Overview of Comparative
Economics
Chapter I
How do we compare economies?
1
Criteria for Classifying Economies
How do we classify economies?
2
Institutional Mechanisms






Allocation Mechanisms
Forms of Ownership
Role of Planning
Types of Incentives
The method of Income Redistribution and
Social Safety Nets
Role of Politics and Ideology
3
I. Allocation Mechanisms



What good and services are produced?
How goods and services are produced?
For whom goods and services are produced?


Production → allocating factor inputs
Distribution → allocating produced goods and service
Three basic kinds of allocation mechanisms:
1. Traditional Economy
2. Market Economy
3. Command Economy

4
II. Forms of Ownership
Who owns the means of production?
 In capitalist economies, land and produced
means of production (capital stock) are
owned by private individuals or private firms
(Market Capitalism)

In socialist economies the state owns the
land and the capital stock (Command Socialism)
5
II. Other Forms of Ownership



Intermediate forms of ownership (like
cooperatives or worker ownership)
Under socialism: central government vs local
government ownership
Religious groups’ ownership
6
II. Forms of Ownership
Market Capitalism vs Command Socialism
 United States vs Soviet Union
ALSO
 Market Socialism vs Command Capitalism
 Yugoslavia and China vs Nazi Germany

7
III. Role of Planning


Centrally planned economy → planners’
preferences dominate allocative decisionmaking
Market economy → consumers’ sovereignty
dominates allocative decision-making
8
III. Role of Planning

Centrally planned economy is usually
correlated with command socialism
(Soviet Union, there are exceptions –command
without planning → Soviet Russia during 1910s and
1920s)

Market economy is usually correlated with
market capitalism (there are exceptions—indicative
planning → France and Japan)
9
IV. Types of Incentives

Material Incentives → paying people
according to their productivity (their marginal
product that maximizes profits for competitive
firms hiring labor in such a system)


Under capitalism → takes the form of rewards for
entrepreneurship and capital investment as
economic profits
Moral Incentives → trying to motivate workers
by appealing to some higher collective goal
10
V. Income Redistribution and Social
Safety Nets


Social Market Economies (or some advanced
capitalist countries) → do their income
redistribution through social safety nets
Command Socialist Economies → did not
have to redistribute income → their
governments controlled the distribution of
income by setting wages and forbidding
capital or land income
11
VI. Role of Politics and Ideology
Central controversy
 Is democracy linked with market
capitalism???
 Is authoritarian regime linked with command
economy???
12
VI. Role of Politics and Ideology


Friedman “libertarian” laissez-faire → lack of
individual freedom
In democracies, social democrat parties exist
(like Sweden)



They support income redistribution and extensive
social safety nets
They support nationalization and central planning
They do not support dictatorship
13
VI. Role of Politics and Ideology



Authoritarian political regimes pursued market
capitalism (East Asia and Latin America)
Market capitalism is not a guarantee of political
democracy
Islamic Fundamentalism



Imposition of an Islamic code-Shari’a
It is not a liberal democracy → individual rights and
freedoms are subordinated to a Shari’a and the religious
authorities
Economically it does not follow neither capitalism nor
socialism
14
Overview of Comparative
Economics
Chapter II
Market Capitalism
15
Market Capitalism



Form of Ownership → Most of the time land and
produced means of production (capital stock) are
owned by private individuals or private firms
Role of Planning → Market capitalism is usually
planned by the market (with demand and supply)
Material Incentives → In market capitalism material
incentives exist in forms of rewards for
entrepreneurship and capital investment as
economic profits
16
Market Capitalism


Income Redistribution → is usually done
through social safety nets in market
capitalism
Role of politics and ideology → Are market
capitalist countries mostly democratic?

Social democrat parties exist in market capitalist
countries supporting income redistribution,
extensive social safety nets, nationalization and
central planning
17
Why market capitalism popular?


End of communism →most former
communist countries are concentrating on
market capitalist economic systems
Predominantly market capitalist economies
are making efforts to move toward a purer
version of this system
18
Advantages and Disadvantages of Market
Capitalist Economies

Experienced enormous technological
advances and growth as they underwent the
Industrial Revolution in the late 18th century


“ability to revolutionize the means of production”
Experienced large macroeconomic
fluctuations with serious downturns in the 19th
century (unequal distribution of income and
increasing concentrations of industrial
monopoly power)
19
Pure version of market capitalist system


Pure version of market capitalist system does
not exist
Closest to the ideal of pure laissez-faire
market capitalism are:



Hong Kong
Singapore
New Zealand
20
Efficiency

Static efficiency → no one in society can be
made better off without making someone else
worse off


resources are being utilized to their best potential
given the existing technology
Dynamic efficiency → allocation of resources
over time to maximize long-run sustainable
growth


technological dynamism
destabilizing process of “creative destruction”
21
Theoretical Efficiency of Market
Capitalism

Efficiency Theorem

The general ability of markets to allocate goods
and resources efficiently through the law of
supply and demand
 A complete
 competitive
 full-information
 general equilibrium is efficient
22
Theoretical Efficiency of Market
Capitalism

Complete


For any good or service that affects someone’s
utility, there is a market
Competition



There are many buyers and sellers with free entry
and exit
There are well-defined homogenous goods and
services
No individual supplier has any control over the
price in his or her market
23
Theoretical Efficiency of Market
Capitalism

Full information


All agents in the economy know everything about
consumer preferences, production technologies, and prices
General equilibrium


Every single market is in equilibrium in the sense that the
quantity supplied equals the quantity demanded of the
good or service
If that does not happen:



Surplus
Shortage
Partial equilibrium with a few markets being in equilibrium
24
Theoretical Efficiency of Market
Capitalism

Efficiency


Pareto optimality→ no one in the economy can be
made better off without making someone else
worse off
If someone can be made better off without making
someone else worse off, then the economy is not
producing as much as possible of what people
want
25
Why is a complete, competitive, full-information,
general equilibrium efficient?



Adam Smith’s invocation of invisible hand of the
market working across all sectors to allocate goods
in a way that maximizes the “wealth of the nations”
He founded classic laissez faire economics
He argued that the government should get out of the
economy (minimal government intervention)

It is at the equilibrium price that the maximum amount
will be both produced and sold and thus actually
consumed by public
26
Invisible Hand





In the free marketplace an “invisible hand”
regulates and self-corrects the economy
The market itself will regulate the economy
Efficient producers will prosper and the
inefficient producers will lose
The public will get the best product for the
lowest price
Supply and demand will determine prices
better than any government official can
27
Limits to the Efficiency of Laissez-Faire
Market Capitalism




Monopoly Power
Externalities
Collective Consumption Goods
Imperfect Information
28
Source of Inefficiency:
Monopoly Power
Monopoly power prohibits competition
 Monopolist will maximize profits by setting marginal
cost equal to marginal revenue
Exceptions:
 Natural monopoly



Characterizing an industry with economies of scale
(declining LRAC) even at level of output equal to total
market demand
Technological dynamism

More competitive industries will be more technologically
progressive
29
Source of Inefficiency:
Monopoly Power

Intermediate market forms

Monopolistic competition



Many firms, each having some price setting power as a
result of product differentiation
Excess capacity theorem
Oligopoly


