Twentieth-Century Economic Systems
Through most of the twentieth century, the nations of the world have been divided, and some
of their conflict was over their different economic systems. Since the fall of the Soviet-type,
or "Communist," governments in eastern Europe, this division may seem to be a thing of the
past. It might be hasty to draw that conclusion, though. In the 1930's, it seemed to many
observers that capitalism had failed, and that the future belonged to one or another of the noncapitalist systems. A little more time proved that that impression was wrong -- capitalism
came back to a dominant position, but it was a somewhat different form of capitalism. In early
1997, it seemed as if the non-capitalist systems have failed, and the future belonged to
capitalism. But just as the perception of things in the 1930's was wrong, the perception of
things in the 1990's may also be wrong. Indeed, by late 1998, problems for capitalist countries
had mounted to the point that a major American newsmagazine could run as a headline the
question "Who Lost Capitalism?"
Certainly, there is something to be learned from the collapse of the Soviet-type systems, but
what? Is the debate over economic systems over, or has it entered a new phase? Only time
will tell. What we can do in this chapter is look back over the debates in the 20th century, and
review a bit of what economists have learned from them and taught about them. The point of
view will be that of neoclassical economics. (The Marxist view of capitalism is discussed in
another appendix).
Discussions of economic systems have usually focused on the ideal conceptions of the
different systems and on the extent to which the ideal might be realized in the actual systems
of the different countries. One fallacy we want to avoid is that of comparing the ideal in one
case with the actual performance of another. That's not fair and can only lead to confusion.
But ideals can be deceptive -- it is quite possible that one system might be preferable to
another, as an ideal, but so difficult to realize in practice that in actual examples, it is worse.
We shall have to look both at the ideal, and at the obstacles to realizing that ideal in practice.
It is here that we may learn something from the failure of the Soviet-type systems in the
1990's (and perhaps also about the failure of the capitalist systems in the 1930's).
The ideal economic systems have played a part in different ideologies and social movements,
but the ideal systems are not the same thing as the ideologies and social movements. As
economists have conceived them, the ideal systems of the twentieth century have been market
capitalism, government-managed capitalism, central planning, market socialism, and labormanagement. The last three of these have played some part in socialist thinking, in different
times and places, while central planning has also played some part in fascism and, in some
countries, capitalism.
This chapter will focus mainly on the ideal systems and the problems and difficulties of
putting them into practice. Accordingly, we will first quickly summarize market capitalism as
an economic system, largely drawing on ideas in other chapters of this text. We will say a
little about different kinds of capitalism, including government-managed capitalism, and
about the difficulties of putting market capitalism into actual practice, and about the social
movements that challenged capitalism. We will then talk about ideal central planning, the
difficulties of putting it into practice, and about two other non-capitalist ideal systems, market
socialism and labor-management, and the difficulties they, too, face in practice. Finally we
will try to draw some lessons from the collapse of the Eastern European Communist
countries.
Ideal Market Capitalism
In a market capitalist system, capital and land are private property. Enterprises may be formed
by individuals who can get access to land and equipment, either because they own it or can
rent or borrow to get it, and who can hire labor or employ themselves. Enterprises organize
and direct production, and they are operated for the private benefit of the person who
organizes the enterprise. Private benefit is interpreted as profit, so we say that the enterprises
maximize profits.
In a capitalist economy or in any economy, production is limited by existing resources and
technology. We can express this limit with a concept from neoclassical economics: The
production possibility frontier. Once again, we will use the simplified production possibility
frontier for Economia, which produces only machinery and food. Here it is, to help jog your
memory. The idea is that economia can produce any combination of food and machinery on
or below the curve.
Figure 1
The economy can produce only combinations on or below the curve. But what combination of
goods will be produced? Of course, that will be determined by and equilibrium of supply and
demand, but we can skip over a many of the details from chapters 3-14 above. In an ideal
market, production at market equilibrium will give the highest possible market value.
Figure 2
The result is shown in Figure 2. In the Figure, the line indicated by Y1 shows all
combinations of food and machinery that add up to the same market value a value of Y1.
Similarly, line Y2 shows all combinations that add up to a market value of Y2, and line Y3
shows all combinations that add up to a market value of Y3. The slope of all three lines is the
same, and it is the relative price of food and machinery -- the amount of machinery we have to
give up in the marketplace to get one more unit of food. We see that Y2 is the highest market
value that can be produced, and it can be produced only if the combination of food and
machinery is on the production possibility frontier at point *. And it makes sense that an
economic system based on profit would produce that amount. If it did not, some enterprise
would be able to increase its profits by shifting its production toward a higher market value.
But combination * is not just the greatest market value. In the ideal market capitalist system,
the prices reflect consumers' "marginal benefits," and that means that the combination of
outputs at * is efficient.
Of course, there may be other things about capitalism that are more important than this. Some
economists would argue that it is the creative act of forming enterprises and discovering new
technologies that is most important, especially in the long run, and that even a capitalism that
departs quite far from this ideal could still have great advantages. But this discussion
summarizes the argument for market economies in neoclassical economics, and thus it
summarizes the neoclassical ideal conception of capitalism.
Kinds of Capitalism
Enterprises in capitalism as Adam Smith and Karl Marx knew it were typically individual
proprietorships. There were few corporations, and probably none in the modern sense, in
Smith's time. Smith regarded corporations as hangovers from feudal times, and saw no future
for them. This early form of capitalism was proprietary capitalism. One problem for
proprietary capitalism is that these individual enterprises seldom got very large, by modern
standards. This meant that many projects that could have been useful and profitable could not
be undertaken by capitalist firms, because the projects were too large -- there were no
enterprises large enough to afford them. Modern corporations came into existence to finance
and administer these huge projects -- canals, railways, telegraph and telephone systems, gas
and electric power distribution. (Nevertheless, government carried out the large-scale projects
in many capitalist countries). The corporations became more predominant, transforming
proprietary capitalism into corporate capitalism.
