|Schools of economics|
Socialist economics is a term which refers in its descriptive sense to the economic effects of nations with large state sectors where the government directs the kind and nature of production. In a normative sense, it applies to economic theories which advance the idea that socialism is both the most equitable and most socially serviceable form of economic arrangement for the realization of human potentialities.
There has developed a diverse array of ideas that have been referred to as "socialist economics," from forms of "market socialism," which advocate achieving economic justice through taxation and redistribution through state welfare programs to the hardcore communists who advocate total state control of all property and the economy, to the unique Chinese variation known as "socialism with Chinese characteristics."
However, particularly when featuring a planned economy, attempts to put socialist economics into practice have failed. Many critiques of socialist economics warned of this. Some noted the impossibility of knowing the economic data necessary to have total control over an economy, finding it impossible to replace the "invisible hand" that Adam Smith regarded as guiding free market economies. Placing production goals above consumer leads to failure, as does removing all motivation by taking total control over the economic system. Critics of socialist economics argue that human beings are beings of free will and their success in any endeavor comes from their free pursuit of desires and the fulfillment of their individual potentials. No centralized system run by a distant government, even if well-meaning, can take into account the diversity of needs and contributions of all people; it is this diversity that makes human society human. Prosperity and happiness for all can only, critics maintain, come when each individual is regarded as a unique and valuable member of society. Socialist economics, despite aiming to care for all people and provide fair distribution of wealth, lacks sufficient understanding of human nature to establish a society that can succeed in doing so.
Socialist economics is a broad, and mostly controversial, term. Generally, however, most theoretical economists would agree that the definition of a socialist economy is based on four main features:
Altogether, socialist economics, as these four features suggest, is characterized by large scale central planning of all possible types and quantities of consumer goods and machinery for their production (with a price system attached) and their quantitative regional allocation. Socialist economics also plans the qualitative and regional distribution of labor and the appropriate wage system. To be competitive with Western free market systems, it has to plan for technical and technological innovation and quality of products that are to be in demand.
Also, the four principles clearly define a necessary political condition for a socialist economics to become a workable reality in any society’s history: A non-democratic authoritarian or totalitarian regime of one party that can change the constitution to legally anchor all the above elements. Without such authority, centralized control by government of the economy cannot be achieved.
Theories of socialism first arose in the late 18th century in response to the Industrial Revolution. Factory owners were becoming wealthy and the workers were impoverished. Thus, workers wanted a greater share in the wealth that factories were making. Later a form of socialism called, somewhat ambitiously, "Communism," emerged based on the writings of Karl Marx and Friedrich Engels. The economics of Communism had not yet been precisely defined; not by Marx (nor by anybody else since), as can been seen in several editions of Das Kapital where the definitions changed (see Marx I :793, 2nd edition and Marx I:728, 4th edition).
Communism advocated class struggle and revolution to establish a society of cooperation with strong government control. In other words, this would amount to politically totalitarian societies where the socialist principles could be enacted into their constitutions. Such a doctrine with socialist economics predominated in the former Soviet Union and much of Eastern Europe, as well as in China and Cuba, at one time. Today its influence has lessened.
Western democracies were not considered to be examples of true socialist economics at any time. Nationalization (the act of taking an industry or assets into the public ownership of a national government) of major industries, which has occurred in several Western European countries, is just one of the four necessary conditions mentioned above; and this could be (and has been) reversed when a different political party came to power.
Marxian economics is one form of socialist economics, and the most influential for the half of the world's economies during a large part of the 20th century. It was also, through the decades of its existence in the USSR and the other COMECON (socialist countries of Eastern Europe, Balkans, Central Asia, China, and Cuba) countries, the only government-sanctioned economic doctrine. This is why Marx can be considered the founder of socialist economic thinking.
There are two important points from Marx, drawn from Das Kapital (which is discussed in more detail below), on which socialist economics rests:
Therefore, according to this theory, by destroying the capitalist system “surplus value” would no longer be needed (for the enrichment of capitalists) and, instead, the working class would have the fruit of its labor fully at its disposal (Masaryk I: 319).