Small number of firms in industry with reaction to any
action taken by others
Perfect collusion


Joint-maximizing cartel (OPEC in oil crisis)
Longest surviving cartel?
30
Source of Inefficiency:
Externalities

These are either costs or benefits that are
born by or accrue to an agent other than the
agent generating them


External costs negative externalities
External benefits positive externalities
31
Source of Inefficiency:
Externalities

External costs are negative externalities,
such as environmental pollution

If the firm that generates pollution damages
another industry but does not reduce that damage
→ the private marginal cost to the firm does not
equal the social marginal cost and too much
pollution is produced, resulting in inefficiency
32
Source of Inefficiency:
Externalities

External benefits are positive externalities,
such as technological invention without patent
protection for inventors


If an inventor has no patent protection, then other firms can
steal her invention and she may make no money even if
her invention generates great social benefits
Private marginal benefit to the inventor does not equal
marginal social benefit of the invention and too little
inventing will occur, resulting in inefficiency
33
Source of Inefficiency:
Collective Consumption Goods

Consumption goods=public goods → such as
national defense


Because of the nature of such goods, it is difficult for
private markets to organize themselves to provide these
goods in optimal quantities
The characteristics of pure public good:


Nonexcludability of consumption: It is not possible to
exclude this kind of consumption
Nondepletability of consumption: Everyone consumes it
simultaneously, and no individual’s consumption reduces
any other individual’s consumption

Free-rider problem
34
Source of Inefficiency:
Imperfect Information


Unrealistic to have perfect information
When one party in a transaction knows more
than another, special problems arise causing
asymmetric information



Akerlof “The market for Lemons”
Principal agent problem
Sub-optimizing behavior
35
Macroeconomic Instability of Market
Capitalism

The General picture



The major market capitalist economies have been less than
perfectly stable over time
There was a general increase in unemployment rates after
the early1970s in many countries, associated with a
general stagnation of economic growth, that appears to
have been reduced recently
The considerable variation in capital investment can be
explained by factors



Exogenous fluctuations in new technologies that can serve as
the basis for the investment
Fluctuations in government monetary policies affecting
interest rates
Psychological fluctuations due to the “animal spirits” of those
making investments
36
Macroeconomic Instability of Market
Capitalism

QUESTION


Why do these variables lead to fluctuations in the
unemployment rate, since in a perfectly labor
market, wage rates should fall when the demand
for labor falls, thereby preventing the emergence
of any involuntary unemployment?
TWO DIFFERENT ANSWERS


Keynesian School
Classical School
37
Macroeconomic Instability of Market
Capitalism

Keynesian School


Rigidities of various sorts exist in labor markets
and that capital investment can collapse and stay
down for extended periods of time, as in the Great
Depression
The implication is that government intervention
through fiscal or monetary policies is advisable to
stimulate the economy and to stabilize and
smooth out business cycles
38
Macroeconomic Instability of Market
Capitalism

The Classical School




Deriving from 19th century classical political
economists such as David Ricardo
Market capitalist economies are powerfully selfstabilizing
Conscious government intervention merely
generates inflation and intensifies fluctuations
To minimize unemployment, unions should be
broken up and a stable fiscal and monetary
environment should be maintained within a
laissez-faire environment
39
Laissez-faire Economic Policies


Shift toward supporting more laissez-faire
economic policies
There is a tension between asserting the
efficiency of competitive equilibria and
recognizing the limits of the applicability of
that theorem

Chicago School’s (Milton Friedman) argument
draws directly from the efficiency theorem and
follows by asserting the irrelevance or
unimportance of the various exceptions and limits
40
Chicago School






Markets are almost always efficient, so government should keep its
hands off
The most externalities will be resolved by private markets if property
rights are properly defined and enforced “free market”
Many of the goods provided by the public sector are not really
collective consumption goods and could be more efficiently provided
privately
Information costs are inevitable and cannot be avoided
The Chicago School supports the Classical School approach in
macroeconomics
 Friedman is the most prominent advocate of monetarism in the
US
With respect to distribution of income, people should be allowed to
keep what they earn from the free market
 Inequalities are the necessary outcome of providing sufficient
incentives for production, investment and growth
41
Austrian School


They reject equilibrium analysis and emphasize
dynamic market processes
Entrepreneurs are the most important agents in the
economy


They must be allowed to function freely, without
government restriction, so that they can lead the market to
evolve in conjunction with the evolution of consumer
preferences through process of innovation
Static efficiency is relatively unimportant

It is the dynamic success of market capitalism that is its
most important economic feature
42
Overview of Comparative
Economics
Chapter III
The Theory and History of Marxism and
Socialism
43
Command Socialism




Form of Ownership → Most of the time the state
owns the land and produced means of production
(capital stock)
Role of Planning → Economy is planned centrally
and the planners’ preferences dominate allocative
decision-making
Incentive Structure → Moral Incentives-trying to
motivate workers by appealing to some higher
collective goal
Income Redistribution → The governments control
the distribution of income by setting wages and
forbidding capital or land income
44
Command Socialism

Role of politics and ideology → Are
command socialist economies usually linked
with authoritarian regimes?


Authoritarian political regimes also pursue market
capitalism
Command socialism can also support democracy
45
Socialism





An economic system characterized by state or collective
ownership of the means of product, land and capital
Not actually exists as a system until the early 12th
century
Its emergence based on criticism of feudal and capitalist
systems that existed prior to its modern appearance
Criticism originated from religious sources favoring
egalitarian income distributions and collective sharing
Became a secular theory of history and society in the
writings of Karl Marx
46
Is Socialism still popular?


With the collapse of Soviet Union and end of
communism, nowadays many countries that have
identified themselves socialist are attempting to
move toward market capitalism
Why examine the socialist economic system?



Many are still socialist in actual practice
Frustration with efforts to move toward some form of
capitalism have led to a revival of socialist ideology in some
of the countries
Difficulties experienced in the market capitalist world have
stimulated reconsideration of limited elements of socialist
model as reformist devices
47
Development of Socialist Ideology:
Religious and Philosophical Precursors



It is originated in religious and philosophical criticism
of inequalities in existing societies and the
formulation of ideal alternatives in which collective
sharing and equality reign supreme
In ancient Greece → philosopher Plato described
an ideal society of in his Republic
Christianity provided opportunity for socialism
expecting the second coming of Christ → when all
would be judged and there would be heaven on
earth for the saved (millennium)
48
Development of Socialist Ideology



Thomas More “Utopia” described an island
where everyone shared and was equal
Enlightenment of 1700
Secularized version of egalitarianism in
French philosophy by Jean-Jacques
Rousseau led to French Revolution in 1789

The revolution was against feudal aristocracy and
inequality
49
Development of Socialist Ideology

In 1796 Francois Gracchus Babeuf is often
identified as the founder of modern
Communism



“Conspiracy of Equals” → abolition of private
property and the holding in common land
Communism → local units of government in
France are called communes
The term socialism originated in the early
1830s with the British utopian socialist
Robert Owen
50
The Marxian Worldview


Marxian → refers to the writings and views of Marx himself
Marxist → refers to any view or idea strongly influenced by Marx
51
The Marxian Worldview