The collapse of world markets in the period 1930-1940 threatened to destroy capitalism
entirely. After some delay (and in the context of world war) governments stepped in to
support capitalism by various means of regulation, controlling money supplies, and
government expenditure. Thus, market capitalism was transformed into government-managed
capitalism. Sometimes called a "mixed economy," because it relies largely on markets but
partly also on government to direct the economy, this system has been predominant during the
second half of the twentieth century. Conservatives deplore this, and there have been
conservative governments pledged to return to pure market capitalism, from time to time, in
most major capitalist countries. But they have been unable or, perhaps, finally unwilling to do
it. No matter how ideologically committed, governments have not yet been willing to let
markets find the way, fail if they would, and let capitalism be destroyed by the failure. But
more than that -- in the conditions of the 1990's, it is hard to see how a pure market capitalism
could exist at all. To move toward a more pure market capitalism, it has been necessary to
privatize, reform regulations, and manipulate interest rates -- some of the largest government
initiatives in the history of capitalism. But perhaps the future will be different.
Problems of Capitalism
In ideal market capitalism, the equilibrium outputs are efficient. Efficiency is important, but
there are some criticisms even of ideal capitalism.
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Most fundamentally, the prices in the marketplace reflect consumer preferences. Thus,
in ideal market capitalism, production is directed by consumer preferences. It is not
clear that production should be directed by consumer preference, though. To say that
production ought to be directed by consumer preferences (called "consumer
sovereignty") is a value judgement, not a law of nature, and some people may
disagree with it. Consumer preferences may be determined by addiction and
persuasive advertising. Some may feel that esthetic and cultural values, or national
traditions, should have a bigger role than the market gives them. These ideas are not
by any means limited to those on the left. Traditionalist conservatives might want to
stress traditional values rather than the tawdry vanities of the marketplace. Middle-ofthe-roaders might want to put more weight on things that consumers evidently don't
prefer, objective benefits such as reducing fat and calories and heart attacks, and
increasing vaccinations to reduce infection.
Even in ideal capitalism, the distribution of property and income could be very
unequal. Ultimately, the benefits and costs reflect the subjective preferences of
consumers who have money to spend. One might want to put more weight on the
preferences of people who cannot spend, that is, on the welfare of the poor.
So even an ideal capitalism might have some shortcomings, depending on one's value
judgements. But any real capitalism will fall short of the ideal, and real capitalisms have
fallen short in several predictable ways:
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Monopoly and restricted competition may cause prices and output to deviate from the
efficient ones, and they are likely also to increase inequality, especially if competition
for labor is limited.
Markets may not respond efficiently to cases where costs and benefits are "external,"
and public goods may not be produced in efficient quantities.
Real-world markets may not move toward an equilibrium of supply and demand.
Perhaps for some of the reasons discussed by Keynesian economics, or for other
reasons, markets may settle into stable conditions quite unlike the equilibrium of
supply and demand, and quite inefficient and non-optimal.
One response to these criticisms is that government can step in and correct the failure of the
market to provide the desired and (in some cases) efficient outcome. Governments can
subsidize the poor and can subsidize or provide the goods and services that ought to be, but
are not demanded by consumers, and the government can finance this out of taxes, including
taxes on those goods that consumers demand although they ought not. Monopoly can be
regulated and to some extent prevented through antitrust legislation. Regulation, taxes, and
subsidies can be used to promote efficient outcomes in cases of public goods and external
costs and benefits. Deliberate government spending, tax reductions, and interest rate
manipulation may move the market system toward market equilibrium if it falls short for the
reasons Keynesian economics envisions.
But this is rather a long list of jobs for government, and if government does any large fraction
of them, we no longer have market capitalism but government-managed capitalism. Freemarket conservatives will point this out, and will point out that, however imperfect markets
may be, government too is imperfect. Just as markets will sometimes fail to deliver the
outcomes we want, government too often fails to do the jobs we set for it. What it means in
this context is that some of these failings of real-world capitalism cannot be remedied without
risking a greater evil in government failure, and some cannot be remedied at all. Real systems
are not ideal but imperfect systems, and real capitalist systems will fall short of our hopes on
at least several scores. And that has been no secret for two hundred years.
Challenges to Capitalism
Ideal market capitalism says nothing about social classes. In principle, it might be a classless
society -- that is, a society with only one class, without class divisions . The one class might
be a class of yeoman market farmers. But, in practice, market capitalist societies have been
divided between two classes with quite different conditions: employers and employees. The
tension between the employer class and the class of employees led to socialism, an idea that
arose in the first half of the 1800's. Socialists knew that the old aristocracies, from feudal
times, had ceased to exist as a class. The revolutions and gradual changes of the two centuries
before 1800 had eliminated the special role of the old aristocracy and transformed them (at
best) into capitalist land-renters. The socialists looked forward to a future in which the class
of capitalist employers would also be eliminated as a class, with the former employer class or
their descendants having to work for a living as the vast majority already do. This would be a
society with only one class, the working class; a society without class distinctions and thus a
classless society. In the words of W. Arthur Lewis, a spokesman for the Fabian Socialist
Society in the 1940's (and later a Nobel Memorial Prize winner in economics) socialism is
"democracy and a classless society."
Perhaps we should treat "democracy and a classless society" as a definition of democratic
socialism. Then socialism means just a society with only one class, the working class,
regardless of the system of government. Certainly there were people who favored a dictatorial
socialism, "dictatorship and a classless society." Nicolai Lenin, the founder of the Soviet
Union, was one of them. Their idea was that the dictator would be the voice by which the
working class would express its government of society. There were also libertarian socialists,
that is, people who favored a classless society with the maximum of possible political
liberty.[1] Some of the libertarian socialists were anarchists, who wanted a classless society
with no government at all.
When it is put that way, perhaps the terms "democratic socialist," "libertarian socialist," and
"anarchist socialist" may not seem so strange. Is there something about a classless society that
requires the existence of a government? The only balanced answer is "maybe." All of these
socialist ideas have been controversial from the beginning, and have been critical of one
another. For example, the libertarian and democratic socialists often argued that a dictatorship
could not co-exist with socialism, since the bureaucracy and political groups surrounding the
dictator would eventually form a new exploiting class, and re-establish capitalism with
themselves as the capitalists.[2] This is probably what Lewis had in mind when he included
democracy in his definition of socialism.