To summarize, from a political point of view socialism, which Marx referred to as the "first phase," and communism, the "higher phase," involves the destruction of the bureaucratic state: From the social point of view socialism is the destruction of the class system, and from the economic point of view socialism is the destruction of the compulsion to economic growth.
In other words, the capitalists’ optimized allocation of specific products produced at competitive wages and logistics vis-a-vis specific markets offered at competitive prices—which, due to this constant competition, have been automatically achieving constant growth in productivity and, hence, economic growth—would no longer exist. The question is: How to substitute the void?
Marx explained that, since the first stage of socialism would be "in every respect, economically, morally, and intellectually, still stamped with the birthmarks of the old society from whose womb it emerges," each worker would naturally expect to be awarded according to the amount of labor he contributes, despite the fact that each worker's ability and family circumstances would differ, so that the results would still be unequal at this stage, although fully supported by social provision.
Thus, the problem of substituting the capitalists' optimized allocation translates into a question of marginal readjustments. Going slowly about the "substitution," Oskar Lange, a theoretician of socialist economics, assumed the retention of the existence of money and a wages system at the beginning, in order to maintain at least some semblance of productivity growth. Lange suggested that solving these readjustments as the socialist economic system took shape (when the money and wages might be slowly withdrawn from the system), would be done by central planning bureaus and would be based on mathematical (quantity, quality, and logistic) optimizing models. According to him, this was an adequate solution (Lange 1949).
Das Kapital is one of several famous incomplete works of economic theory: Marx had planned four volumes, completed two, and left his collaborator Engels to complete the third. In many ways the work is modeled on Adam Smith's Wealth of Nations, seeking to be a comprehensive logical description of production, consumption, and finance in relation to morality and the state.
Marx employed systematic analysis in an ambitious attempt to explain capitalism's contradictory laws of motion, as well as to expose the specific mechanisms by which it exploits and alienates. He radically modified classical political economic theories. Notably, the labor theory of value, developed by Adam Smith and David Ricardo, was transformed into his characteristic "law of surplus value and capital" which is, according to Marx, not only an economic but also an ethical issue. Thus, the whole concept and explanation of capitalism transforms into the statement of workers’ exploitation (Masaryk I: 157).
In such a context the accumulated wealth, which is the source of the capitalist's social power, derives itself from being able to repeat this cycle:
Money → Commodity → Money +,
where the “ + “ the capitalist receives is an increment or "surplus value" higher than their initial “money” (Marx I, 271).
This “surplus value,” the stepping stone of the Marx’s thesis, is of two forms:
This has one negative side-effect, however. One part of the labor force works still longer labor hours, hence there still exists an increasing part of the labor force that is unemployed. Hence, the net effect is relative overpopulation. (This can be seen as different from Malthus’ absolute overpopulation theory, which Marx did not accept.)
In his Theses on Feuerbach (1845) Marx famously concluded: "Philosophers have hitherto only interpreted the world in various ways; the point is to change it." This brilliantly encapsulates Karl Marx's philosophy. It explains his priorities by choosing the economic interrelations to be of primary and indelible importance in any society. These were supposed to be the very “basis” of the society's history and future (what can be called “economic materialism”) while the web of historical norms of law, ethics, religion, philosophy, culture, arts, and just about everything that holds the society together was relegated into the “superstructure.” And, obviously, according to this model, the “superstructure” is only the mirror of the “basis,” which for Marx is the real foundation of the society.
As the base for economic materialism, having been taught to generations in all the Socialist (and/or Communist) regimes of the 20th century, this model may have had at least a theoretical value. The problem is that neither Marx nor Engels had provided any proof of this mainstay of Das Kapital, and neither did anyone else since.
Capitalist production is the production of “an immense multitude of commodities” or generalized commodity production. A commodity has two essential qualities: firstly, they are useful, they satisfy some human want, “the nature of such wants, whether, for instance, they spring from the stomach or from fancy, makes no difference,” and secondly, they are sold on a market or exchanged (Marx I: 59).
Notice that Marx deleted from his theory any subjective element whatsoever.