Karl Marx (1818-1883) was born in Trier in the
German Rhineland
Studied philosophy in Berlin
Became a radical journalist
Participated the uprising of Rhineland
Spent most of his life in exile in London
Supported financially by his collaborator, Friedrich
Engels, who owned a textile mill

Together Marx and Engels developed Marxian worldview in
writings which influenced socialist thought
52
The Marxian Worldview


Marx’s worldview constitutes a holistic
system by seeking to explain virtually
everything in a unified whole
His holistic theory is his integration of three
major strands of 19th century European
thought:



German political philosophy
French political sociology
British political economy
53
The Marxian Worldview:
The Hegelian Dialectic
German Political Philosophy
 Hegel developed the idea of dialectic



All phenomena reflect a conflict between pairs of
unified opposites whose joint opposition evolves
over time to critical breakpoints where reality
qualitatively changes
These opposites are labeled as thesis and
antithesis
At the critical breakpoint their opposition
generates something brand new, the synthesis
54
The Marxian Worldview:
The Hegelian Dialectic



The ultimate Hegelian thesis is the Universal
Idea → God
The antithesis is the individual person
The synthesis is the state


The idea of emergent powerful and nationalist
German state
These ideas influenced the movement for German
unification that accelerated toward its culmination
under Bismarck in 1871 and influenced the
ultranationalist Nazi movement in the 20th century
55
The Marxian Worldview:
Historical Materialism
Marx “materialized” Hegel’s dialectic by using the
idea of French Revolution
 The key to historical materialism → the idea that the
driving force of history is the dialectic between
conflicting socioeconomic classes
 The class conflict of the emerging industrial society
between the bourgeoisie (capitalists) and the
proletariat (worker)
 The Communist Manifesto starts as
“The history of all existing societies has been the
history of class struggles”

56
The Marxian Worldview:
Historical Materialism





The struggle concerns
 ownership
 controls of means of production
One class owns and controls the means of production and
exploits the other class, which does not own and control the
means of production
The technology of society → forces of production
Combines with the structure of classes → relations of
production
To determine the mode of production → the substructure or
base of the society that determines everything else, the
superstructure, that is religion, politics, culture and so forth
57
The Marxian Worldview:
Historical Materialism




The mode of production of ancient Greece and
Rome was slavery, characterized by the struggle
between master and slave
The fall of the Roman Empire was a result of this
contradiction → resulting in the mode production
transforming from slavery to feudalism
In turn, feudalism was driven by the struggle
between lord and serf and was transformed into
capitalism
In capitalism, the struggle is between the capitalist
who owns the means of production and the workers
who does not
58
The Marxian Worldview:
Historical Materialism

As this struggle reaches its peak in the most
advanced capitalist countries such as
England and Germany, there would be a
revolutionary transformation into socialism
with



state ownership of the means of production
direction of a production by a common plan,
income inequalities and wage payments
control by a dictatorship of the proletariat
59
The Marxian Worldview:
Historical Materialism

Marx claims



Once socialism is accomplished, communism
would eventually develop
All classes and property ownership would
disappear
The state would wither away
60
The Marxian Worldview:
The Labor Theory of Value and the Breakdown of
Capitalism

Ricardo’s labor theory of value


The value of a commodity is determined by the
amount of socially necessary labor time it takes to
produce it
Contradicts the neoclassical economic theory that
value is determined by supply and demand, with
capital contributing to the supply side
61
The Marxian Worldview:
The Labor Theory of Value and the Breakdown of
Capitalism

Land and capital as productive but not as
contributing to value

Capital goods as being the product of past labor,
indirect labor
Core of Marxian doctrine

The true reality of capital was not the capital
good itself but the social relation of
exploitation between the capitalist and the
worker
62
The Marxian Worldview:
The Labor Theory of Value and the Breakdown of
Capitalism

The value of commodity (W) = c+v+s



Constant capital (c) fixed capital stock as
measured in the labor time required to produce it
Variable capital (v) the value of labor power used
in production that is the amount of socially
necessary labor time it takes to reproduce labor,
equal to subsistence wage
Surplus value (s) value created by the worker but
taken by the capitalist, leading to exploitation


“Marx’s modification of the labor theory”
Marx concentrated on the “surplus value”- profit
63
The Marxian Worldview:
The Labor Theory of Value and the Breakdown of
Capitalism





Capitalist → capital investment → raising the organic
composition of capital
c rises while s and v are constant → the rate of profit
declines
 The fundamental tendency of capitalism
Increase the rate of exploitation → by lowering wages or
by working longer
The class struggle and the commercial crisis
Concentration of capital in fewer hands and proletariat
becomes more miserable
 Eventually the contradiction between the forces of
production and the relations of production becomes so
intense that the system is overthrown by the
revolutionary working class
64
Controversies in Socialism:
Theory of Imperialism



Capitalism had succeeded in transforming itself into
imperialism, expanding overseas into colonies to
exploit their raw materials, cheap labor and new
markets
The domestic market could not absorb what the
capitalists produced, so they found overseas
markets
With the enormous profits capitalist made from their
colonies, they started paying off their working class
→ this changed this class into reformists rather than
revolutionaries
65
Controversies in Socialism:
Marxism-Leninism



Vladimir Illich Ulyanov known as Lenin developed
the Imperialism thesis
Lenin noted that imperialism was expanding
unevenly
The revolution would come in capitalism’s weakest
link, Russia


Industrialized too late to participate in the conquest of
Africa
Dominated by foreign investment from the leading capitalist
powers like Great Britain, France and Germany
66
Controversies in Socialism:
Marxism-Leninism


Refocusing revolutionary expectations on
less developed countries became MarxismLeninism, the official Soviet doctrine after
1917
It also became the guiding light of Marxist
revolution in the 20th century in less
developed countries from China to Cuba and
to Vietnam
67
Some Divisions of Socialism since 1917



Trotskyism
Titoism
Maoism
68
Some Divisions of Socialism since 1917:
Trotskyism


Leon Trotsky, founder of the Red Army in the
Soviet Union, was Stalin’s chief rival for
power after Lenin’s death in 1924
He was exiled in 1927 and founded the
Fourth International, which fragmented into
factions after his assassination in Mexico in
1940
69
Some Divisions of Socialism since 1917:
Trotskyism


Trotsky and Stalin agreed about the need for
rapid industrialization, but they disagreed
whether this should be done in isolation or in
an international context
Trotsky supported the idea of an international
permanent revolution, believing that true
socialism could not be achieved in the Soviet
Union without an international revolution
70
Some Divisions of Socialism since 1917:
Titoism


Marshall Tito led Communist partisans in
throwing the Nazis out of Yugoslavia during
the Second World War, with little assistance
from Soviet Red Army
A strong Stalinist Tito broke with Stalin in
1948 and declared political independence of
Yugoslavia from Soviet influence
71
Some Divisions of Socialism since 1917:
Titoism



Tito developed a distinctive economic system
for Yugoslavia → worker-managed market
socialism
State-owned enterprises in a one-party state
operating with little central planning and with
managements appointed by worker selected
boards
After Tito’s death in 1981, the economic
system in Yugoslavia deteriorated and
eventually collapsed
72
Some Divisions of Socialism since 1917:
Maoism




