needs and
supplies as these were laid down in the plans of the central authorities.
Calculations based on these prices for products and for the means of
production could not command the factors of production to meet the
needs of the plan; and profit and loss calculations and budgets gave no
information as to whether the factors of production were being combined
in the optimum way for the production of the goods as planned
by the central authorities.
No improvement in the methods of calculation could get round this
fact. The prices which the firms reckoned with in their books failed
as an expression of scarcities, and so lost their controlling function.
B. This made a second question all the more important: would
it not have been possible to fix prices afresh ? The prices of I936 were
useless for the purpose of reducing the aggregate valuations of the
central authorities to prices for particular quantities. But would it
perhaps have been not impossible to do this by new prices ? The
existing prices represented a long obsolete system of data. Couldn't
new prices be fixed which would have given the maximum support
to the plans of the central administration ?
Two methods were discussed in connection with this problem:
(i) was it perhaps possible for higher authorities themselves to fix
important prices afresh ? Or (z), if this was not possible, could not
the prices be refixed by a temporary application of the market
mechanism
To take a particular examiple in Germany, namely that of the price
and use of copper-beech wood. Almost throughout the whole of the
nineteenth century beechwood had been used only for fuel and charcoal.
Owing to a series of discoveries in the last 50 years it found
many new uses and gained considerably in importance. There
was the discovery that the soaking of the wood with tar would turn
beech logs into railway sleepers of high quality. The discovery of
artificial drying and steaming methods led to beech being used on a wide
scale for furniture and woodwork of many kinds. Many discoveries
in the plywood industry again considerably extended the range of uses.
Finally, there was the discovery which made beechwood a basic material
for the production of cellulose and opened up a further field of
consumption.
What would constitute a reasonable distribution of the continual
supplies of beechwood between these almost unlimited uses if an
optimum utilisation was to be obtained ? Without doubt, the pegged
price of beechwood as compared with other timber prices, and with most
other prices, was much too low. It had been kept at the same level
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92 ECONOMICA [MAY
since 1932. Would it not have been reasonable, by raising the price
of beechwood, to ensure an efficient use of particular qualities and
quantities ?
The forestry authorities had several times examined the question
as to whether a new and higher price for beechwood should be fixed,
but the right price could not be discovered. The central forestry
administration only knew that the current price for beechwood was too
low. It was able to get a rough conception of the new value of beechwood
and thus could make a rough aggregate valuation. But from this
aggregate valuation no exact price per unit could be discovered. The
new data and prices were far too imprecisely known to venture on
such an experiment. A distinguished forestry specialist said at the
time: " We do not know the value of beechwood; we only know that
it is relatively high. How high, the market must decide later."
It may well be asked whether the market could not have decided
then and there. That would have been to adopt our second method:
to have left the prices of wood free for a time. Wouldn't then the
right price for beechwood have resulted ? But the prices of all the
products of the consuming industries, of furniture, plywood, cellulose,
mining, railways, and so on, were fixed. So were the prices of all the
substitutes for beechwood. Thus, the prices of all the various products
which made use of wood as a raw material gave no expression to the
relationship between needs and supplies in the market for wood. In
short, the partial freeing of the prices of a single group of goods would
have been pointless. The interdependence of all markets and of the
economic process as a whole, would have necessitated the freeing of
all prices and the determining of the scarcities of all goods, in order
thereby to establish them in the single case of beechwood.
Here we reach a more fundamental question. Why were not all
prices free ? Wouldn't it then have been possible to determine relative
scarcities by new price relationships, and thus reduce the new round aggregate
valuations of the central authorities to individual prices ? Such a step,
alone for reasons of monetary policy, was ruled out by the German
government. The general freeing of prices would not merely have led
to the development of new price relationships. The existing inflationary
pressure would have led to a sharp rise in the general level of prices,
to an appreciable fall in the value of money, to irrefutable wage claims,
to obvious losses for savers, and to a rise in the cost of armaments.
The tight hold on prices at their previous level, and the repression of
inflation by pegging prices, became a dogmatically held principle of
economic policy, as it has since become in other countries.