The socialists felt that a capitalist society is unavoidably divided between the capitalist
employer class and the working class of employees, so a classless society would have a noncapitalist economic system. But this does not tell us just what the non-capitalist economic
system would be. There have always been several schools of thought on this, among
socialists. Karl Marx and Friedrich Engels, the major theorists of socialism in the 1800's, were
careful not to describe a "socialist economic system" (though they clearly had their own
opinions of what it was likely to be). Instead, their position was that the economic system of a
socialist society should be decided democratically by the workers themselves.
Another element in this mix was communism. Originally separate from socialism, the
communism saw competition as the root of all evils. In the communist society, the economic
rule would be "from each according to his ability, and to each according to his need." But that
rule could not be applied in a capitalist society, because of the defective human character
capitalism produces. Communists believed that human character is formed by the
environment. A competitive environment would cause people to grow up greedy and
aggressive. But, in turn, a population of greedy, aggressive people would create a highly
competitive society, so that their children, too, would be greedy and aggressive. Thus, the
communists saw the social evils of aggression and competition as the result of a vicious
circle. To break the vicious circle, the communists felt that the small, intelligent minority who
understood this truth should take power as a dictatorship, an "educational dictatorship," and
ruthlessly suppress competition, and direct the allocation of resources "from each according to
his ability, and to each according to his need." Thus, over a few generations, a new virtuous
circle might be set in motion, in which sharing and action on behalf of the whole population
would replace greed and aggression as the basis of society and human character.[3]
In "The Communist Manifesto," Marx and Engels tried to bring the socialists and communists
into a common movement with a common program. To reconcile these quite different ideas,
they proposed that socialism -- a classless society -- would be the first stage in a social
evolution that would lead to communism as a later and higher stage, without an educational
dictatorship. Marx and Engels argued that competition could not be eliminated so long as
there is scarcity; but that the socialist society would rapidly increase productivity so that
scarcity could be eliminated, and then "from each according to his ability, and to each
according to his need" could be the rule. Does this make sense? We should not reject it too
hastily. Increasing labor productivity has already transformed society in many ways: just a
few generations ago, most human beings were farmers who consumed most of what they
consumed, and market capitalism was impossible. Increasing productivity made market
capitalism possible. Perhaps it will eventually make communism possible. The reader may
judge these ideas, since "The Communist Manifesto" is still in print.[4]
Yet another challenge to capitalism came from nationalism. Capitalism arose at the same time
as nationalism did, and capitalism could not have come into existence without the national
state. But the national state challenged the capitalist system in two ways. On the one hand,
some nations lagged behind others, remaining poor and agricultural as other nations
industrialized. Some of the relatively poor nations borrowed part of the socialist idea,
changing it and applying it not to a division between classes but to a division between nations.
The real key division was not between classes but between nations, they said, and the poor
nations, the "proletarian nations," had to rely on their national governments rather than on a
capitalist economic system to assure their prosperity. This idea led to fascism in the first half
of the twentieth century and played an important part in the ideologies of some less-developed
countries in the second half of the twentieth century, though (it should be stressed) fascism
and the less-developed country ideologies were very different in some important ways.
But, second, the national state was seen as a vehicle of economic planning. This idea held that
the market economy was unplanned and thus, in some sense, wasteful and misdirected; by
contrast, if the national state were to take over direction of the economy, production could be
carried out on the basis of a coherent plan.
This idea of a centrally planned economy was a very powerful one. It has come to be
associated with socialism and with the failure of the Soviet-type systems in the twentieth
century, but that identification is hasty in a number of ways. It is true that many socialists,
probably a large majority, advocated a centrally planned economic system. They thought
central economic planning fit well as the economic system for the first stage of socialism. On
the one hand, if the government would direct the economy, there would be just one class -everyone would be government employees. On the other hand, a planned economy might (it
seemed) be able to speed the growth of productivity, bringing nearer the transition to
communism. But there might be other ways of accomplishing the same things -- we will
discuss some of them later in this chapter -- so central planning was not necessary for
socialism. Nor was socialism necessary for central planning. A centrally planned economy
might keep and even reinforce the distinction between the working and employing classes,
and, in fact, that was part of the Fascist idea.
In any case, the combination of socialism, communism, and central planning was an idea with
great intellectual power in the first half of the twentieth century, and this idea had
consequences. Accordingly, we will next explore the pure idea of a centrally planned
economy, then look at the real attempts to put central planning into practice in the Soviet-type
and Fascist economic systems, and then finish up by looking at some other approaches to
constructing a classless socialist society.
Central Planning 1
Advocates of central economic planning agreed that the economic plan would be rational, in
some sense that market economies are not. The word "rational" can mean many things.
Neoclassical economists usually interpret "rational" as meaning "optimal;" that is, a decision
is "rational" if it is directed to an objective (or a compromise between two or more objectives)
and achieves that objective (or those objectives) to the greatest extent possible. Thus,
economists have explored the idea of an "optimal plan."
The first step in optimal economic planning, then, is to determine the objective or objectives
the plan is to advance. Since there will almost certainly be more than one objective, the
central planner will also have to determine how one objective is traded off against another -how the objectives are to be compromised, when they conflict. If the planned society is
supposed to be democratic, then these objectives and compromises will be decided by
democratic procedures -- otherwise, by the sovereign authority in an authoritarian system.
Next, it will be necessary to translate those objectives into quantities of goods and services
that will support the objectives to a greater or lesser extent. For example, if health
improvement is a highly ranked objective, then a mixture of goods and services that includes
more medical care and less chocolate will probably advance the objectives of the planners
more than the reverse -- but only up to a point. If production of medical care were to compete
with the production of food, resulting in malnutrition, that mix of production would rank low
in terms of the health objective, and probably others as well. Notice that this judgment is a
technical one. It depends on knowledge of how production of goods and services affects the
objectives. This is a question of fact, and not politics; leaving it to politics, however
democratic, could only cause confusion.