In 1949 a Communist insurgency led by Mao
Zedong took power in mainland China
Rural guerilla movement that encouraged
egalitarian economic development in zones
of revolutionary control
Imitated the centrally planned command
industrialization model of Stalin
More emphasis upon rural agricultural
development, egalitarianism, the use of moral
incentives
73
Some Divisions of Socialism since 1917:
Maoism

In the Great Proletarian Cultural
Revolution (1966-1969), Mao emphasized





industrial decentralization
complete communalization of agriculture
total egalitarianism
moral incentives
After Mao’s death in 1976, a decline of
support in his ideas
74
The Theory of Economic Socialism



The Socialist Planning Controversy
The Theory of Command Socialist Central
Planning
The Participatory or Cooperative Alternative
75
Theory of Economic Socialism:
Theory of Command Socialist Central Planning



Central planning first appeared in Soviet
Russia with the 1920 electrification plan
Indicative planning instituted for heavy
industrial sectors under state ownership such
as electricity, steel and cement
Long-term planning was on a five-year time
horizon
76
Theory of Economic Socialism:
Theory of Command Socialist Central Planning


Five year plans were broken down into one-year
plans from which monthly quotas for individual firms
were derived
Each firm had a technical-production-financial plan
that specified




output quantities and prices
input quantities and prices including wages
levels and kinds of capital investment
One year’s overall general plan generally involved
minor modifications of the previous year’s plan
based in the outcome of that plan
77
Theory of Economic Socialism:
Theory of Command Socialist Central Planning


For the first five-year plan, the material balances
were based on the inherited structure of production
Figure out




how much of which final goods were to be produced
the amounts of all the inputs required to produce those
outputs
the inputs to produce those inputs
If a commodity was in “deficit” then either



one of the three previous mechanisms would be drawn on
or greater efficiency in its production would be induced
or demand for it had been cut back
78
Theory of Economic Socialism:
Participatory or Cooperative Alternative




Also known as the labor-managed
economy-Yugoslavia is the example
Market Socialist System → state owns the
means of production
Characterized by workers’ ownership or
workers’ management
Combination of capitalism and socialism,
constituting a Third Way
79
Theory of Economic Socialism:
Participatory or Cooperative Alternative





Workers will manage the firms
There will be income sharing
Productive resources are not owned by the
workers → workers enjoy usufruct rights to
the fruits of the operation
Market economy → Any kind of planning is
indicative planning rather than of the
command sort
Workers can freely choose where to work
80
Transition from Socialism to Capitalism

Transition from command socialism to market
capitalism requires



replacement of command economy with market
mechanisms in decision-making
privatization of state-owned enterprises to move
from socialism to capitalism
liberalization of the political system
81
Transition from Socialism to Capitalism

In adopting markets rather than command




Freeing prices from central control was the easiest thing
Macroeconomic stabilization was more difficult to achieve
as sudden freeing of prices led to inflationary outburst
Total output declined sharply with unemployment rising
Establishment of the institutional framework that allows for
the open and stable functioning of markets is difficult





Developing banking, financial and accounting systems
A proper competition policy
Laws of corporate governance and bankruptcy
Opening to trade and investment
Foreign currency convertibility
82
Transition from Socialism to Capitalism

Problems of privatization




Restructuring of enterprise management is more important
than privatization
Countries that privatized quickly ran into serious problems
(Russia and Czech Republic) compared to those that
privatized more gradually (Poland and Slovenia)
Privatized firms in transition countries exhibit greater
productivity that state-owned ones
The emergence of social problems as countries fell
into deep recessions with high inflation and
institutional instability
83
Varieties of Advanced Market
Capitalism
Chapter V
The United States of America:
The Market Capitalist Leader
84
World’s Largest Economy

Not only the prime example of market capitalist economy but is
technological leader of the world with very high per capita income

Its important role in developing distinctive institutions of market
capitalism, such as modern corporation

From a nearly pure laissez-faire economy in the mid-19th
century has become a mixed economy, but still laissez-faire
oriented

The “darker side” of market capitalism, with relatively high
levels of income inequality and poverty
85
World’s Largest Economy

Oldest constitution of any nation on earth 1787

Well established private property allowed the market
capitalist economy to function flexibly

Greatest crisis and conflict was over the slavery
system that divided the industrial North from the
cotton-growing South

Civil War of 1861-1865
86
World’s Largest Economy

Leading in technology with the emergence of the
American system of interchangeable parts and
standardization during the early 1800s

Innovator in economic institutional structures and
organizational forms

The key organization of the modern world economy
→ industrial corporation whose standard form
emerged in the railroads
87
World’s Largest Economy

Fordist assembly line production

US automobile industry → modern multidivisional
corporation → General Motors Corporation

Mass production with rapidly rising productivity

Institutional foundation of modern American
macroeconomic policy established in 1913


Federal income tax and the establishment of the Federal
Reserve System
Development of a strong financial system
88
World’s Largest Economy

After WW I displaced Great Britain as the world’s
leading financial power

but avoiding a global role

Isolationist attitude → refusal to join the League of
Nations in 1920

The Great Depression of the 1930s and the
presidency of Franklin Roosevelt → expansion of
the federal government’s role in economy moving
away from pure laissez-faire
89
World’s Largest Economy

Change in attitudes with WW II

Took the lead at the Bretton Woods Conference (1944)


Washington D.C became the headquarters for the new
postwar global economic institutions → IMF, World Bank
New York City → UN (successor to League of Nations)

The General Agreement on Trade and Tariffs (GATT) in
1948 → tariff-reducing negotiations and moves to
expand international trade

Establishment of World Trade Organization (WTO)
90
World’s Largest Economy

1980s → a period of deregulation of the US economy

US leadership of the word economy challenged by other
countries, especially Japan

The stagnation of Japanese economy after 1990

New Economy high technology development in US in late
1990s, led by the information technology sector → reasserted its
primacy position

A speculative bubble in the US stock market that peaked in early
2000 and high-tech sector has been in slowdown since

Recession of 2001 → terrorist attacks
91
Historical Development of the US Economy:
Growth and Reform

By the end of the 19th century → the world’s largest
aggregate economy with rapid growth and
industrialization



Major technological innovations



Expansion of railroads
Development of the new corporate industrial organizational
form
Light bulb by Thomas Edison → General Electric
Corporation
Telephone by Alexander Graham Bell → AT&T
Establishment of a strong patent system
92
Historical Development of the US Economy:
Changing Trends

Rapid economic growth in the 1960s and early 1970s
dramatically slowed down after the first oil price shock in 1973

US economy only managed to recover in the late 1990s with
high-technology boom after inflation was brought under control

The Soviet Union, America’s greatest postwar ideological and
military rival, ceased to exist in 1991

Japan, America’s greatest economic rival, went into severe
economic stagnation after 1990

America’s high-tech sector emerged in the 1990s
93
Basic Ingredients of the American
Economy:



Natural Resources
Labor
Manufacturing and Investment
94
Basic Ingredients of the American Economy:
Natural Resources

Rich in mineral resources

Fertile farm soil

Fortunate to have a moderate climate

Has extensive coastlines on both the Atlantic and Pacific
Oceans and Gulf of Mexico

Rivers flow from far within the continent

Has Great Lakes → provide additional shipping access
95
Basic Ingredients of the American
Economy: Labor

