Moral Hazard—The Other Nemesis of Socialism

Having dealt with the consequences that in one way or another resulted from the inability of a socialist management to calculate the contributions of the various factors of production, Mises pointed out that there was another, equally “insurmountable obstacle” for the realization of the socialist scheme:

It is impossible to find a form of organization which makes the economic action of the individual independent of the co-operation of other citizens without leaving it open to all the risks of mere gambling.²⁴

In other words, socialism makes subordinate decision makers irresponsible. By socializing the costs of individual action, socialism induces moral hazard at every level of society. All members of a socialist society know that most of the negative consequences of their behavior fall on others. Everyone has an incentive to behave more recklessly than in a strict privateproperty system, where costs are borne by individual actors.

It is impossible to solve the problem with payment schemes to provide incentives for “suitable” behavior.

[T]he problem is not nearly so much the question of the manager's share in the profit, as of his share in the losses which arise through his conduct of business. Except in a purely moral sense the property-less manager of a public undertaking can be made answerable only for a comparatively small part of the losses. To make a man materially interested in profits and hardly concerned in losses simply encourages a lack of seriousness. This is the experience, not only of public undertakings but also of all private enterprises, which have granted to comparatively poor employees in managerial posts rights to a percentage of the profits.²⁵

In capitalism, the individual responsibility of each property owner for his property is a strong force that harmonizes his actions with those of all other members of society. In contrast, a characteristic feature of socialism is to sever the link between an action and its consequences. Under such conditions, individual actions are necessarily out of step with what is required for the system to perform well.²⁶

There is only one remedy: the imposition of strict rules for subordinate behavior. To safeguard the economic system against the recklessness of irresponsible underlings, the central authorities would have to deprive them of all autonomous power of decision-making, to give detailed prescriptions for the actions of subordinates, and reserve for itself the right of decision-making in all cases not covered by the rules. In short, socialism requires an all-encompassing bureaucratic system.