COMPARATIVE ECONOMIC SYSTEMS

LECTURE NOTES

Lecture Notes 1
Good Socio-economic System
Introduction
A good society is a society that is successful in fighting the scarcity problem in such a
way that it promotes material welfare as well as non-material weflare. The scarcity
problem is the basic economic problem everywhere. The performance criteria or success
criteria in relation to promotion of material welfare are achievement of (a) full
employment; (b) efficient employment not only in terms of technical efficiency but also
allocative efficiency; (c) growth in terms of extensive growth as well as intensive growth;
and (d) equity or fairness in terms of distributive justice and/or commutative justice. The
success criteria in relation to promoting non-material welfare are (a) avoiding alienation
from self; (b) avoiding alienation from others in terms of consumer sovereignty, worker
sovereignty and citizen sovereignty; and (c) avoiding alienation from nature. We
elaborate all this as follows.

The Scarcity Problem as the Basic Economic Problem

The basic observation about most people on earth is that they have desires for a truly
staggering variety and quantity of goods that they believe will enhance their welfare, and,
thus, be good for them. Goods, which are objects of immense desire, are classified into
commodities and services. There are tangible commodities like food, clothes, cars, etc.
Intangible services refer to temporary use of physical objects or other people (e.g. a house
by the sea during summer; a seat for 8 hours on a jet aeroplane from New Delhi to
Amsterdam; and 10 minutes of a doctor’s time).
How to make the various goods that people desire? We need resources and
technology to make goods.
Real resources or productive ingredients are put to work in the process of
production in order to make goods. There are three kinds of resources, viz. human
resources (i.e. people able and willing to participate in the productive process by
supplying their mental and/or physical labour); natural resources (i.e. gifts of nature like
sunlight, wind, ocean tides, virgin land, plants and animals, minerals and fuels, etc.); and
man-made capital resources (i.e. factory buildings, blast furnaces, warehouses, highways,
airport control towers, equipment of producers like computers, milling machines, or
fleets of trucks, and producer inventories of rawmaterials, semifinished goods or even
finished goods that have not yet reached their ultimate users). With regard to human
resources, it may be noted that different people possess different amounts of an invisible
kind of human capital, consisting of health care, general education and training embodied
in them. With regard to natural resources, it may be noted that natural resources which
are in a sense made by people like the animals that have been domesticated and specially
bred or soil that has been cleared, irrigated and fertilized or oil that has been pumped
from the ground and shipped far from its original place of deposit are treated as capital
resources by the economists. Further, capital resources do not include financial capital
such as money, stocks, deeds or bonds which are not directly productive.
Technology refers to the knowledge in order to make goods. It is the set of known
methods of production. It is like the recipe book for converting inputs into outputs.
Now the empirical truth is that there are limited resources and limited technology
in this world. Limited resources plus limited technology yield limited flow of resource
services and so ultimately limited goods which are far less in relation to the combined
desire for goods by all the people. So, goods are scarce. This is what is meant by the
scarcity problem.

Fighting the Scarcity Problem

Obviously, people dislike scarcity. And they would like to go towards abundance.
According to economists, in order to move from scarcity towards abundance, certain
specific actions will have to be taken by people. The possible actions against scarcity, for
promoting material welfare and non-material welfare, constitute the success criteria for
assessing the performance of a socio-economic system.

Promoting Material Welfare

In order to promote material welfare, the following actions must be taken by
people.