This negative answer in the German case does not dispose of the
whole problem. Let it be supposed that there was no inflationary
pressure, and that the arguments on monetary grounds against freeing
prices had not held. Could not freely formed prices have replaced
the aggregate valuations of the central authorities ? For example:
an armament firm receives io millions on account of deliveries, and pay
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1948] rHEORY OF THE CENTRALLY ADMINISTERED ECONOMY 93
5 millions of this to its workers. If the workers had been allowed with
this purchasing power to express freely their demands for consumption
goods, for bread, meat, clothing, housing, and so on, they would of
course have expressed their own valuations for consumption goods
and not those of the central authorities. Prices would have expressed
the valuations of the mass of consumers, not those of the central
administration. The prices of bread, houses, clothing, and of all the
factors of production responsible for these goods, would have conflicted
with the carrying through of the plans of the central authorities. Prices
would have expressed the plans of consumers and not the plans of the
central administration. Above all, goods would have been drawn
into consumption rather than investment uses, and a conflict would
have arisen between the central plans and those of individual households
and firms. Here we reach the basic question.
(z) Would it not perhaps have been possible to graft prices on to the
controlling mechanism of the centrally administered economy in the
following way ? The central administration would have distributed
consumption goods by rationing, as well as fixing prices. With regard
to consumption goods, demand and supply would have been equated
by rationing. But with regard to the factors of production, there would
have been no rationing. Entrepreneurs would have applied for these
to the state authorities. The factors would have been priced, and
then these prices adjusted according to the extent of demand. By
this adjustment of prices would not demand and supply have been
brought into equilibrium and would not thus exact cost calculations
have been possible ? In this way, the German authorities would have
been proceeding in accordance with proposals outlined by, for example,
0. Lange. Wouldn't it have been possible to follow out this proposal?
The position was that a constant struggle was taking place for the
factors of production between the different control offices, planning
departments, and ultimate users. To stick to our example, the representatives
of agriculture fought to get leather for harness, those of industry
for machinery, of the workers for shoes. Or iron was wanted for small
craftsmen, for machinery, for transport and so forth. The quantities
available were generally too small and didn't meet the demands of all
the sectional controls and departments. The proposal we are discussing
would have had these battles fought out through a pricing system.
The distribution of suitable supplies of leather between individual
uses would have been effected by prices.
This method of control was out of the question for the central
administration, for it would have meant to some extent letting the
control of the means of production-in this case leather or iron-out
of its hands. When fixing prices and rations for food and also for manufactured
goods, and in its investment programme, the central administration
could not know the amount of leather or iron that would be
wanted by the different control authorities or the other requirements for
such materials. These demands only appeared subsequently. If the
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94. ECONOMICA [MAY
allocation of the means of production had been left to the decision of the
price-bids of the businesses and departments, then the results might have
contradicted the plans of the central administration. For example, it
might have happened that a relatively large quantity of leather would
have been used for agricultural purposes, or for workers' shoes, which
would have brought about an acute shortage of, say, driving belts for
machinery, and thus jeopardised the production programme of the
central administration in other branches of industry. Therefore, the
central administration cannot leave the direction, in any important
respects, of such means of production, to be decided through pricing,
but must reserve the direction for itself, which was what happened in
Germany. (See I above.)
As soon as the firms, or sectional controls, had been left free to
determine their own demand independently, with the central administration
confining itself to fixing prices in relation to scarcities, conflicts
would have arisen between the plans of the central administration and
the plans of the firms and controls. Such conflicts would have been
resolved by orders from the central authorities, that is, by abandoning
the price mechanism. This proposal, therefore, cannot be carried
through in practice, even under the assumption of a suitable monetary
policy. Competition can be used to improve efficiency, but as a mech
anism of direction for an important section of the economy it cannot be
applied without the abdication of the central authority.
IV
SOME CONSEQUENCES
It is possible to understand the economic process in the centrally
administered economy, now we have seen the place in this process of
the central factors these are, the plans and production orders of the
central authorities arrived at by calculations of physical quantities
to which ' overall' aggregate valuations are assigned. The following
features at once arrest the attention:
i. Central planning presupposes standardisation and the fixing
of norms and types for production. It is impossible for the planning
authorities to take full account of the countless changing individual
needs of consumers, to provide variety in clothes or shoes, to get these
goods to those who want them most, and to adapt their plan to changing
wants. (V., Section i.) Central orders are the easier to give the more
schematised are production and consumption.