From this point on, most of the decisions to be made in economic planning are like that,
technical rather than political. The next step is to determine what goods and services the
economic system is capable of producing. An optimal plan is one that achieves the objectives
to the greatest possible extent; one thing that limits the possible extent is that the economy can
produce only a limited quantity of goods and services.
Once again, we express this limit with the production possibility frontier, as in Figure 1
above. This limitation on what can be produced with scarce resources is what forces the plan
to compromise between the various objectives the planners might pursue.
But the first step for Economia's planning bureau (we recall) is to determine what its
objectives are, and to express those in terms of quantities of food and machinery produced.
Let's suppose the planning bureau's objectives are expressed by the gray curves in Figure 3.
The idea is that every combination of food and machinery expressed by a point on the lowest
curve meets the planning bureau's objectives to the same degree, and that is a fairly low
degree. Every combination of food and machinery expressed by a point on the highest curve
equally meets the planning bureau's objectives to a relatively great degree. Every combination
of food and machinery expressed by a point on the middle curve meets the planning bureau's
objectives to the same, fair-but-not-great degree. Combinations of food and machinery on a
higher curve meet the planning bureau's objectives more completely than those on a lower
curve. In brief, the planning bureau wants to place the economy on the highest curve that it
can -- and that is what the curves express. The curves are one way to express the planning
bureau's objectives in terms of production. (There could be many more curves -- infinitely
many). These curves express the Planners' preferences.
Figure 3
Visually, the highest curve the Economian economy can get to is the middle one, and to do
that the planning bureau has to plan for the production of the combination of food and
machinery shown by the *. That is the optimal plan. But how is the planning bureau to move
the economy toward that optimal plan? If they simply had all the necessary information, and a
very powerful computer, perhaps they could simply tell each farm, workshop and office -that is, each enterprise in the economy -- what to produce and where to ship it. (This is called
the double address system -- each directive is addressed to the enterprise that is to produce the
good or service and also to the enterprise, perhaps a retail store, that is to receive it). The
difficulty is that the planning bureau is not likely to have all the information it needs to do
this. It may direct some enterprises to produce much more than they are capable of producing,
with the resources supplied, and others to produce much less, so that most of their resources
go to waste. In general, the managers of the enterprises will probably have a better estimate of
what they can produce than the planning bureau has, and of the resources necessary to
produce it. How can the planning bureau function, in such a case? How can they get the
information they need?
Central Planning 2
Once again, how can the planners get the information they need?
One possibility is to ask the enterprise managers how much they can produce. Let's make the
optimistic assumption that the enterprise managers will tell the truth -- either because they are
nice guys or because the planning bureau has found some costless way of giving them an
incentive to tell the truth. The planning bureau could start out by sending the enterprise
managers a tentative list of outputs to produce, and ask the enterprise managers how much
resources they would need to produce that list. Then add up the resource demands and
compare them with the resources available. Adjust the tentative plan accordingly, and try
again. Keep trying until the plan is (pretty close to) optimal. Each of these tentative lists of
outputs is called an "iteration" of the plan.
Figure 4
Figure 4 shows one possible series of iterations of the plan. The bureau starts out
optimistically with a tentative plan at A. Looking at the diagram, we know that A is
infeasible. That means the enterprises' resource requirements will add up to more resources
than are available. Adjusting, the planning bureau follows up with B. That doesn't really help
-- B is infeasible, too -- but with the information they have gotten from the enterprises on
these two attempts, the plan bureau is able to make its third iteration C. That is an
improvement -- C is feasible -- but C is not efficient, since enterprises are capable of
producing more than C with available resources. On the next round, then, the planning bureau
scales up the production amounts to D. This is better still -- D is efficient, that is, on the
production possibility frontier -- but it is not optimal. With the available resources, the
planning bureau would prefer to see more machines and less food produced. By now,
however, the planning bureau has gotten the information they need, and on the next iteration
they move up the production possibility frontier to *, the optimal plan. This is the plan they
direct the enterprises to carry out.
This is a very optimistic story. There are many pitfalls that could make it difficult to move
to an optimal plan, and further problems in making the plan work even if it were optimal.
Even if the enterprise managers tell the truth, it might take many costly iterations of the plan
to get to the optimum at *. Worse, the enterprise managers have strong incentives to lie and
distort their productive potential and resource needs. Suppose that I am an enterprise manager,
and I guess wrong, thinking that I can produce 2000 with 500 of resources. In reality, I can
only produce 1000. So the planners send me 500 of resources, and an order for 2000 olf
output, and when I try to do it, I find I cannot produce what I have been ordered to produce.
By the time I have found out, I'm in trouble. On the other hand, if I had lied, telling the
planning bureau that I could only produce 500, then the 1000 actual production would leave
me in very good shape. I would probably only send in 700 or 800 of my production, hiding
the rest in case I should have some problems next year. On the other hand, the planning
bureau may have other information. In most cases, they can take it for granted that the
quantities produced in earlier years are feasible, and they may be able to use statistical,
engineering and computational techniques to fill in the information they don't get from the
enterprise managers.
Then again, even if the plan is optimal -- by the preferences of the planners -- the consumers
may not be very happy with it. If the planning bureau tells the enterprises to produce one
finger brush per person, the chances are that the consumers won't buy them all at any price,
nor use them even if they are free.
Nevertheless, we cannot rule out the possibility that an optimal planning system might be set
up, might be successful, and might improve human life from many points of view. The
problems that would have to be overcome are difficult ones, and no-one knows now how to
resolve them. But human beings are inventive, creative beings, and it may be that future
generations will come up with solutions that we cannot now conceive.
