Communist economic systems and, to a lesser extent, socialist economic systems suffer from what economist F.A. Hayek described as the "socialist calculation problem" – namely that an absence of private property rights and an inability of economic actors to pursue profits in these economies keep free market processes from efficiently distributing resources. This spontaneous process in the market is often colloquially referred to as the "invisible hand."

What Is the Invisible Hand?

The invisible hand of the market was described by Adam Smith, an influential member of the Scottish Enlightenment and considered by many to be the father of microeconomics. According to Smith, separate individuals who pursue their own self-interests create unintended benefits for all of society "as though guided by an invisible hand."

Though the specific mechanics of this phenomenon wouldn't be fully understood until after the development of subjective theory of value and the marginalist revolution, Smith nonetheless laid the groundwork for laissez-faire economic philosophies.

Prices serve an important role in economics. They tell producers what goods and services consumers are demanding and how much of each good should be brought to market. Prices coordinate all actors simultaneously and dynamically, automatically conserving scarce resources and deploying labor and capital towards the most valued ends. The price system is both spontaneous and largely unseen, yet crucial.

The Invisible Hand in Socialism and Communism

The core conflicts between economic efficiency and socialist systems has less to do with specific government policies and more to do with the treatment of private property. In both socialism and communism, the government owns and operates the factors of production: land, labor and capital. All production decisions are therefore made by a central authority, which does not base production decisions based on market prices and cannot accurately distinguish between higher and lower uses of goods.

Indeed, real market prices are impossible in a socialist society; the crucial input signals generated from the interaction between utility-maximizing consumers and profit-seeking producers are lost. Communism compounds the problem of economic calculation by also controlling the consumption of economic goods. Without the invisible hand to direct the factors of production, unwanted shortages and surpluses are inevitable.

Austrian economist Ludwig von Mises famously predicted the collapse of communist economies in his 1919 essay "Economic Calculation in the Socialist Commonwealth," centering his argument around the inability of the price mechanism to work properly.

Socialist and communist economies also suffer from a psychological handicap; economic actors have reduced incentives. Since profits are either reduced or impossible, companies stop innovating and entrepreneurs stop taking financial risks. Since nobody owns private property, the tragedy of the commons ensues and resources become depleted.

The last major problem created by government control of the economy centers around political hazard. When central power controls the means of production, decisions about wealth accumulation and resource allocation become tools of the elected political elite. The same self-interest that guides economic activity also guides political activity. Governments can shield themselves from competition and compel action; all action in a market economy is voluntary. Here, the invisible hand is replaced with the very visible arm of the state.

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  4. What is the difference between Communism and Socialism?

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