Steady growth in the labor force → led to constant
economic expansion

Until shortly after World War I, most workers were
immigrants from Europe, or African Americans

Beginning in the early 20th century, many Latin
Americans immigrated

They were followed by large numbers of Asians
96
Basic Ingredients of the American
Economy: Manufacturing and Investment

In US, the corporation has emerged as an
association of owners, known as
stockholders, who form a business enterprise
governed by a complex set of rules and
customs

Through the stock market, American banks
and investors have grown their economy by
investing and withdrawing capital from
profitable corporations
97
The American Corporation:
Nature of the American Corporate Form

America’s most important contribution to the world economy has
been its development of the organizational form of the modern
corporation

Anglo-American Corporate Form that is different from those found
in Japan, Germany and other nations






Distinct internal hierarchies and divisions
Led by strong and highly paid chief executive officers (CEOs)
With relatively little control by banks, other firms, workers, and
government
Ownership is by stockholders
Tendency in recent years to make CEOs or other top managers part
owners by giving them stock options as part of their compensation
Reduces the principal-agent problem arising from the separation of
ownership and control in large
98
The American Corporation:
Nature of the American Corporate Form

In 1819 the doctrine of the juridical identity of
the corporation as effectively a legal person
distinct from its owners

The emergence of the limited liability
corporation, whose finances were legally
distinct from those of the owners of the
corporation
99
The American Corporation:
Regulation and Deregulation

The rise of American corporations generated a broad movement to
restrain their power and perceived excesses

This began in 1887 with the establishment of Interstate Commerce
Commission (ICC) to regulate the rates charged by railroads

Anti-trust regulations started after the passage of Sherman Act of
1890

Federal Reserve System regulated the banking system after 1913

Civil Aeronautics Board regulated airfares and airline routes

Federal Communications Commission regulate allocation and the
use of the radio spectrum
100
The American Corporation:
Regulation and Deregulation

Monopolies are allowed in certain industries
that were subject to rate regulation



AT&T in telephone industry
Electric utility industry
During 1960s focused on safety and
environmental concerns


Monitoring food and drug safety
Consumer product safety
101
The American Corporation:
Regulation and Deregulation

As the 1970s proceeded, movements to reduce regulations arose:
 The first deregulation is to deregulate the airline fares and routes
(The CAB was eliminated in 1983)

The ICC was eliminated in 1996

In the early 1990s the FCC moved to auctioning of spectrum
rights

EPA moved to the use of marketable pollution emission permits,
notably for sulfur dioxide

Long distance telephone industry AT&T

The deregulation of the electricity supply industry
102
Prospects and Problems of the American
Economy

The Problem of Poverty and Inequality
The overall time trend of inequality





There was a gradual trend toward greater equality from the
late 1920s
Increased dramatically during WW II
Continued until the mid-1970s
After the trend reversed and inequality has since tended to
increase
The role of government in these trends



Transfer payments rising
Social security for elderly
Transfer payments to low income groups have raised
103
Prospects and Problems of the American
Economy

The Rise of the New Economy
Second half of the 1990s






A steady decline of the unemployment rate
Low inflation
Decline in poverty
Acceleration in the economic growth rate
Increase in rate of productivity
The accumulated impact of computerization and the
spread of new technologies as the internet
104
Prospects and Problems of the American
Economy

The Mass Consumption Society and Its
Sustainability
High levels of consumption

Luxury fever “never ending pursuit of more and
more expensive luxury goods”

Low savings rate and high personal debt/income
ratio

US become its largest net debtor by the mid-1990s
105
Back and forth:
From laissez-faire economy to government’s intervention in
economy and back to laissez-faire


During much of the 19th century, US was almost a
purely laissez-faire economy
In the 20th century, role of federal government
increased on various stages:




Progressive Era Reforms of 1901-1909
New Deal of 1930s
Great Society initiatives of the 1960s
Since 1960s US economy has experienced
deregulation and other moves back to laissez-faire
(although 1/3 of the economy is directed by some level of government)

US definitely has a mixed economy despite its
strong orientation to market capitalism
106
Conclusion:
The United States of America: The Market Capitalist Leader







The world’s most dynamic and flexible society and
economy
Immigrants from an increasingly diverse array of nations
Established institutions of contract and property
Evolving corporate forms, patterns of standardization
and mass production
A tradition of entrepreneurship
Technologically leadership based upon basic science
and solid R&D within a financial and institutional
framework
The darker side of market capitalism with high levels of
income and wealth inequality
107
Varieties of Advanced Market
Capitalism
Chapter VI
Japan: A Planned Market Economy
with Traditional Elements
108
Japan As a New Traditional Economy?

Experienced the most rapid rate of sustained
economic growth in the world

Maintained low unemployment and inflation
rates and a greater degree of income equality

Leading many areas of technology
109
Japan As a New Traditional Economy?

Have large trade surpluses resulting in the
largest accumulation of foreign reserves

Number One? → stagflation in 1990s

Its conflicts with other nations on trade issues
threatened to push the world economy into a
trade war and depression
110
Japan As a New Traditional Economy?

Debates about the basis of Japanese
success

Advocates of government economic intervention
argue that bureaucratic guidance through
indicative planning and industrial policy has been
key to its success

Advocates of laissez-faire argue that these have
been more a hindrance than a help, with the most
dynamic sectors ignoring the government
bureaucrats
111
Japan As a New Traditional Economy?

A mixture of structures and systems unique in the
world

A market capitalist economy

The government engages in indicative planning and
exerts significant influence

The first society of non-European origin to carry out
industrialization and modern economic growth
112
Japan As a New Traditional Economy?

Succeeded in adopting foreign technologies and
practices without giving up its indigenous culture

Late 19th century slogan “Japanese spirit and Western
ability”

Familistic groupism of Japanese society → a
feudalistic holdover

Harmonious labor-management relations and
government-business relations
Planned market capitalism with strong traditional elements
113
The Microeconomic Foundations of The
Japanese Economy

The “Three Sacred Treasures” of LaborManagement Relations

The Japanese Firm and the Keiretsu System

Managerial Decision Making

Industrial Policy by Government
114
The “Three Sacred Treasures” of LaborManagement Relations

Highly educated and well-motivated labor force

Many quality-and productivity-improving innovations
suggested by workers on site

Three sacred treasures:



Lifetime employment
Seniority-based wages
Enterprise unions
115
The “Three Sacred Treasures” of LaborManagement Relations

Japanese labor








Intra-enterprise job rotation by multifunctional workers
On-the-job firm-specific training
Bonus payments
Compensation flexible
Contracts negotiated annually
Employment stable
Large severance payments at retirement but few
pensions
Dualism
116
The “Three Sacred Treasures” of LaborManagement Relations: Lifetime Employment

The key to stimulating loyalty and drawing forth
innovative, productivity-improving suggestions

Limited to about 30 % of the labor force, mostly
educated men in large firms that must retire at age
55 with large severance payments and assisted in
getting other jobs in smaller firms

Japanese workers more likely to stay with a single
firm for a longer period of time, even in small firms
117
The “Three Sacred Treasures” of LaborManagement Relations: Lifetime Employment

Depending on

Stability of employment

Rapid growth of the economy between 1945 and
1990

Synchronized annual negotiating system

Bonus system → a form of profit sharing
118
The “Three Sacred Treasures” of LaborManagement Relations: Lifetime Employment