Critically, the exchange value of a commodity “is independent of the amount of labor required to appropriate its useful qualities.” Rather, it depends on the amount of socially necessary labor required to produce it. All commodities are sold at their value, so the origin of the capitalist profit is not in cheating or theft but in the fact that the cost of reproduction of labor power, or the worker's wage, is less than the value created during their time at work, enabling the capitalists to yield a surplus value or profit on their investments (Marx I :158).
This is tantamount to the “surplus value theory” described above.
As noted above, Marx did not allow any subjective element in his theory of value. This can be better understood through his theory of economic fetishism, which encapsulates Marx's entire economic system, and, in particular, his theory of value. In the first chapter of Das Kapital Marx explains his view:
For Germany, the critique of religion is practically done (by Feuerbach), and the critique of religion is the very basis of the critique of everything (in society). As religion is the fetishism of one’s head, economic fetishism is driven by one’s hand, that is “goods” (products). Thus, by the critique of the consumers goods, the fetishism will be driven forever out of existence, since the religious reflection of the real world will be substituted by the reflection between the practical life and people’s natural environment (Marx I, 46).
Marx, however, also showed that the structure of the commodity economy causes things to play a particular and highly important social role and thus to acquire particular social properties. He discovered the objective economic bases which govern commodity fetishism:
Illusion and error in men's minds transform reified economic categories into "objective forms" (of thought) of production relations of a given, historically determined mode of a specific commodity production (Marx I, 72).
Thus, for Marx,
Characteristics which had appeared mysterious because they were not explained on the basis of the relations of producers with each other were assigned to the natural essence of commodities. Just as the fetishist assigns characteristics to his fetish which do not grow out of its nature, so the bourgeois economist grasps the commodity as a sensual thing which possesses pretersensual properties (Rubin 1976, 8).
In the wake of Marx, "Marxist" economists developed many different, sometimes contradictory tendencies. Some of these tendencies were based on internal disputes about the meaning of some of Marx's ideas, especially the "Law of Value." Other variations were elaborations that subsequent theorists made in light of real world developments. For example the monopoly capitalist school saw Paul A. Baran and Paul Sweezy attempt to modify Marx's theory of capitalist development, which was based upon the assumption of price competition, to reflect evolution toward a stage where both economy and state were subject to the dominating influence of giant corporations. World-systems analysis restated Marx's ideas about the worldwide division of labor and the drive to accumulate from the holistic perspective of capitalism's historical development as a global system.
Accordingly, Immanuel Wallerstein, writing in 1979, maintained that
There are today no socialist systems in the world-economy any more than there are feudal systems because there is only one world-system. It is a world-economy and it is by definition capitalist in form. Socialism involves the creation of a new kind of world-system, neither a redistributive world-empire nor a capitalist world-economy but a socialist world-government. I don't see this projection as being in the least utopian but I also don't feel its institution is imminent. It will be the outcome of a long social struggle in forms that may be familiar and perhaps in very few forms, that will take place in all the areas of the world-economy (Wallerstein 1979).
Market socialism is a variation of socialist economics that combines government control with free market forces. It refers to various economic systems in which the government owns the economic institutions or major industries but operates them according to the rules of supply and demand. In a traditional market socialist economy, prices would be determined by a government planning ministry, and enterprises would either be state-owned or cooperatively-owned and managed by their employees.
The earliest models of this form of market socialism were developed by Enrico Barone (1908) and Oskar R. Lange (Hahnel 2005, 170). Several suggestions on this topic were discussed in the 1930s, most notably by Lange (1939), H. D. Dickinson (1933, 1934), and Fred M. Taylor (1939).
Lange and Taylor (1929) proposed that central planning boards set prices through "trial and error," making adjustments as shortages and surpluses occurred rather than relying on a free price mechanism. If there were shortages, prices would be raised; if there were surpluses, prices would be lowered (Skousen 2001, 414-415). Raising the prices would encourage businesses to increase production, driven by their desire to increase their profits, and in so doing eliminate the shortage. Lowering the prices would encourage businesses to curtail production in order to prevent losses, which would eliminate the surplus. Therefore, it would be a simulation of the market mechanism, which Lange thought would be capable of effectively managing supply and demand (Kornai 1992, 476).