The needs of consumers can easily be reduced to norms by rationing
and allocations, and the influence of the infinite variety of individual
preferences eliminated. "The experiences of the last seven years
clearly demonstrate," wrote a textile expert in 1946, " that it was
not only the deployment of industry for war purposes, but rather,
the increasingly dominating role of the planning authorities that conThis
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1948] THEORY OF THE CENTRALLY ADMINISTERED ECONOMY 95
stantly tended to reduce the number of goods (r
products) which the plans envisaged ". Simplifying the production
side was more difficult. The multitude of small and middle-sized firms
in Germany had each their own different variety of demand for
machines, spare parts, materials and so on, which it was very difficult
for the planning authorities to weigh up and decide upon. In every
way the small and middle-sized firms in their infinite variety are difficult
to fit into central plans. Planning authorities can best carry out their
tasks of valuation and direction with respect to mass-produced goods,
which use a few standardised materials and a small number of processes.
The comparatively standardised character of agricultural.
production explains why agriculture is easier to plan than industry.
Central administration of the economy has led not only to standardisation
but to a general preference for the largest scale for production
when new factories are being built. The "Volkswagen" factory in
Fallersleben is an example. The significant point here is that it
is not only the size of the plant which affects the economic order.
Much has been written about this in the literature of the subject,
and it has been argued that the growing size of the plant must result
either in monopoly or in a centralised economy. Sometimes this
development has in fact taken place. But the causal connection runs
also in the reverse direction. According to the type of economic
system, different optimum sizes of plants will be aimed at. For
example, in the centrally administered economy, a particularly large
scale will be preferred or created such as would never have come
into being otherwise. This is what happened in Germany. The
preference for particularly large-scale units results from the special
form which planning takes in the centrally administered economy.
Over a period of years, under a centrally administered economic
regime, the German economy took on quite another shape: the trend
was all to standardisation and large scale units. But where this could
not develop quickly enough-which of course was apt to happendifficulties
and disturbances were inevitable. For example, as a
consequence of the numerous different types of motor car, it was very
difficult for the central administration to keep the armed forces supplied
with spare parts.
z. As we have seen, the programmes were drawn up by the sectional
controls. Each control was out to produce as much as possible, for
each held its own line of production to be specially important. So the
Leather Control would try to get hold of as much coal and transport
as possible in order to step up leather production. Coal and transport
facilities were needed by all the other sectional controls. The resulting
struggle between the controls for the factors of production, and particularly
for labour supplies, had, as we have seen, to be decided by
orders from the centre. But much time went by before the ministry
or political authority responsible could be called in and give its
decisionl. Meaniwhile, each control would be using every means it
13
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96 LCONOMTCA [MAY
could to procure factors of production or labour supplies. This
collision between sectional controls was a characteristic of the centrally
administered economy. A sort of group anarchy seemed to be inherent
in the system. In spite of the intervention of the higher authorities,
this 'anarchic' tendency must be recognised if the apparatus of
control is to be understood.
3. The centralised method of control also results in the leadership
responsible for directing the economic process passing' into quite other
hands than those which wield it in a competitive economy. The
business man disappears with the rise of a centrally administered
economy, because his main function, that is, the meeting of consumers'
needs and the discovery of possibilities for supplying them at a profit,
disappears also. In his place, the technician moves into the key position
both in the firms and in the planning offices. Friction in firms between
the technical and the business side is a well-known phenomenon. In
the centrally administered economy in Germany it was the technician
who gained the supremacy. But along with the privileged -technician
the statistician took on an important role in the direction of planning,
for the entire planning process was based on statistics from the first
proposals to the working out of budgets, and to the comparison of
planned and actual figures.
This change in the nature of the leadership was no accident, but a
direct result of the special method of control in the centrally administered
economy, in which the tendency is increasingly to replace
economic considerations by technical.
4. Finally we must ask whether any equilibrium emerges in. t.he
centrally administered economy.