Development of firm-specific human capital by
rotating workers from job to job within the firm

Workers know all about the firm but lack skills that
are transferable to other firms

On-the-job training of blue-collar workers → but
white collarization in larger firms


Greater loyalty to firm → Confucian code
Firms more willing to engage in firm-specific training if they
believe workers will remain for a long time
119
The “Three Sacred Treasures” of LaborManagement Relations: Seniority Wages

Confucian view of respect for elders

Steeper age-wage profile for blue-collar

Seniority wages reinforcing loyalty to the firm
among lifetime employees

Expectations of performance-based pay
120
The “Three Sacred Treasures” of LaborManagement Relations: Enterprise Unions


If one is committed for life to a specific company
One has been working at several different jobs with the
company, thus not being tied to a particular skill or craft
→ it is logical to belong to a union that negotiates directly
with that company and only that company

Stability of labor-management relations

“Happy family of the firm”

Critics “Inefficiency”
121
The Japanese Firm and the Keiretsu
System

The existence of interlocked associations of firms →
keiretsu

Horizontal keiretsu



Revivals of the prewar zaibatsus (single holding
companies)
Firms in different industries all linked to a common bank
and trading company maintaining their formal
independence
Vertical keiretsu

A set of suppliers and distributors linked to a major
industrial producer by long-term contracts
122
The Japanese Firm and the Keiretsu
System

Toshiba Corporation

At the center of a vertical keiretsu including
distributors, suppliers and suppliers of direct
suppliers

A member in Mitsui horizontal keiretsu
123
The Japanese Firm and the Keiretsu
System

Horizontal keiretsus practice three sacred
treasures of labor-management relations

Peripheral firms in vertical keiretsus tend not
to do so

Keiretsus → cross-holding of stocks

In horizontal form → much stock ownership by the
bank and a large proportion of loans from the
bank
124
The Japanese Firm and the Keiretsu
System

Network externalities

Group membership may have a negative impact on
profitability relative to independents run by founderentrepreneurs

Vertical keiretsus may achieve efficiencies because
their stable long-term contracts allow for just-in-time
delivery, kanban system that minimize inventory
costs and encourage superior quality control
125
Managerial Decision Making

J-mode depends on both long-term relationships
between workers and firms and long-term
relationships between banks and firms which tend to
hold for keiretsu members with lifetime employment
systems

Top managers risen from within the firm increase
the loyalty


Management as the representative of the employees
Labor-managed firms
126
Managerial Decision Making

Horizontal coordination through processes of consensual
decision making

Dependence upon workers for suggestions for improving the
firm’s performance

Seniority-based rank hierarchies

Given long-term nature of employee-firm relations and of
bank-firm relations, managers use longer time horizon for
strategic planning

Emphasis upon maximizing market share subject to minimum
profit constraint, rather than maximizing short-run profits
127
Industrial Policy by Government

Government-business relations labeled industrial
policy

Ministry of International Trade and Industry (MITI)

The state being the driving force of the Japanese
economy → supremacy of government bureaucrats

High-level bureaucrats to high-level employment in
top firms
128
Industrial Policy by Government


MITI intervention in markets → product
cycles
Beginning stage of an industry




Infant industry tariffs
Subsidies for special capital investments
Rationalization cartels that carry out MITI-financed
R&D
At the end of product cycle

To reduce closeout using depression cartels
129
Industrial Policy by Government


Overall rapid growth
Export success of targeted industries


Shipbuilding, steel and computers
MITI failed in the late 1950s to cartelize the
automobile industry down to two firms


Honda → the most technically innovative of the
automobile companies and a great export success
Sony → rejected to produce transistor radios

Both founded and led by strong-willed entrepreneurs
operating outside of the planning and keiretsu system
130
Why Japan Failed to Become Number
One
Macroeconomic Performance

High rate of growth

High capital investment rate backed by a high
savings rate

After bursting of the Japanese stock market bubble
in 1990

Growth rate fell below those of other leading market
capitalist economies with unemployment rate increasing
131
Why Japan Failed to Become Number
One

High savings rate







Confucian ideals
High growth rates as consumption increases lag behind
income increases
Individuals save to make down payments on homes
Workers save for old age because of the combination of
early retirement with low pensions and low social security
payments
The lumpiness of large bonuses
No capital gains tax except on land
Most of the postwar period, a relatively young population

But rapidly aging population
132
Why Japan Failed to Become Number
One

Macroeconomic Planning Policy
Market capitalist economy with elements of a traditional economy
and indicative planning
 Sectoral and technological planning → MITI
 Macroeconomic plans → Economic Planning Agency (EPA)

Relatively low levels of government spending and taxation

Low level of social transfer payments

Low defense spending, due to US demilitarization
133
Why Japan Failed to Become Number
One

Quality of Life
The highest quality of life

Top in life expectancy

Gender empowerment, (31st)

High per capita income and consumption

Low crime rate
134
Why Japan Failed to Become Number
One

One of the more equal income distributions in the
world

Egalitarian wage structure arising from the labormanagement system

Workaholics in rabbit hutches

Environmental pollution

Problems of discrimination (against women and
foreigners)
135
Why Japan Failed to Become Number
One

The End of the “Economic Miracle”
Rising dependency ratios that reduce savings

Opening of financial markets caused by deregulation, leading to
outflows of capital

Technological stagnation

Weakness of the non-tradeable goods sector

The failure of government spending to stimulate the economy
136
Why Japan Failed to Become Number
One

Hollowing out of the industrial base as large
corporations invest in other countries

The emergence of a liquidity trap in financial
markets

A decline in the rate of return to capital investment
owing to overinvestment in the past

A credit crunch caused by the accumulation of bad
loans in the banking sector
137
Why Japan Failed to Become Number
One

A general disruption of the financial sector in the
aftermath of the collapse of the stock market

Deeper cultural arguments involving a breakdown of
Confucian values

Saving-investment nexus


Rapidly aging society, experience rising dependency ratios
that tend to depress the savings rate
A victim of its own success as a society able to support
long life
138
Why Japan Failed to Become Number
One

In early 1990s, a low rate of return for large
corporations resulting from overinvestment

After 1997 Asian financial crisis, credit
problem

The collapse of the bubble economy

Technological leadership?
139
Variants of Transition among
Former Socialist Economies
Chapter X
The Former Soviet Union:
The Myth and Reality of the Command
Economy and Russia’s Economic Transition
140
Transformation of Russian economy in
1990s

Centrally planned economy was replaced by
an economy operating on the basis of market
forces and private property

Some of the former communist states of
Central Europe began their process of
economic transition earlier
141
Historical Background of The Soviet Economy:
Until December 25, 1991

USSR was the largest country in the world

Occupied 1/6th of the earth’s inhabited land

293 million population (third largest in the
world)

128 ethnic groups
142
Historical Background of The Soviet Economy:
Russian Empire before 1917

Intermediate case compared to underdeveloped
Asia and to industrially developed Western and
Central Europe

Duality between



traditional agriculture and
military-driven industrial development
This duality produced undecided attitudes toward
change and reforms: Change is seen as
industrialization at the expense of agriculture
143
Command Economy:
Launching the Model