(i) The full employment of resources

This means avoiding less than full utilisation of resources. However, the proper meaning
of ‘full’ employment can be debated.
Take the case of human resources. Are they fully utilized only if every citizen is
participating full time in the making of goods? Since the very young, the very old and
the very sick cannot possibly aid in the production of goods, we will have to focus on
able-bodied adults. But who is an able-bodied adult? Everyone aged 18 or above, 14 or
above, by excluding people above 65 or 70 or 75? Similarly, what is the meaning of ‘full
time’? For example, does that mean working 18 hours everyday of the year or in some
other way that supplies fewer labour hours to the productive process but gives people
more leisure to enjoy?
Take the case of non-human resources, i.e. natural and capital resources. Should
these resources be utilized at the rate of 24 hours a day each day of the year? Or should
they be used less intensely, thereby extending the lifespan of the resources, particularly if
they are non-renewable natural ones?
Clearly, every society must find some way of answering the above types of
questions and thus defining full employment.
(ii) The efficient employment of resources
This means avoiding incorrect or inefficient utilization of resources, even after fully
employing them. In this connection there are two concepts, viz. technical efficiency and
allocative efficiency.
The concept of technical efficiency, which focuses on each productive enterprise,
refers to achieving maximum possible outputs out of the inputs actually being employed,
under the current technology. Technical efficiency is mainly due to inadequate motivation
of the workers and managers involved in the production process.
The concept of allocative efficiency, which considers the economy as a whole,
means, inter alia, discovering possibilities for improvement by comparing the
circumstances of two or more producers. There exists allocative or economic efficiency
when it is possible to increase output through some reallocation of resources among
different producers to make some people better off without making others worse off.

(iii) Growth, extensive and intensive

The basic idea of growth is like this. People can think about the types of goods being
produced and give up any attempt to get the greatest possible set of goods for current
consumption out of the limited resources currently available. They can divert some of
these resources from the current production of consumption goods, saving them for
another purpose. And they can turn to investing the resources so saved in the production
of more resources or better methods of production or higher-quality resources.
Consequently, their ability or capacity to produce goods over time increases immensely
so much so that scarcity gives way to abundance.
Extensive economic growth means an expansion of production possibilities
resulting from the availability of more units of the very types of resources previously
available, technology being unchanged. Output can be increased by increasing the capital
stock, discovering new natural resources or reclaiming natural resources currently
considered useless for producing goods. An increase in labour force due to population
growth can increase output but any increase in population is bound to increase the overall
quantity of goods people desire along with the production possibilities. Therefore,
scarcity can be reduced only if there is a population-reducing policy.
Intensive economic growth can be obtained through the promotion of basic
research and applied research; tolerating and encouraging entrepreneurship in terms of
risky, innovating activity in the very proces of production itself; and production of
improved types of resources such as sophisticated machinery or of more productive
workers who are abundantly endowed with human capital through expenditures on
education, healthcare and training for skill formation.

(iv) Economic equity

People will also have to focus on how the goods they are producing are being
apportioned among themselves. As long as there is scarcity, the matter of apportionment
or sharing or distribution is bound to be hotly debated issue in any society. In this
connection there are notions of distributive justice and commutative justice.
According to the advocates of distributive justice, goods should be apportioned
among people by some central authority seeking to act justly in three ways. First, people
may receive goods in accordance with their true, material needs and not with material
desires that are false. Secondly, Each person may get an equal share of the total set of
goods produced in any one year. And thirdly, each person may receive a share of society’s
total output corresponding to the number of hours that person worked. There are
problems with the above three ways of achieving distributive justice. With regard to
apportioning goods according to need, there are two problems: first, how to distinguish
between true material needs and false material desires; and secondly, when all people are
assured of getting what they truly need, they have no incentive either to contribute to the
process of production at all or to contribute in such a way as to produce just the types of
goods that are truly needed. These two problems can only be resolved through a
centralised definition of needs as well as a centralised direction of labour. The problem
with equal distribution is that if everyone were assured of the same income as everyone
else no matter what, someone would have to make sure that people worked at all and also
that they produced the types of goods people wanted. Again, making people work and
telling them what to make will have to be done by a central authority. Apportioning goods
according to hours worked, unlike the earlier two ways, has the advantage of providing a
strong incentive to work, but it has two drawbacks in that the very young, the disabled or
the very old who could not perform labour will get a zero share; and there would exist no
incentive for people to produce the right kinds of goods; a person working 40 hours
producing apples would get the same share of society’s output as would someone else
spending 40 hours doing some work that nobody wanted. Thus, a central authority will
have to tell people what they should produce during the hours they worked.
According to the advocates of commutative justice, there is no need for a central
human authority to bring about equity. Justice can be brought about through an
impersonal process. According to them, output shares ultimately received by people
would be fair (even if they should be highly unequal) as long as these shares had been
determined by the free choices of all people, all of whom enjoyed as nearly equal
opportunities as possible in the process of allocating resources to the production of goods.
A just world is one in which all persons are given the chance, as far as possible, to own
equal quantitites of all resources and are given an equal freedom to use these resources to
produce goods and to trade resources and goods with others. The idea of commutative
justice can be appreciated by conceiving of economic activity as something like a card
game. As long as one distributes cards at the beginning of the game fairly (equal
quantities of resources to all) and as long as one follows rules equally applicable to all
(equal freedom to use resources, to trade resources and goods), the end result is seen as
just. But in a fair card game, some win and others lose! Similarly, in a society aspiring to
commutative justice, the incomes of people (and, thus, their shares of output) can be
expected to differ in the end.

