Can Neoclassical Economics Underpin the Reform of Centrally Planned Economies?

Abstract

This paper addresses whether neoclassical economics can provide the intellectual underpinning for a theory of reform. I examine whether the neoclassical model satisfies an essential condition to qualify for this role: does it give us a satisfactory explanation for the vast differences in performance between capitalist and socialist economic systems? First, I focus on the theoretical arguments that have traditionally been used to examine the comparative properties of central planning and markets. I show that developments within theory over the last 20 years have substantially changed the tone of these arguments, making their message more equivocal. Next I discuss empirical evidence, but of a particular sort. Much research shows that centrally planned economies perform less well than market economies; but few studies test whether the superiority of market economies appears within empirical models derived using the framework of basic neoclassical economics. Those studies are the relevant ones for the present exercise. The central conclusion is that economists must look outside the standard models of competition, the focus on Pareto-efficient resource allocation, and the welfare theorems to build a theory of reform.