Socialism and Planning
As we have seen, many socialists saw a planned economy as a means for the economic
organization of a classless society. Everyone would be of the same class -- government
employees. One of the clearest and most complete proposals along these lines came from the
Fabian Socialist Society in Great Britain, under the leadership of Sidney Webb, in the first
half of the twentieth century. Webb envisioned a socialist country with a democratic
parliament, much like the British one in his time. Once the government had taken over the
control of production, the management of enterprises would become part of the civil service.
The various branches of production would be organized as "ministries of production,"
alongside the ministries of education, health, war and so on. For example, there might be a
ministry of agriculture, a ministry of mining, a ministry of heavy industry, of computer
hardware, of computer software, and so on. The planning bureau would then work rather like
a cabinet committee, coordinating the plans of the different ministries of production.
That sort of "democratic socialism" has never been tried in an industrialized country. Perhaps,
if it had been tried, it might have worked -- though, as we have seen, the obstacles are pretty
discouraging, and no doubt that is one reason why it has never been tried.
However, the Soviet Union adopted a system based on it, roughly from 1930 to 1989. The
Soviet Union had come into existence in the Revolution of 1917 that destroyed the Russian
Empire. Nicolai Lenin (aka Vladimir Ilich Ulyanov) made himself its dictator and was
succeeded by Joseph Stalin. Under Lenin's government there were a series of experiments in
economic organization; but Stalin adopted something like the system Webb had proposed.
The Soviet legislature was not the democratic parliament that Webb had in mind -- although
at one point Webb managed to persuade himself that it was close enough. However, in the
context of a dictatorial political system, the Soviet Union did organize its different branches
of production into ministries, making the managers part of the governmental "apparatus."
They did also adopt a system of planning that involved tentative plans and repeated iterations,
along the lines described in the last system. (In fact, that discussion was suggested partly by
the historical Soviet planning system.) However, they never really tried to get to an optimal
plan. Indeed, they don't even seem to have tried to make the plan efficient. In terms of Figure
3, if they got to a feasible plan -- something like point C -- there was little effort to move to an
efficient point like D, and no effort to get to an optimal plan like *. It is not clear that the
Soviet planners even understood the concept.
We should keep in mind that, at the beginning of the Soviet planning system, there were no
computers. The Soviet civil service and business management were backward, even by
noncomputerized standards. In its earlier period, the Soviet government was quite terroristic,
and in the later period corruption became the major factor in the economy. For these reasons,
some may judge that the Soviet experiment was not a fair trial of the ideal of economic
planning. Some very fine American neoclassical economists have believed that a highly
computerized late twentieth century industrialized economy could make planning work, even
though the Soviet Union could not. All the same, it has yet to be demonstrated.
More "Planners"
Fascism
Fascist political systems were not designed to create a classless society, but a new class
system, a "new order," with the fascists themselves (of course!) at the top. Fascists claimed
that class differences were not important, but that the important struggles and exploitation
were relationships among nations. Some nations were "proletarian nations," exploited by
other nations, because of historical accidents or of treachery by some part of their own
populations. But a superior nation, with a strong, absolute leader and with a great
revolutionary act of will, could reverse that, making itself a new national ruling class over its
former oppressors and over the whole world. This would be the "new order."
What reason might an "oppressed nation" have to think that it might really be possible to
conquer its neighbors and oppress them in turn? In the 1920's and 1930's, the Fascist nations
found historical precedents to convince themselves. For Japanese fascism, the precedent was
relatively recent. Only a few hundred years before, their neighbors the Manchu people had
made themselves the rulers of China -- that is, all of the world that really mattered from the
Manchu point of view in 1600. For Italian fascism, there was the Roman Empire. The
ancestors of the Italians themselves had, two millennia before, dominated (almost) all of the
world they could reach. For the Germans, the case was more difficult. Their ancestors had
once overcome half of the Roman Empire (but then divided among themselves and given
most of it up to others) and, a few hundred years later, German knights had dominated many
of their neighbors. But that is thin stuff, so the German Fascists claimed that the Germans
were really Aryans, who had (they supposed) conquered pretty much everything, just a few
thousand years ago. This idea that the clock could be turned back to a time when Our Nation
Ruled the World was an important part of Fascism.
Fascists were contemptuous of profit motives, and aimed to subordinate all other purposes
(including profit) to the national objectives of victory over other nations. Thus, they rejected
market systems in principle, and officially established "planned economies." In practice, they
fell even further short of "optimal planning" than the Soviets. (Since the Fascist powers were
able to survive for only about 20 years before being conquered by the Soviets and the
democracies, perhaps they just didn't have time to get it working). Although terroristic, their
"economic planning" was, at the same time, disastrously corrupt. Far from subordinating the
profit motive to national purposes, the Fascist system seems in practice to have subordinated
terroristic national government to the corrupt profit motives of the Fascist party leaders. This
so weakened the Fascist nations that they were defeated despite having very good armies in
some cases.
It is hard to say this -- given the evil that Fascism has done in this century -- but perhaps we
can conceive a Fascist system that would not be avoidably oppressive, terroristic, or warlike.
Perhaps we can conceive of an upper class distinguished mainly by its support for traditions
that a large majority support. (For myself, I don't believe it is possible, but let us set my
doubts, and perhaps yours, aside). It makes sense that a government of this kind would not
rely on the untraditional forces of the market to control production. It might adopt a system of
central economic planning, with objectives based on its traditionalist views. Like a
hypothetical future socialist system, it might even make central planning work, in the service
of a class-based and antisocialist ideal. Many things are possible. Time may tell.
Emerging Nations
The most dynamic Fascist governments were destroyed by their defeat in World War II. After
World War II, the colonial governments of many countries of Africa and South Asia were
eliminated. These countries, and the poorer Latin and Caribbean countries of the Western
Hemisphere, often saw themselves as the victims of exploitation by other countries -- and
their colonial history gave them some reason for that view. Many of these "emerging nations"
moved toward a considerable degree of government control of the economy and planning.