Promoting Non-material Welfare

So much on promoting material welfare. But it is well said that ‘man does not live
by bread alone’. Non-material welfare, i.e. spiritual aspects of human welfare, in the
process of promoting material welfare, has also been a botheration of mankind since
long, i.e. since the beginning industrial revolution more than two centuries ago. Thus the
success of any society must also be judged by the degree to which all individuals are
given the chance to develop during their lifetime the manifold creative potential dormant
within them; to participate on an equal basis with others and free from coercion by others
in all decisions affecting their lives; and to live in harmony with the natural world of
which all human beings are a part. All this is what is meant by avoiding alienation from
the self, others and nature, which is elaborated a bit as follows. Alienation means
estrangement or being out of touch with oneself, others and nature.

(i) Avoiding alienation from the self

The root cause of alienation from the self is the larger production made possible by
detailed division of labour and specialisation and exchange that people in all societies on
earth have come to embrace rather than self-sufficiency based on small scale production
and mastercraftsmenship. While division of labour as the supreme organizing principle of
the productive process makes the society richer, it also enslaves people to repetitively
working machines, in central workplaces, following rigid schedules of work and thereby
causes degradation of human beings in terms of boredom, meaninglessness, atrophied
muscles, tormented spirites, brainless and hated toil, etc. Work becomes joyless as the
work process has crippling effects so much so that people fail to discover and develop
their talents during their leisure time. And so, pursue the goal of challenging the scarcity
of material things but do not lose sight of people’s deepseated need to develop themselves
through a lifetime of creative activity, say the social critics.

(ii) Avoiding alienation from other people

The ideal in this regard is that individuals must have the chance to participate on an equal
basis with others and must be free from manipulation and coercion or force by others, in
all decisions affecting their lives. This can be realized by ensuring consumer sovereignty,
worker sovereignty and citizen sovereignty. Consumer sovereignty exists when all
consumers share the power to decide what types of goods are being produced and
consumed. Worker sovereignty exists when workers share the power to decide what type
of labour is being supplied and under what terms and conditions it is rendered. Citizen
sovereignty exists when all citizens share the power to control their political leaders and
thus to ensure themselves precious individual liberties like right to free speech and press,
to peaceful assembly, to privacy in their homes, to habeas corpus, to speedy trial by jury,
etc.

(iii) Avoiding alienation from nature

This means that people must learn to live in harmony with nature. People should not
treat the natural world as nothing more than a resource to be exploited and destroyed.
Man’s hitherto disregard for nature, the ever-growing size of man-made world and the
high levels of all kinds of pollution of the natural world not only undermine the natural
aesthetics, but, more importantly, could ultimately amount to the end of life on the planet
earth, given that even the experts still do not fully understand earth as a single vast
ecosystem, a system of interrelationships among plants and animals and people and
climatic forces.