In this system, a regime, assuming ownership of all means of production, could use markets to find relevant consumers' prices and valuations while maintaining social and state control over production, income determination, investment, and economic development. Managers would be instructed to minimize costs, while the planning board would adjust producers' prices to eliminate disequilibria in the markets for final goods. Thus, at a socialist market equilibrium, the classical marginal conditions of static efficiency would be maintained, while the state would ensure equitable distribution of incomes through its allocation of the surplus (profit) from efficient production and investment in socially desirable planned development.
Dickinson (1933, 1934) proposed a mathematical solution whereby the problems of a socialist economy could be solved by a central planning agency. The central agency would have the necessary statistics on the economy, as well as the capability of using statistics to direct production. The economy could be represented as a system of equations. Solution values for these equations could be used to price all goods at marginal cost and direct production. Dickinson (1939) eventually adopted the Lange-Taylor proposal to simulate markets through trial and error.
The Lange-Dickinson version of market socialism kept capital investment out of the market as Abba Lerner (1944) admitted that capital investment would be politicized in market socialism. Lange insisted that a central planning board would have to set capital accumulation rates arbitrarily. Lange and Dickinson (1938, 1939) saw potential problems with bureaucratization in market socialism. According to Dickinson “the attempt to check irresponsibility will tie up managers of socialist enterprises with so much red tape and bureaucratic regulation that they will lose all initiative and independence" (Dickinson 1939, 214).
In sum, Oscar Lange, Abba Lerner, and H. D. Dickinson proposed state control over credit and financial capital. While these market socialists accepted trade and the use of money with consumer goods, markets for capital goods would be simulated and markets for financial capital would be wholly replaced by central planning. Capital investment would therefore be determined by state officials, rather than by competition for funds in financial markets. Lange was particularly clear about how the state would determine the overall rate and pattern of capital investment. State officials would set the overall rate of capital accumulation, instead of interest rates. State officials would also determine the pattern of investment, instead of profit-seeking capitalists and entrepreneurs.
Before discussing some of the problems of socialist economies as they appeared over the decades of its practice, one issue appeared immediately. It was the problem of how to substitute the “invisible hand” that guides the economy in a free market economy in a centrally planned economy. Vladimir Ilyich Lenin observed this problem right away shortly after taking power in Russia in 1918. Hence, he introduced his New Economic Policy (NEP), that allowed for a private ownership of small businesses. However, he did not live long enough and under his successor, Joseph Stalin, the NEP was abolished. Market socialism, developed in the 1930s as described above, has suggested several ways of “squaring this circle.”
The Soviet Union and some of its European satellites aimed for a fully centrally planned economy. They dispensed almost entirely with private ownership of capital. Workers were still, however, effectively paid a wage for their labor. The characteristics of this model of economy were:
A farm, mine, or factory was judged on the basis of whether its production met the quota. It would be provided with a quota of the inputs it needed to start production, and then its quota of output would be taken away and given to downstream production units or distributed to consumers. Critics of both left and right persuasions have argued that the economy was plagued by incentive-related problems. To ensure locative efficiency central planners would have required accurate information about the productive capabilities of each enterprise (including labor), however the system incentivized enterprise managers to under-report their unit's productive capacities so that their quotas would be easier to achieve, especially since the managers' bonuses were linked to the fulfillment of quotas.
In contrast with systems where prices determined allocation of resources, in the Soviet Union, allocation, particularly of means of production, was determined by a bureaucratic elite, which was notable for its exclusion of any democratic process. The prices that were constructed were done so after the formulation of the economy plan, and such prices did not factor into choices about what was produced and how it was produced in the first place.
Every worker was ensured employment. However, workers were generally not directed to jobs. The central planning administration adjusted relative wage rates to influence job choice in accordance with the outlines of the current plan.
If a surplus of a product was accumulated, then the central planning authority would either reduce the quota for its production or increase the quota for its use.
Five Year Plans were made for the long-term development of key industries.
According to some interpretations of Marxist theory this should have been a step towards a genuine workers' state. However, other Marxists consider this a misunderstanding of Marx's views of historical materialism, and his views of the process of socialization.