Many called their system "socialist." In practice, their planning tended to be patterned after
that of the Soviet Union, but large parts of the economy remained outside both the plan and
the market. Also, some of the governments were far more democratic than the Soviet Union,
and even those that were not much more democratic were less powerful. On the other hand,
they were even less prepared than the Soviet Union had been for the technicalities of optimal
planning. More recently, market-oriented systems in less developed countries have been more
successful, and, following that example, socialist "emerging nations" have tended to move
toward market systems.
Market Socialism
After the beginnings of the twentieth century, neoclassical economics became better known,
and socialists such as the Polish Marxist Oscar Lange were aware of the theory that market
equilibrium could lead to an efficient allocation of resources. If planning should prove too
difficult (they argued), a government-controlled economy could be run according to the same
principles of supply and demand.
Remember, for the socialists (not the communists) the main thing about government
ownership of enterprises was that it was a way of organizing a classless society. Enterprises
should be owned by the government, not by a class of capitalist employers; and everyone
should be an employee. But this does not quite mean that the economy is directed by the
government. In a "market socialist" society, enterprises would be owned by the government,
but independently run by appointed managers. The managers would be instructed to direct the
enterprises in such a way as to maximize profits, at market prices, as (in theory) the directors
of capitalist enterprises do. Thus, the various enterprises would adjust their production to an
equilibrium of supply and demand. The allocation of resources would be efficient, as in the
ideal market capitalist system. Since the profits would revert to the government, as owner,
they could be distributed to the poor (or to everybody) as a "social dividend." Thus, a market
socialist society would be an efficient, classless market society with a lower limit on income
and thus no extreme poverty.
This is a very appealing ideal from the viewpoint of neoclassical economics. A few
neoclassical economists, driven by logic rather than socialist convictions, endorsed market
socialism as simply a superior economic system. However, as with all the ideals, there may be
problems in practice.
Problems of Market Socialism
A system of independently managed government-owned enterprises maximizing profits at
market prices would run into some of the same problems that market capitalism would. Like
market capitalism, the values it would realize would be consumer preferences, not other kinds
of values that some may feel are "higher." Monopoly and externality could also be problems,
and perhaps "Keynesian" failures to employ the labor force might occur. Thus, in practice it
would be necessary for a market socialist society (like a market capitalist society) to mix in a
good deal of government control of the economy. On the other hand, centrally planned
economies always had some markets. Thus, it might be hard, in practice, to find the boundary
between real market socialism and real government-controlled socialism. During its period of
communist government, the Hungarian Republic adopted reforms that made it a fair
approximation to "market socialism," and the criticisms of market socialism in Hungary
suggest a more general obstacle to market socialism.
The technical term is "soft budget constraints." The meaning is simpler than the term. If a
government-owned enterprise should overspend its budget and lose money, what would
happen? In practice, government would not allow the enterprise to fail, but would instead
"prop it up" with subsidies and "bail it out" with more wasteful government capital
investments. Thus, government-owned enterprises that really should be liquidated would
never be liquidated, but would continue to exist, eating up government subsidies. Perhaps
even worse, enterprises that could shape up and improve their efficiency would have no
incentive to do so. As long as you can fall back on government subsidies to make up losses,
why go to the trouble to improve efficiency? (After all, one way to increase in labor
productivity is to eliminate your job).
But soft budget constraints are not a market socialist exclusive. Despite the abolition of
communism in eastern Europe, "soft budget constraints" are still a problem there, according to
many of the pro-market economic reformers. And, indeed, governments have been known to
"bail out" enterprises with government investment and to "prop up" losing enterprises with
subsidies even in countries which have never been socialist in any sense. Here in the United
States, some losing Savings and Loan Companies were "bailed out" with government
investments in the 1980's, and some of the beneficiaries were the relatives of prominent
politicians of both major parties. The problem seems to arise unless the control of enterprises
is distinctly separated from the control of government. When the government owns the
enterprises, or the owners of enterprises control the government, "soft budget constraints"
become a problem.
However, it is plausible that a real-world "market socialist" system would be especially
vulnerable to the "soft budget constraint" problem, since the enterprise is government owned,
the manager a political employee, and a separation between the control of enterprises and the
control of government is especially difficult to establish.
Labor-Management 1
Before the Russian Revolution in 1917, there were a number of schools of thought in
socialism, as we have seen. Some were opposed to government control of the economy, and
some were opposed to the existence of government at all -- they were anarchists. Thus, they
opposed government control of the economy, and opposed economic planning in that sense.
Instead, they proposed that the economy should be controlled by the working people
themselves, in the individual workshops, factories, and offices. Their idea was that each place
of employment should be a little democratic republic, with the employees electing the bosses
and determining the basic policies of the enterprise by majority voting. In the twentieth
century, the ideal of a market economy with labor managed enterprises has been followed by
one country, Yugoslavia, and has been advocated by some economists and others.
We may think of labor-management as a form of market socialism, with the difference that,
rather than being managed by government appointees directed to maximize profits at market
prices, labor-managed enterprise would be managed by a person elected by the employees and
directed to manage the enterprise in their interests. Ideally, then, the control of enterprises is
distinct from the control of government, and we might hope that "soft budget constraints"
might not be so much of a problem.
While Yugoslavia is the only country that has ever attempted to base its economic system on
labor-managed enterprises, many labor-managed "cooperative" enterprises have existed in
generally capitalist countries, and they have been successful in many cases. Some also existed
in Soviet-type economies. In the German Federal Republic, some large enterprises have been
required for generations to allow the employees to elect one-third to one-half of the members
of their boards of directors, introducing a democratic element into the operation of capitalist
corporations. This, too, has been successful. So there is a good deal of experience in the
operation of democratic enterprises, in and of themselves, and the proposal that enterprises
could be run democratically is by no means visionary.
But who would "own" labor-managed enterprises? If the system is to be socialist, then they
cannot be owned by a capitalist class. Most advocates of a socialist system with democratic
firms would say that the enterprises themselves, and their machinery and factories and
workshops, should be "social property," the property of society. But what does that mean?