Conclusion
It is clear from the above discussion that a good society is one which fights scarcity in
such a way as to promote not only material welfare but also non-material welfare of its
people.
 Lecture Notes 2
Defining Economic System and Classifying Economic Systems
Defining Economic System

The set of institutional arrangements through which people in a society make choices
about the allocation of their scarce resources and the apportionment of their scarce goods
is called an economic system.
One could also say that an economic system is a social arrangement through
which people cooperate with each other on matters affecting their material or economic
welfare which, inevitably, affects their non-material or noneconomic wefare as well.

The institutional arrangements that we have in mind are (a) ownership status of
resources, human, natural and capital; and (b) incentives for coordination.

Classifying Economic Systems

There is no universally acceptable scheme of classifying the world’s economic systems.

However, two criterial have been employed quite often in order to avoid confusion in this
regard. These time-honoured criteria classfiy economic systems by asking two crucial
questions: Who effectively owns the resources and, therefore, has the power to make
choices with them? What types of incentives are used to coordinate the choices of
different resource owners? We elaborate the answers to these questions as follows.

Capitalism and Socialism: Classification by Resource Ownership

Modern economic systems can be classified on the basis of resource ownership, i.e.
property rights in natural and capital resources, which together are also known as the
nonhuman resources or the means of production. Nonhuman resource ownership
accounts for the major differences among the world’s economic systems in the 19 th and
20th centuries. Since in modern times, the ownership of human resources is widely
dispersed over many individuals, i.e. mosts persons have exclusive control over their own
labour power, the ownership status of human resources is not particularly helpful in
differentiating modern economic systems.
Table 1 shows how we can distinguish between capitalism and socialism on the basis of
resource ownership.

Table 1
The formal ownership of The effective control of Name of the economic
nonhuman resources nonhuman resources is system
resides in: exercised by: (3)
(1) (2)
1. Private individuals a. Private individuals Capitalism
b. Self-selected small
groups of private
individuals
2. Groups of people a. A central government Socialism
(possibly even in all of a b. Designated individuals
society’s people as a group) or small groups
c. All group members
jointly

Column 1 of Table 1 indicates two major arrangements with regard to resource

ownership. First, the total of nonhuman resources is divided into numerous subsets the
formal ownership of which is widely dispersed among many private households.
Secondly, the formal ownership of nonhuman resources is vested in groups of people,
possibly even in all of a society’s people as a group.
Column 2 of Table 1 indicates some of the major alternatives concerning the
effective control of nonhuman resources. Case 1a refers to a situation where private
individuals are formal owners, while the same or other private individuals exercise
effective control. For example, the owner-managed single proprietorship or the
corporation run by a manager who has usurped most of the powers of individual
stockholders. Case 1b describes a situation in which private individuals are formal
owners, but they have joined their resources with those of other such individuals and are
exercising control jointly as well. For example, partnership or corporation run by a
manager strictly controlled by individual stockholders. Case 2a describes a situation in
which groups of people (or even all people as a group) are the formal owners, while a
central government is in fact exercising effective control. For example, public enterprises.
Case 2b describes a situation in which groups of people (or even all people as a group)
are the formal owners of nonhuman resources, while effective control over many subsets
of these resources is exercised by designated individuals ( such as appointed or elected
managers) or small groups of people (such as all the people actually working with these
resources). For example, the Soviet collective farm or the Yugoslavian labour-managed
firm. Case 2c, finally, describes a situation where groups of people ( or even all people as
a group) are the formal owners of nonhuman resoruces, while the effective control is
exercised by all group members jointly. For example, a commune.
The economic system in which the formal ownership as of nonhuman resources
resides predominantly in private individuals and the effective control of them is with
private individuals or self-selected small groups of private individuals is categorised as
capitalism; and the economic system in which the formal ownership of nonhuman
resources resides predominantly in groups of people or even all people as a group but the
effective control is with a central government or designated individuals/small groups or
all group members jointly, is categorised as socialism.