Whatever beliefs anybody harbored, one thing was clear: The USSR and all its COMECON economic allies were officially still only “socialist” countries. Therefore, wages and prices under the “socialist” umbrella were still bona fide economic tools. They might become obsolete under the “communist” label. The problem was not only was it not clear how to transition into the communist phase, or how that would actually work in reality, it appeared impossible to successfully navigate the economies in practice even through the socialist phase—which must precede the communist one—even after several generations in all of the socialist countries.
In 1950, China embraced a wholehearted socialist model after the Communist victory in its Civil War. Private property and capital were abolished, and in the large agricultural sector, the state simply replaced peasants' existing warlord or landlord. The first attempt, the so-called Great Leap Forward (GLF), saw a remarkable large-scale experiment in entirely abolishing wages based on work. Agricultural workers were assured that they would receive food regardless of the output of their village.
The central idea behind the Great Leap was that rapid development of China's agricultural and industrial sectors should take place in parallel. Substantial effort was expended on large-scale but often poorly planned capital construction projects, such as irrigation works often built without input from trained engineers. The hope was to industrialize by making use of the massive supply of cheap labor and avoid having to import heavy machinery.
To achieve the targets, Mao Zedong advocated that a further round of collectivization modeled on the USSR's "Third Period" was necessary in the Chinese countryside, where the existing collectives would be merged into huge people's communes. An experimental commune was established at Chayashan in Henan in April 1958. There for the first time private plots were entirely abolished and communal kitchens introduced. At the Politburo meetings in August 1958, it was decided that these people's communes would become the new form of economic and political organization throughout rural China.
This system was abolished soon afterward, and is often considered to be one of the reasons for a significant famine in China in the 1960s, in which millions of Chinese starved. Ironic considering its name, the Great Leap Forward is now widely seen, both within China and outside, as a major economic disaster, effectively being a "Great Leap Backward" that would adversely affect China in the years to come. The official toll of excess deaths recorded in China for the years of the GLF is 14 million, but scholars have estimated the number of famine victims to be between 20 and 43 million (Xizhe 1987).
The subsequent economic reforms that led to China's rapid GDP growth and poverty reduction at the end of the 20th century passed thirty in number. The conventional wisdom—often called the “Beijing Consensus"—is that incremental privatization is the key to China's economic growth.
China's economic system became known as a "Socialist market economy." It is a market economy that combines substantial state ownership of large industries with private enterprise, where both forms of ownership operate in a free-pricing market environment. In contrast to the proposal of market socialism put forth by Oskar Lange in the early 20th century, prices were not set by a government central planning board. The transition to this socialist market economy began in 1978 when Deng Xiaoping introduced his program of "Socialism with Chinese characteristics."
The reforms in the 1980s were very far reaching and substantial for private sector development, especially in rural areas led by township and village enterprises (TVEs). In the 1990s, however, those reforms slowed, and rural privatization was rolled-back (Pei et al 2008). Although a large part of the Chinese population lives in rural regions, a new focus was put on developing the urban regions. To pay for these urban reforms, the government heavily taxed rural citizens and reduced services in rural health and education. The migration from rural China to urban centers thus began.
The question became whether urban or rural economic growth should be given higher priority. In the early years of the 21st century, the Chinese Communist Party (CCP) returned to some of the policies of the 1980s: In rural regions, they abolished the rural tax, reduced education and health fees, and revised rural finance. The logic of such steps is easy to grasp. Most people live in rural areas and to reverse the world crisis that hit China as a net exporter, its own manufacturers turned to Chinese villagers rather than American consumers. Nationwide schemes offering tax breaks to rural buyers of such items as televisions and washing machines are evidence that China began looking to tap its own potential—a milestone in the global rebalancing story.
Regardless of whether urban or rural economic growth is given the higher priority, it is clear that China's economic success in the early 21st century came from abolishing its original socialist economy and replacing it with a form that did not involve the setting of prices by a central planning board.
The Socialist Economic Calculation Debate (SECD) was first proposed by Ludwig von Mises in 1920 and later expounded by Friedrich Hayek, both of the Austrian school of economics. The thrust of Hayek's argument was that Oskar Lange (1949) and his fellow socialists had become excessively preoccupied with the use of the static equilibrium models that were (and still are) the framework of neoclassical economic theory. Lange’s exposition of the workings of market socialism relied on all of the crucial “data” being “given” to the Central Planning Bureau (CPB), when in fact the totality of such data is not only unknown but unknowable.