One possibility is that the enterprises could be the property of the state, with the state acting
as the agent of society. This comes even closer to market socialism, but it also poses the
question of keeping the control of enterprises clearly separated from the control of
government and eliminating "soft budget constraints." An alternative approach to "social
property" has been suggested in these pages, but it is untried in practice. In the alternative
approach, organizations such as workers' pension funds and endowment funds for socially
useful activities such as free hospitals and fire protection would be recognized as agents of
society and could be owners of social property. But "what could social property mean?" will
have to remain an open question for now.
Labor-Management 2
What can we say about efficiency in a labor-managed socialist market economy? Beginning
in the late 1950's, a number of economists explored that question. As in the neoclassical
theory of capitalism, they began from the assumption that the enterprise would maximize
something. If it is managed in the interest of the employees, the enterprise would not
maximize profits, but it might maximize income per employee. That is the assumption with
which we begin. Next, we make the usual assumptions of "perfect competition:" all inputs and
outputs are homogenous, including labor, and prices of all goods and services are determined
by supply and demand. Wages are not determined by supply and demand, however -- the
enterprise' wage is simply its average sales revenue per worker.
Figure 5
We can visualize the difference between an ideal labor-managed enterprise and an ideal
market capitalist enterprise in Figure 5. The downward sloping line VMP is the value of the
marginal product curve -- the price of output times the marginal product of labor. The curve
AR is the average sales revenue per employee, excluding the costs of inputs other than labor - the price of output times the average productivity of labor, net of the fixed costs of
production. The line OC is the opportunity cost of labor -- the market value of the marginal
product of labor in other industries. Thus, in an ideal market capitalist system, OC is the
wage, and the enterprise would employ N2 units of labor. By contrast, the labor-managed
enterprise will employ only N1, since income per employee is largest with N1. This is
inefficient. There has been a good deal of controversy about this analysis, but what it seems
fair to say is this: in at least some circumstances, a labor-managed enterprise would have a
motivation to restrict its hiring to a work force smaller than the efficient size.
This applies only in the short run. We know that this result would not be stable in the long
run, in an ideal market capitalism, since the enterprise is making an economic profit. That is,
there is revenue in excess of the labor cost and also in excess of the nonhuman costs (because
of the way the curve AR was constructed). Therefore, with free entry, more companies will
enter this industry and compete for some of those profits. So the price will drop, and the AR
will shift downward until we have the situation shown in Figure 6:
Figure 6
What we see in Figure 6 is that, in a long-run equilibrium, the capitalist firm and the labormanaged enterprise employ the same labor force, N1. Since we know this is efficient, we see
that the labor-managed enterprise, like the market capitalist enterprise, is efficient in long-run
equilibrium.
Problems of Labor-Management
In comparing ideals, then, we may say that the labor-managed enterprise may be somewhat
less efficient in the short run, but equally efficient in the long run. But there are practical
difficulties on both sides. In the labor-managed enterprise, we may have higher labor
productivity because the employees feel they are "working for themselves." Many economists
have expressed skepticism about that, but a mind as great as that of John Stuart Mill accepted
it. In any case, it is a question to be decided by the evidence, and the evidence is that labormanaged enterprises do attain higher labor productivity than capitalist-owned (or governmentowned) enterprises in comparable circumstances. Thus the inefficient labor-managed
enterprise may actually produce more than the efficient capitalist enterprise! (With more
output per worker, a smaller work force might produce a larger output). This is not shown in
the diagrams, of course. On the other hand, the actual labor-managed enterprise may do less
well than the ideal one in the long run. Long run equilibrium comes about through free entry.
The ideal labor-managed economy would have free entry, in that new enterprises may be set
up to compete for the wages above the opportunity cost that we see in Figure 5. But a labormanaged enterprise is a bit more complicated than a capitalist firm, and so it could be more
difficult to set them up. Thus, we have to worry about whether enough new labor managed
enterprises will be set up to bring the labor-managed economy into long run equilibrium.
In addition to these practical difficulties, a labor-managed market economy would face the
problems of any market economy: What some see as the tawdry values of the marketplace,
monopoly and externality, and possibly "Keynesian" unemployment. In addition, the unclarity
of the concept of social property has been a crucial difficulty. Yugoslavia, which had labormanaged enterprises for several decades beginning in the 1950's, never really decided this
issue. At the beginning, the government was the owner as the agent of society. Later on,
attempts were made to modify this, but no-one ever really knew what the rules of the game
were.
The Collapse of Communism
After 1989, the Soviet Union and the other European countries with "planned" economies
(that is, the Soviet-Type Economies) experienced a period of troubles of various kinds, and
largely abandoned both the planned economy and the aims that define socialism and
communism. It seems to be widely believed that this proves that a planned economy cannot
succeed. However, a careful look at the evidence suggests that this view is oversimple.
Figure 7 below shows the economic performance of four groups of countries for 1960-1989,
the generation just before the collapse of the Soviet-type countries. Each curve shows gross
domestic product per person (GDP per capita), adjusted for inflation and international
differences in purchasing power, as a proportion of the country's gross domestic product per
capita in 1960. Thus, they all begin at one in 1960 and rise as the country's GDP per capita
increases relative to the starting point. These data are taken from the Penn World Tables and
represent the best estimates of production from the neoclassical economic point of view. The
red line shows the average for four countries with Communist governments : the USSR,
Czechoslovakia, Romania, and Yugoslavia.[5] These are the only four for which the Penn
World Tables have data for the full period. The blue line shows the average for four very
successful industrialized capitalist countries: the U.S.A, West Germany, Japan and Britain.
We see that, by the standard of economic growth, the Soviet-type countries did better than the
capitalist ones. On the whole, the Soviet-type countries increased their GDP per person by 3.3
times, while the capitalist countries increased their performance by 2.74 times. If the cause of
the collapse of the Soviet-type countries was their economic performance, we might suppose
that the capitalist countries would have collapsed too; but they did not.