Market Economy, Command Economy and Economy of Love: Classification by

Coordination Incentives
When different people own resources and independently make choices with them, it is
possible for these choices to be inconsistent with each other. That is why every economic
system needs some type of incentive to guide people into acting in such a way that their
actions mesh with those of other people.
There are three major types of incentive as follows:
(i) Money
One can arrange matters in such a way that people are always free to exchange for money
any scarce good or resource that they own. Thus, owners of resources who wish to make
choices requiring compatible choices by other owners of resources can apporach those
others with conditional offers in terms of units of money. Changing prices in terms of
money units can adjust the behaviour of people and make their choices consistent with
each other. People will come to know of others’ preferences and capabilities through
money.

(ii) Command
One can arrange matters in such a way that some people have the right to give specific
orders to other people, telling them what to do or not to do. In this scheme, the others can
be threatened for noncompliance and forced into acting or not acting in specific ways that
remove the inconsistencies in the choices of different people.

(iii) Love
Instead of being made aware of other people’s wishes by their offers of money or their
direct command accompanied by threat of harm, in this arrangement the internal
incentive of goodwill or love solves the coordination problem.

In light of the above discussion, we can classify economic systems as market

economies if the money incentive is predominant; as command economies if the
command principle is most prevalent; and as economies of love if the rule of love is the
coordination incentive.

Market Capitalism, Centralised Socialism, Market Socialism and Communal Socialism:

Classifying Economic Systems by Combining Ownership and Incentive Criteria

As Table 2 shows, Capitalism plus money as the coordination incentive as pointed out
above results in market capitalism ( 1 plus A = market capitalism). Socialism with
effective control by a central government plus command economy results in centralised
socialism (2a plus B = centralised socialism). Socialism with effective control by
designated individuals/small groups plus money as the coordination incentive results in
market socialism (2b plus A = market socialism). Finally, socialism with effective control
by all group members jointly plus love as the coordination incentive results in communal
socialism (2c plus C = communal socialism).

Table 2
Resource ownership Coordination incentive
Money (A) Command (B) Love (C)
1. Private individuals are Market capitalism
formal owners, while
effective control is
exercised by private
individuals also or by self-
selected small groups of
them
2.Groups of people,
possibly even all of a
society'’ people as a group
are the formal owners,
while effective control is
exercised by
a. A central government Centralised
socialism
b. Designated Market socialism
individuals/small groups
c. All group members Communal
jointly socialism

Conclusion

Modern economy systems can be classified in terms of the four general types or models
of economic systems by combining the criteria of resource ownership and coordination
incentives. However, no real-world economic system fits any of these categories
perfectly, but all actual systems as observed in the 20th century tend to come closer to one
of these models than to the rest.
 Lecture Notes 3
Ideologies and ‘Isms’
or Different Ideologies and Different Economic Systems

Ideology

An ideology is a set of ideas, shared by a social group (e.g. a class or a nation) that (a)
represents a certain picture of social reality; and (b) sets up desirable values and goals for
society to strive for, or preserve.

Capitalism
Capitalism is a system in which productive assets/means of production/nonhuman
resources are predominantly privately owned. Advanced western capitalist economies
also contain smaller or larger publicly owned sectors and so they are mixed economies.
Production in this system is primarily for sale with profit motive. Profit motive of free
enterprise is considered the great engine of capitalism. In fact, according to some
historians, it is the greatest economic drive in all history to date. Profit motive over time
was subject to standards of humanitariansm and justice; in other words,it was subject to
social restraints, moral as well as legal. Capitalism is also characterized by the
institutions of inheritance and the law of contract.
In order to better understand the evolution of capitalism, it is useful to distinguish
between Earlier Capitalism (i.e. during 19th century/early 20th century)) and
Contemporary Capitalism (i.e. during the post II World War).