Those of the planners who pondered thils question were inclined to
answer in the affirmative. They understood by ' equilibrium ' the
balancing of the budget of physical quantities in their section of the
economy, and they were concerned that this should finally be completely
achieved. Extensive negotiations among the sectional
controls, and finally decisions by the central authorities higher up,
could, they thought, bring it about that, for example, the quantity
of coal which the Leather Control used came to the same figure both
in the balance sheet of the Coal Control and in that of the Leather
Control: or that the quantities of leather goods, shoes, harness, and
so on, which appeared in the balance sheets of different sections of
industry and agriculture, corresponded with the quantities in the
budget of the Leather Control. The plans then were held to " balance ",
and a quantitative equilibrium was held to have been attained.
Certainly this equilibrium, when it actually existed, was not an
equilibrium in the economic sense. The question thus remains open
whether an economic equilibrium can be said to emerge in the centrally
administered economy, or whether any tendency to such an equilibrium
exists.
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1948] THEORY OF THE CENTRALLY ADMINISTERED ECONOMY 97
This question is difficult to answer, because the concept of equilibrium
in an exchange economy is not immediately applicable to a
centrally administered economy. In the exchange economy, three
different levels of equilibrium can be distinguished.
First, there is equilibrium for the individual household or firm.
In the centrally administered economy, equilibrium for the household
is not possible nor is it aimed at. Rather, it is a characteristic of the
centrally administered economy that the household cannot actively
press its demands, but is simply the passive recipient of quantitie
fixed in the aggregate ' overall' allocations from the centre. Hence
the case can occur in a household of a scarcity of bread with. a superfluity
of tobacco. Thus the balancing of satisfactions or marginal
utilities in accordance with Gossen's second law does not take place.
This brings it about that households try to approach nearer to maximum
satisfaction by means of exchange, that is by other procedures than
those of the centrally administered economy. (Barone and many
of his followers come to a different conclusion because they work with
a model which is not that of a centrally administered economy. They
assume that the individual income receiver gets a particular sum of
money from the central authority which he can freely dispose of.
Here the principle of Gossen's second law and of the equilibrium of the
household would actually be fulfilled. But then the State would
be surrendering the directing of the economy to consumers and would
cease to direct it from the centre.)
Partial equilibrium for the individual firm is also impossible in the
centrally administered economy. It is impossible to speak of the
marginal returns to capital for each kind of factor of production being
equal, or of there being any 'law' of, or even tendency to, equimarginal
returns. For the individual firm only makes subsidiary
decisions and has to fit in with the allocations of factors that come
from the planning authorities.
Sirmilarly, the concept of partial equilibrium ofJ individual markets is
not applicable in the centrally administered economy. With regard, for
example, to accommodation in a town, if this is distributed not by
demand and supply in the market, but by allocation, there can be no
equilibrium in the sense of the commercial economy. There is no
equating of two independent quantities, demand and supply, but the
distribution of a supply fixed to correspond with the planned requirenents
of the central authorities.
If these two conceptions of equilibrium fail to apply to the centrally
administered economy, must this also be so with regard to the third
conception, that of general economic equilibrium ? The question
arises whether in the centralised economy the productive processes
for all goods, that is, the proportions in which labour and the means of
production are applied in each case, can be so fitted in with one another
as to represent an optimum fulfilment of the requirements of the plan.
In the centralised economry in Germany, these proportions were not
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98 ECONOMICA [MAY
realised. One bottleneck followed another. Often they accumulated
simultaneously, and there was no mechanism for guiding the processes
of production in the direction of equilibrium proportions. Aggregate
valuations and calculations, which could not be essentially improved
on by the grafting on of a price mechanism, did not suffice to bring
about these adjustments. This fact, as remains to be shown, was of
particular importance with regard to investment.
V
SUPPLEMENTARY REMARKS
i. It was shown at the start that the study of an economic system
predominantly of the centrally administered type, as in Germany,
must turn away from the private households and firms and be
focused rather on the planning authorities. That is where the mechanism
of direction is to be found. But if one subsequently turns back
to the firms and households it will be noticed that what goes on there
does not correspond with the account given by the planners. This
discrepancy was of essential importance for economic life in Germanyand
indeed not only in Germany. Certainly the procedure in private
firms was completely overshadowed by the plans of the central administration.