Several economic subsystems coexist that ranged
from

Self sufficient communes with mostly barter exchange

Individual small-scale proprietorships

Medium-sized businesses that produced for markets with
the use of hired labor

Also publicly owned large-scale enterprises (mostly in
heavy industries) that by nature were socialist prototypes
using direct administrative allocation of resources and
assigned labor
144
Command Economy:
Launching the Model

This economic pluralism produced political break in
the ruling Communist Party

Leon Trotsky, founder of the Red Army in the Soviet
Union, was Stalin’s chief rival for power

Advocated super-industrialization in the Soviet
Union that would lead to a worldwide permanent
communist revolution

Call for liberalization of domestic and international
markets
145
Command Economy:
Launching the Model


Divisions between Trotsky and Stalin
Trotsky and Stalin agreed about the need for
rapid industrialization, but they disagreed
whether this should be done in isolation or in
an international context
Trotsky supported the idea of an international
permanent revolution, believing that true
socialism could not be achieved in the Soviet
Union without an international revolution
146
Command Economy:
Launching the Model

Stalin supported an autarkic model of socialism in
one country

Exterminated his opponents (Trotsky) in the party

Established his own cult

Reasserted economic traditionalism in the guise of
revolutionary socialism
147
Command Economy:
Launching the Model

Implementing socialism in one country
required speedy industrialization

For self-sufficiency

Military Buildup

Social transformation from a relatively backward
agro-industrial economy into an urban industrial
one ordered by the political center
148
Command Economy:
Launching the Model

Disallowed market allocation of resources

State monopolized foreign relations

Closed the economy through restrictions on foreign
trade, currency inconvertibility, and limited trade
specialization

Accelerated industrialization, which favored
producer and military goods at the expense of
agriculture, assumed unbalanced economic growth
149
Command Economy:
Launching the Model

Super-industrialization favored the
teleologists that asserted the need for longrun plans and opposed market forces

First Five-Year Plan in 1928



Central comprehensive planning
Ensured political control over the diverse republics
Grouping them into economic regions to meet
nation-wide production needs
150
Command Economy:
Launching the Model

Prioritize industry over agriculture for sociopolitical
reasons

Emphasize on regional specialization

Deemphasize republic-level diversification

Establish state monopolies in key industries

Eliminate the entrepreneurial subsystems alien to
socialism
151
Command Economy:
Launching the Model

Agricultural collectivization

Forced collective ownership on peasants as a
stepping stone to comprehensive public
ownership

Success of industrialization program turned
out to be a disaster for agriculture

An over-industrialized and over-urbanized
economy with an inadequate and no longer
self-sufficient agricultural sector
152
Command Economy:
Soviet Central Planning: The Beginning

The goal of First Five-Year Plan was to catch up
with capitalist industrial countries

Success of the initial industrialization push
attributed to central planning accomplished at cost
of forced collectivization and a major decline in
living standards


The share of private consumption declined
Concentrated investment in growth-supporting
sectors based on domestic savings
153
Soviet Central Planning:
Implementation

Planning versus market

Planning is concerned with expanded
reproduction and particular investment, with
consumption deemphasized

Soviet planning → Prioritized investment to catch
up with the West industrially and militarily

Ignored static efficiency in favor of high rates of economic
growth
154
Soviet Central Planning:
Implementation

Prices were used by planners to ensure compliance with
plans and continuous control over plan implementation

Domestic prices were distorted because they reflected
planners’ priorities in distribution and production rather than
relative scarcities

Pricing disabled rational decision making by producers

The planners used wholesale prices to balance inter-sectoral
outputs and to provide for comparison of alternative
production mixes based on different technologies
155
Soviet Central Planning:
Implementation

In agriculture, government procurement prices
designated quotas promoted specific crops,
individual regions and financially controlled
collective farms

Retail prices produced inequality in income
distribution

Two policies to solve:


Free provision of public goods (health care and education)
Low prices for mass consumption goods (food, housing,
transportation) while raising prices for luxury goods
156
Soviet Central Planning:
Implementation

The gap between sticky prices and scarcity values
increased over time and lowered the effectiveness
of planning

The planned creation of a socialist market where
efficiency of production rose with diminishing
inequality in income distribution failed

Success in creating a second economy where market
forces partially corrected artificial shortages
157
Soviet Central Planning:
Agriculture: The Peculiarity of Soviet Model

Surviving agricultural producers:




State
Collective
Private farm
Stalin’s industrialization was dependent on
the mass collectivization of peasants and the
elimination of the well-off peasants (kulaks)
158
Soviet Central Planning:
Agriculture: The Peculiarity of Soviet Model

The collective farm (kolkhoz)






A pseudo-cooperative, with elected management ensuring
a supply of agricultural goods to the state at minimum cost
The income of peasants at subsistence level maintained by
household plots and individually owned livestock
Exploited by paying low procurement prices and by
overcharging for state-owned tractors and machinery
Not have guaranteed wages and were paid in labor days
Payments were arbitrary and variable depending on
regions, seasons and specific farms
Consumer goods sold to kolkhozes at high prices
159
Soviet Central Planning:
Agriculture: The Peculiarity of Soviet Model

The state farm (sovkhoz)




Factories in the fields and were run under more
favorable policies
If underpaid, compensated by subsidies
State employees and got a guaranteed wage
Have access to better inputs at wholesale prices
160
Soviet Central Planning:
Agriculture: The Peculiarity of Soviet Model

The individual farmer




Found in private sector
Land in auxiliary household plots not privately
owned and cultivated only by peasants and state
employees
Livestock was privately owned but usually
pastured on collective or state land
Individuals worked on these plots for themselves
and owned their produce but also worked for
collective or state enterprises
161
Soviet Central Planning:
Agriculture: The Peculiarity of Soviet Model

The collective farm (kolkhoz) versus the
state farm (sovkhoz)


Their coexistence served the sociopolitical goal of
crowding out entrepreneurship
A decline in productivity and in absolute
production


On collective farms because of price discrimination and
compulsory deliveries
On state farms because of subsidization
162
Soviet Central Planning:
Agriculture: The Peculiarity of Soviet Model

Agriculture deprioritized resulting in
dependence on grain imports

The increasing role of imports of agricultural
products and other goods inspired reforms in
export sector and the overall economy

Raising questions about maintaining itself
as a closed economy?
163
Soviet Central Planning:
Closed Economy: Command Trade Isolationism

Its ideological underpinning is an autarkic
socialist country encircled by hostile
imperialist countries

The anarchy of world markets could
undermine the effectiveness of central
planning

Domestic firms were protected from foreign
competition and world prices
164
Soviet Central Planning:
Closed Economy: Command Trade Isolationism

State authority over foreign trade and foreign currency
transactions through state monopolies

Planners determined imports and exports by balancing
domestic inputs with projected outputs and making up for
potential discrepancies

Export production derived from the need to pay for imports

Producers of exportable goods did not have direct
relationships with foreign buyers but dealt with foreign trade
bureaucracies organized at the industrial level
165
Soviet Central Planning:
Closed Economy: Command Trade Isolationism

Foreign trade relations bilateral and highly politicized

The use of trade for greater integration with the socialist satellites
through Council of Mutual Economic Assistance (CMEA or
Comecon) founded in 1949

