REFORMING THEORIES OF REFORM

According to the modern theory of institutions, two factors are critical to the performance of an economic system: the information held by the various actors and their incentives. Yet in the past and even in our times, scholars have frequently ignored these factors in their proposals for reform.

In 1908 the Italian scholar Enrico Barone published an article entitled (in translation) “The Ministry of Production in the Collectivist State.” Barone's article encouraged economists and other social scientists to follow a path that took them away from the central issues of information and incentives. Barone, a pioneer in mathematical modeling, used his tools to establish a formal equivalence between the basic categories in a market economy based on private ownership and those in a socialist economy managed by a central authority. In the two instances, optimization involved solving a comparable set of equations.

Barone's vision of the fundamental issues of an economic system has been shared by many scholars in the twentieth century. In the 1930s the famous Lange–Lerner blueprint of a managed economy envisioned a system of “market socialism” where a central planning bureau (CPB) balanced supply and demand by using a trial-and-error method to set prices. The managers of the state-owned enterprises were to be given instructions hailing from Econ 101: (a) pick a combination of productive factors that minimize average costs and (b) set marginal costs equal to the prices determined by the CPB.