Earlier Capitalism

The spirit of earlier capitalism is captured well by free enterprise, venturesomeness,

acquisitiveness, competitiveness, urge to innovate, and, above all, rationality. Rationality
means (a) deliberate subjugation of means to definitive end, which is the pecuniary gain;
(b) careful weighing of alternatives; (c) keeping of systematic records; and (d) break with
tradition, superstition and magic.
A major debate concerns whether we can summarily say that the ideology of
earlier capitalism was typically Laissez Faire. Laissez faire in French means leave
business alone, let businessmen do what they want to do. According to this, earlier
capitalism was individualistic capitalism with no interference in economic activity by the
government. Government was only a ‘night watchman’ in terms of protector of life and
property and enforcer of contracts.
According to some historians, such a depiction is unwarranted because laissez
faire prevailed only for a shorter period in England during the second half of the 19th
century. Before that, in England as also other European countries, the ideology of
Mercantilism prevailed. According to mercantilism, the state has the right and duty to
both regulate and protect private enterprise for the greater power and glory of the state.
Even in USA of the late 19th century and very early 20th century (i.e. during the period
between the Civil War and the Great Depression), the dominant ideology was one of
modified laissez faire. There was government regulation of public utilities, there was
government enforcement of competion in terms of ‘trust busting’, and large federal
subsidies were given for railroad construction. Free competion was diluted with tariff
protection. In relatively latecomers to industrialization such as Germany, France, Russia
and Japan, laissez faire was in fact considered as a luxury to be avoided. Active
government protection and promotion of domestic enterprises including state-owned
enterpises was pursued before the First World War. Moreover, monopoly, cartel and
powerful bank were the dominant capitalist institutions in these countries.

Downside of Earlier Capitalism and the Rise of Various Anti-capitalist ‘Isms’

The downside of the earlier capitalism was that it led to the immiserisation of
large working classes it created; the workers were crowded in urban slums, worked long
hours for low wages and lived in harsh and unhealthy conditions inside and outside their
factories. This downside of earlier capitalism was the source various anti-capitalist ‘isms’
including radical/socialist ideologies and political movements, often of middle class
origin, for the workers and among the workers. Broadly speaking, socialist ideology
emerged as a challenge to the capitalist order.
The various anti-capitalist ‘isms’ as responses or reactions to early industrial
capitalism can be pointed as follows. First, there was opposition from the educated class
in terms of romanticisation of the past in relation to the rise of the ‘dark Satanci mills’
and the consequent loss of natural beauty of the rural landscapes. Secondly, the ordinary
workers showed opposition by smashing the machines and they were known as the
Luddites. Thirdly, the skilled workers showed opposition by organising labour unions
despite police repression and hostile employers. Fourthly, the Utopian Socialists argued
that private property and selfishness were the roots of social evil; and they imagined the
perfect society in terms of communistic or cooperative principles of work and income
distribution. Fifthly, Scientific Socialism fathered by Karl Marx and Friederich Engels
emerged as the most pervasive anti-capitalist ideology throughout the world, and inspired
the rise of various kinds of socialist economic systems in the world. In order to
appreciate the ideology of scientific socialism, we will have to understand the Marxian
Theory of History and Marx’s Analysis of Capitalism.