But the firms had their own subsidiary plans, and to
understand German economic life in this period it is necessary to take
account of this subsidiary private planning.
A shoe factory gets allocations of leather, coal and electric power,
and 'in accordance with its orders, produces shoes of a particular quality.
Often, particular materials would be lacking, say, spare parts for
machines, or chemicals; or allocations of these would arrive late,
In one way or another, there would be "disequilibrium ". The firm
helped itself by resorting to its own " black " stocks, or by purchase
or exchange. Otherwise, production would have been impossible.
The central plans often related only to the so-called " key " materials,
while the others would be obtained privately. The planning
authorities often reckoned with the firms helping themselves, or w
their possessing their own unreported stocks, or with their making
their own deals. In this way, the private plans of the firms supported
and supplemented the centrally administered economy.
It is not correct that the black market always hindered the attainment
of the central administration's targets. On the contrary: in
modern industrial production, firms require too many different kinds
of auxiliary materials and parts for the central authority to keep
track of them all, in spite of the most far-reaching standardisation.
A factory making machinery, for example, had completed certain
machines punctually as ordered. But they couldn't be dispatched
because there were no nails for nailing down the cases. It actually
happened that a manager waited for months with delivery until the
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1,948] THEORY OE TIIE CENTRALLY ADMINISTERED ECONOMY 99
nails were allocated. Other managers would not. Fearing the consequences
of late delivery, they got themselves the nails by exchange.
Such ' illegal' actions were of daily occurrence, but in spite of their
illegality they were an essentail aid to the fulfilment of the " legal "
plans. In other cases, such transgressions certainly were harmful.
2. We reach here an important general question: can such complicated
processes of production as those of a modern industrial
economy be directed alone by the methods of a central administration ?
if, conceivably, all exchange deals and all black markets were completely
suppressed by the confiscation of all stocks, could a central
administration direct the economy at all ? In modern factories,
dozens, even hundreds, of materials are used daily in changing
quantities. Is it conceivable that all these raw materials, goods, spare
parts, chemicals and so on could be allocated by the central authorities
in the right qualities and at the right time ? Wouldn't an attempt
of this kind at a total direction of the central administration throughout
the economic system be suicidal ? Would the disproportionalities
be kept within tolerable limits ?
This question cannot be precisely answered on the basis of German
experience. For in Germany the procuring of many materials, and evern
of labour supplies outside the official channels of the central administration,
played an important role. Certainly from what could be
observed, the conclusion followed that without the procurement of
black supplies of the means of production and of labour, the productive
process would have suffered severe disturbances in many of its
branches and for considerable periods of time. What is unique about
this phenomenon is not that one pure form of economic orderthat
of the centrally-administered economy-has to be supplemented
by other forms. This is also the case with regard to other economic
orders of society. The subsistence economies of small family groups
directed by the head of the family are not usually found in their pure
form. Usually certain goods, say, salt, or metals, are got by exchange,
so that here too, though for quite other reasons, there is a mixture of
different pure forms of economic order. In contrast to other
mixed economies, supplementary arrangements outside the central
plan are explicitly forbidden by the planning authorities and the State.
This is not the case in other mixed economies. It is a peculiarity with
widespread consequences. The functioning of a centrally administered
economy and its methods of control presuppose-at any rate
they did in Germany-private exchanges which were often undertaken
against the special orders of the central authorities.
3. The followiing definite conclusions can be drawn. The economic
planning of a central administration consists of the balancing of the
physical budgets of tlhe sectional controls, and out of that balance a
certain statistical 'equilibrium ' emerges. But because aggregate
econoomic calculations permit of only the roughest cost estimates,
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100 ECONOMICA [MAY
the central administration has no means of bringing about any sort of
general economic equilibrium. Firms and households, within the framework
of the central plans, attempt by exchange to realise as far as possible
the principle of equi-rnarginal returns and of individual equilibrium.
Thus, by these subsidiary and independent plans and actions, firms
and households approach more nearly an equilibrium than is possible
by the methods of direction of the centrally administered economy
alone.
(To be concluded)
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