While the models used by the socialists were not logically contradictory, Hayek argued that they were being misapplied. He noted that they failed to capture the actual process by which markets elucidate information about such things as least-cost production methods and available supplies (Vaughn, 1980).
To the Austrians, the role of markets is one of discovery rather than allocation. Much of the knowledge that is utilized in production in a market economy is not scientific in nature, but rather is knowledge of particular time, places, and circumstances. Many production techniques and possibilities simply do not exist until they are uncovered during the competitive process, a process which does not exist under socialism. So called “tacit” or qualitative knowledge about particular firms and resources presents additional problems, since they cannot be communicated objectively as statistics to the CPB. By its very nature, this crucial information is highly dispersed and fragmentary, and therefore is not ever known to any one agent in the economy (Hayek, 1945).
The model of “perfect competition” that is the core of neoclassical welfare economics was also seen by the Austrians as a misleading description of what actually occurs in a market economy. The concept of equilibrium, argued Hayek, “presupposes that the facts have already all been discovered and competition therefore has ceased” (Hayek 1978a, 259). In particular, the traditional model of perfect competition says nothing about how firms ever come to raise or lower prices, for example, when they are assumed to be externally determined constants.
Most attempts to answer the Austrians’ claims have focused on the non-essential parts of their critique of central planning. By pointing to recent advances in computer technology, for example, advocates of market socialism claimed to have refuted Hayek’s entire position by showing that data transmission and “equation solving” would not pose serious problems under socialism (Cottrell and Cockshott, 1993).
Hayek’s central argument, however, was not so much that a socialist economy could not transmit the necessary data, but rather that it could not generate it to begin with. Without the processes of discovery and innovation, a socialist economy would have available only a small fraction of the knowledge that is utilized in a competitive economy. The task faced by proponents of market socialism is to explain exactly how spontaneous discovery is to occur within a planned economic system (Chamberlain 1998).
In fact, despite Lange’s theoretical assumptions about central planning being solved by mathematical programming via computers, the economists who were doing just that were not so optimistic. Hungarian socialist republic chief economist Janos Kornai, together with mathematician Tamas Liptak, produced what they termed "Two-Level Planning," (Kornai and Liptak 1965), making their names known in the world of mathematical economics. These two authors produced an idealized model of central planning—what "perfect" planning would look like if a number of conditions were fulfilled.
However, Kornai’s attempts to produce a mathematical scheme for socialist planning convinced him that mathematical techniques would never be able to solve Hayek's question about economic information: "How will central planners be able to trace the supply and demand of a million types of products at once" (Kornai 2007).
The second implication of the SECD has to do with the methodology of neoclassical economics in general. It is no coincidence that (1) market socialism was developed by neoclassical economists, (2) that free-market neoclassical economists were unable to produce a theoretical case against central planning, and that (3) neoclassical economic theory has shown to be of limited value in reforming the former Communist states (Murrell, 1991).
The common theme among these points is that there are important institutions and processes in a competitive economic order that are assumed away within most general equilibrium models. The static approach of these models and their fixation on a unique and stable equilibrium misrepresents some very important aspects of reality (Chamberlain 1998).
From Kornai's point of view, general equilibrium theory failed to explain why a capitalist system works better than a socialist system. For example, in neither system did "agents" (planners or firms and households) have perfect information. But capitalism provides incentives to improve the quality of information, since individuals may profit from having better information. In a centrally planned system, such an incentive is lacking; in fact the incentive for the officials in charge may be to expand the sphere of disinformation in order to demonstrate their administrative success. "Capitalism," Kornai wrote, "receives an enormous boost from its combination of decentralized information and decentralized incentive” (Kornai 2007).
The core argument of Hayek (1982) and others is that market socialism as a method of organizing production would be unable to discover and make socially useful the dispersed, tacit, and ultimately subjective knowledge that is available for use within a competitive economic system based on private property rights.
Overall, the inability of modern market socialists to answer all these arguments casts serious doubt on the practical workability of market socialism, or any other form of socialist economics based on central planning, in any possible fashion and in any country.
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