The green line shows the performance of the "four tigers:" South Korea, Taiwan, Hong Kong
and Singapore. Their performance is clearly a good deal better than the others -- they doubled
the growth of the Soviet-type countries (actually growing 2.08 times as much in the period)
and much more than doubled the performance of the four large capitalist countries (growing
2.61 times as much in the period). This group of countries, however, was very unusual. Two
(Hong Kong and Singapore) were city-states. Had they included the surrounding agricultural
regions, they would not have done as well. The other two were the beneficiaries of very large
amounts of American economic and political assistance. This is not to detract from their
performance. They were among the most successful countries in the world -- thus not
representative of either capitalist or Soviet-type countries.
The magenta line at the bottom shows the average growth performance for four lessdeveloped countries: Algeria, Zaire, Brazil, and Indonesia. This group includes one of the
worst performers in the world: Zaire. However, 1) even without Zaire, the other three
countries do not quite double their per capita income over the period, coming in solidly last,
and 2) Brazil and Indonesia are strong performers, for their group, that have been mentioned
as emerging industrial countries in the 1990's. Over the period, Algeria did about as well as
Indonesia did. Thus, except for Zaire, these countries would hardly be considered economic
failures, by the standards of less-developed countries. But the Soviet-type countries easily
tripled the performance of the LDC's, with or without Zaire.
Figure 7
This does not really disprove the view that the planned economies were economic failures. A
more careful examination of the evidence might show up a different kind of evidence that
could support that view. But there is another hypothesis about their collapse that fits this (and
other) evidence better: that the collapse of the communist countries was a result of the failure
of their political systems, and that it was political failure that caused the economic problems,
and not vice versa.
Indeed, why would this be a surprise? Absolute and totalitarian governments have been
collapsing throughout the twentieth century. The great lesson of the twentieth century is that,
in modern conditions, democracies endure and authoritarian governments eventually fail.
However, it does seem that a political collapse can cause even greater problems when the
economy is planned than when it is a market economy. This is a major weakness of economic
planning.
The key fact is that the Communist countries did fail, and they failed in several different
ways:

The overall statistics conceal the fact that some kinds of production were very
unsuccessful. For example, agriculture in the Soviet-type countries clearly failed, and
failed because of the collective and state farms and nonmarket systems the
government imposed on the farmers. Ironically, it is agriculture that has remained least
affected by the so-called market reforms of the 1990's, and agriculture is still dismally
unsuccessful in the post-Soviet countries. (The Chinese People's Republic, more
wisely, began its market reforms by turning agriculture over to the farmers, and this
smart move gave them the boom they have enjoyed in the generation since.) Similarly,
the collapse of human services, such as health and child welfare, in the Soviet
republics and Romania is notorious.



They failed as planned economies. As we have seen, the Communist countries never
really tried to put an optimal plan into effect. In addition, neoclassical economics tells
us that there are some problems that a planned economy could do better with than a
market economy. These are problems based on externalities -- which includes
environmental problems. But the Soviet-Type economies did even worse on these
problems than the market economies did.
They failed as socialists. Just as the critics of "socialist dictatorship" predicted, the
political groups associated with the dictatorship became a new exploiting class and reintroduced capitalism, with "privatization programs" designed to make themselves the
new capitalists. But, in the Russian Republic, they found the gangsters had gotten
there before them. The struggle between the former Communists and the gangsters for
control of the Russian economy has not yet been decided.[6]
They failed as communists, since their dictatorship did not eliminate competition, but
replaced market competition with bureaucratic competition, which is at least as bad.
There is no evidence that they were setting the stage for a new generation that had
learned not to be greedy and aggressive, and, if anything, it appears that they had done
just the contrary -- taught their leaders to be even greedier and more aggressive than
capitalists are!
Thus, while it is not so clear that the planned economies failed in terms of neoclassical
economics, it is quite clear that they failed according to their own values -- and this seems to
be the most important thing.
Summary
Of all the ideal systems that have engaged the attention of political movements during the
twentieth century, it seems the ideal of a government controlled and centrally planned
economic system has been the most influential and the least successful. Market systems have
been predominant in most of the world, but the ideal of a market system has become
politically dominant only late in the century. The collapse of totalitarian governments in
countries with central planning has been widely blamed on the inadequate performance of
central planning, but this seems a hasty judgment. The timing is wrong. The centrally planned
countries had economic problems from the start, in fields such as agriculture, and their
performance deteriorated steadily in some other areas; but despite this they were able to keep
up economic growth at a more rapid rate than the capitalist and less developed nations until
the collapse of their political systems. It was this political collapse that caused their
transformation, and it came about because the ruling groups themselves lost confidence in the
political system they led. But a more detailed look at the performance of these countries is not
encouraging. They did fail in many ways, long before their political collapse. The character of
these failures may not be especially important from a neoclassical point of view. From that
point of view, a high rate of economic growth can redeem most other shortcomings. But from
the point of view of the values that led socialists to support economic planning, the failures of
the Soviet-type economies were damning. They did not support human services and substitute
human values for the tawdry values of the marketplace. They did not build socialism nor
communism. They simply made themselves the new exploiting class, and, finally, the new
capitalist class. And even that they have done badly, so far. The other practitioners of
economic planning, the fascists and "socialist" emerging nations, did even worse from the
neoclassical point of view. So, while we must admit that some future society may make an
all-around success of economic planning, since it is hard to judge what may happen hundreds
and thousands of years in the future, there is good reason to doubt that people now living will
see successful economic planning.
The other ideal systems, market socialism and labor management, have been given less
complete trials. By the same token, they remain somewhat abstract and incomplete in their
conception. If we are to see successful systems of market socialism or labor management or
some combination of both in the future, there are still details to be worked out. How can
enterprises be government-owned and the government not "bail them out" with subsidies if
they fail? And if labor-managed enterprises are not to be government-owned, who shall own
them? What can "social property" mean? For those who want to see a class-less society, those
will be difficult problems to solve, requiring a good deal of thought, trial and error. For those
who see no need for a class-less society, they will seem to be fatal flaws in socialist thinking.
Time will tell the answer, and perhaps some of us will live to see it.