As a multilateral body to persuade these countries to adopt a
uniform strategy of communist industrialization with the USSR

CMEA membership → USSR, Czechoslovakia, Hungary,
Poland, East Germany, Romania, Bulgaria, Albania (withdrew in
1961), Mongolia, Cuba and Vietnam joined later, Yugoslavia as
an associate member
166
Soviet Central Planning:
Closed Economy: Command Trade Isolationism

Two principles:
 Extensive development that prioritized capital goods at the
expense of consumer goods
 An autarkic focus on import substitution and minimal dependence
on western markets

CMEA countries dependent on soviet energy resources and raw
materials

The idea of socialist international division of labor suggested
intra-industrial rather than inter-industrial specialization

A collective isolationism from world markets and a tendency to
create a socialist alternative to international capitalist trade
167
Soviet Central Planning:
Closed Economy: Command Trade Isolationism

Intra-CMEA specialization acknowledged the benefits of trade
for economic development

The international socialist division of labor was shaped by
concentrated planning rather than markets

The problems of inefficiency and non-competitiveness of
individual national industries increased in the mid-1960s,
leading to declining intra-bloc trade

Liberalization of trade with the West brought about by
technological backwardness in the course of the arms race

Decade of trade promotion ended in 1979 with the Soviet
invasion of Afghanistan
168
The Reform Cycle:
Reluctant Reform Thinking

Soviet economy characterize pervasive protectionism

Enterprises were shielded against bankruptcy through centralized subsidies

No financial discipline and managers’ performance assessed on basis of
compliance with the government’s plans

People were protected against economic fluctuations and the possibility of
unemployment

The state monopoly of foreign trade protected domestic firms from external
shocks and from competition with foreign goods

The network of commodity flows with preset prices and quotas created a
sense of certainty in domestic trade

THIS ECONOMIC STABILITY LACKED ANY IMPETUS TO CHANGE
169
The Reform Cycle:
Reluctant Reform Thinking

Reform and reformism unacceptable and interpreted as
dangerous Western imports

The strengths of Stalin’s economic model →
 Mobilization of resources for industrial catch-up
 Development of a military-industrial complex
 The postwar recovery through extensive growth

The weaknesses of Stalin’s economic model →
 Undervaluation of the opportunity cost of planned priorities
absent appropriate criteria to assess economic performance
 Protectionism downplaying economic incentives
 Vertical institutional structure producing shortsighted
bureaucracies and compartmentalism
170
Legacies of Soviet Economy

State-planning for state-owned industries and demand structuring by
the state budget

State-determined monetary policy with a one-tier banking system

State-run monopolistic firms, producing a narrow range of goods at
state-administered prices and facing monopolistic suppliers

Risk-aversion by managers who were reluctant to innovate

Full-employment guarantee and as a consequence, the systemic
impossibility of firms going bankrupt- a soft-budget constraint policy

State monopoly in foreign trade, administered prices and exchange
rates reflecting the inconvertibility of the domestic currency

Fiscal revenues generated by turnover taxes and mandatory transfers
of profits used to subsidize firms
171
Problems with Legacies of Soviet
Economy

Monopolistic producers and risk-averse managers
lacked the motive to innovate

Full-employment guarantees hidden unemployment
and favor labor-intensive production processes

Domestic production is not exposed to international
trade and therefore, becomes non-competitive

State provision caused the creation of poor quality
of public goods
172
Slowdowns and Stagnations

Slowdown in growth rates from the mid 1970s

Economic stagnation in 1980s

Central planners’ inability to deal with a complex, overindustrialized economy’s need for constant adjustment

A succession of reforms failed to improve central
planning, was unsuccessful in questioning state
ownership

Late 1980s → legal recognition of private enterprise
ranging from introduction of cooperatives to individual
proprietorships
173
Collapse of the USSR
Establishment of Russian Federation

After the collapse of the USSR in December
1991, the Russian Federation faced the
demanding need for moving away from
Centrally Planned Economy

Boris Yeltsin, the first democratically elected
president of Russia, launched the sixth
reform to undo the legacies of Soviet model
174
Transition in Post-Soviet Russia:
Boris Yeltsin (1991-1999)

Destroyed of Communist Party’s monopoly
politically and economically

Failed to build a new pluralist society

Finished off the remnants of command economy
system

Yeltsin took great steps toward developing a market
economy:




Price liberalization
Mass privatization of state enterprises
Foreign trade liberalization
Introduction of full convertibility of ruble
175
Transition in Post-Soviet Russia:
Problems with Yeltsin’s Reforms

Price and foreign trade liberalization created high inflation and
decline in domestic production

Mass privatization was accompanied by political rhetoric,
contrary to the West’s economic emphasis on the fundamental
importance of private property for the institution of a market
economy

Voucher privatization forced negotiations in the regional
implementation of privatization

Several local elites succeeded in seizing formerly state-owned
enterprises

Local established elites continued to exercise their power
176
Transition in Post-Soviet Russia:
Problems with Mass Privatization

By the end of 1995, Russia had completed the privatization of
over 120,000 enterprises

55 percent of the large and medium-sized enterprises sold could
be classified as non-competitive worker-management buyouts

Labeled as destatization officially and grabitization informally

This mass privatization failed to improve economic efficiency and
induce normal market behavior

Instead generated effects of persistent arrears (non-payment of
outstanding liabilities) and sliding into a barter (non-money)
economy
177
Transition in Post-Soviet Russia:
Problems with Barter Economy and Persistent Arrears

The emergence of arrears due to the enterprises’ failure to keep
pace with collapse of demand in the short-run and to continue to
produce

The underdevelopment of banking system played an additional
role

Emergence of risk-free tax arrears and reliance on state
subsidies

Resurfacing of barter economy
 1960-mid 1980s → inefficient planned distribution
 Late 1980s-early 1990s → general shortages
 1992-1994 → enterprises’ financial deficits
 Starting in 1997 → institutionally built into system and accounted
for 90 percent of industrial output
178
Transition in Post-Soviet Russia:
Problems with Barter Economy and Persistent Arrears

Barter economy and persistent arrears (amount overdue)
locked regions into local transactions, hindered
competition and corrupted the effectiveness of property
rights

Privatization and price liberalization created income
inequality

State revenues, which consisted mostly of profits from
state-owned enterprises during the Soviet era dropped
as a result of the recession and mass privatization

Issuance of short-term state bonds that offered high
interest rates crowded out private investment
179
Transition in Post-Soviet Russia:
Deep Recession

Russian industrial production fell by 55 %

Consequently, tax rates were raised creating a shadow
economy

Budget debt increased

The rate of export dropped

The fall in oil prices magnified the current account deficit,
causing a financial crisis that resulted in the devaluation
of ruble in 1998

Severe economic instability and hyperinflation
180
Conclusion:
The Soviet Model of a Command Economy

Created by a combination of internal economic
underdevelopment and international political discontinuity in
the aftermath of WW I, when workers’ revolutions threatened
many nations

Designed to produce a transition from a relatively backward
nation to a modern industrial society

Central planning that is a superior tool for balancing economic
proportions and maximizing the use of resources, produced
disproportionate and inflexible economic outcomes

Producing many problems, agriculture being a prominent
example
181