Marxian Theory of History and Marx’s Analysis of Capitalism

In the Marxian theory of history, a society is constituted by the Base ( in terms of
economic facts of life) and the Superstructure (in terms of law, culture, religion, art,
philosophy, etc.). The economic facts of life are sharply capture by the concept of mode
of production which means on the one hand ‘productive forces’ (i.e. production capacity
and level of technology) and ‘production relations’ (i.e. relation of various classes such as
landlords, capitalists, workers to the production process). According to Marx’s theory of
history, all mankind must pass through six major historical stages with corresponding
modes of production, viz. (1) Primitive (tribal) Communism; (2) Slavery; (3) Feudalism;
(4) Capitalism; (5) Socialism; and (6) Communism. Under (1), (5) and (6), there is
absence of private property in that means of production/nonhuman resources are owned
in common. And there exists no exploitation in terms of appropriation of the product of
labour of some class or classes (e.g. slaves, serfs, workers) by others (e.g. slave owners,
feudal landlords, capitalists). According to Marx and Engels, the history of society is
nothing but history of class struggle or antagonism between classes. In socialism which
comes about after the overthrow of capitalism, egalitarianism matters and the collective is
above the individual. The scarcity problem continues to exist. External material
incentives are used to mobilise the energies of the people for increasing output while
distribution of output is according to the labour performed. In communism as the ultimate
destination, there is abundance. There are no external incentives. Distribution is
according to needs. There is no money, no finance, no prices, and no state as the
supporter of an exploiting class.
In marching towards abundance, technological progress is the mechanism for
transition from one stage to another. Technological progress brings about radical
improvements in productive forces which in turn gives rise to a new class which seizes
power and refashions the ‘production relations’ to its own liking and needs. When
productive forces improve, production relations as institutions do not change to be
compatible with it. At first they correspond to productive forces, i.e. they enable the
technology and capacity of the economy to produce fully but they lag behind and become
a hindrance to the further development of the productive forces. This problem in respect
of capitalism is solved by the capture of power by the working class.
In Marx’s analysis of capitalism, there are two antagonist classes, viz. the
capitalists (owners, managers, employers of labour) on the one hand and on the other, a
large working class which is propertyless, i.e. it has no source of livelihood other than
sale of its own labour power. Labour is the source of all economic value. Workers sell
their labour power and get wages which are at the level which is just necessary for the
reproduction of labour force, i.e. for subsistence and bringing up next generation of
workers. There are always unemployment levels which do not permits the wages to
rise. Technology is so advanced that workers always produce more than their own
subsistence needs so much so that surplus value is approriated by the capitalists (for their
own consumption and savings to finance further investment and to make payments to
other property owning classes in terms of interest for financiers and rent for land owners).
The dynamics of capitalism develops in such a way that the ownership of capital and all
power becomes more and more concentrated over time. Society’s polarization increases
as the workers become poorer and poorer. Capitalists in their constant search for profits
overinvest resulting in crises due to decline in long run rate of profit or
underconsumptionism. The only way out of this mess is for the workers to overthrow the
capitalist order by seizure of power through a revolutionary battle against the capitalists.
Although Marx’s views were very appealing and widely influencing, his
predictions did not come true. Capitalist development did not show extreme polarization.
Nor did it show progressive impoverishment of the workers and rising revolutionary
fervour among the working classes. The material levels of the masses did indeed
increase. Moreover, there was rise and enlargement of a conservative white collar
working class.
Rise of Socialism
The rise of socialism in Soviet Union (via Leninism and Stalinism), Yugoslavia (via
Titoism), China (via Maosim), Cuba (via Castroism) and many other countries in the
early and later 20th century was characterised by certain commonalities as follows: (1)
Seizure of power by a professional conspiratorial party led by a small revolutionary elite
which offers determined leadership and which is highly disciplined, internally
authoritarian and which speaks in the name of the working class; (2) economic
backwardness in terms of a backward agrarian context; (3) a poor, disaffected land-
hungry peasantry as the instrument of victory; and (4) war against an invader or a
colonial power. As the ideology of the highly authoritarian small party which is obsessed
with the purpose of achieving industrialization and military power at any cost is not
shared by the bulk of the population, the revolutionary elite resort to political repression
and terror. Stalin was the most absolute of modern dictators as his regime was
characterised by the highest degree of ruthless and bloody totalitarianism. Maoist China
and Castroist Cuba differ from Stalinist Soviet Union in that the former two had different
internal structure and used internal moral incentives to mobilise the energies of people.

Contemporary Capitalism
Before 1950, capitalism was attacked for having caused terrible wars, business cycle of
the 1930s, great inequalities in income and wealth, colonialism, unemployment and much
social tension. But in the post Second World War period up until the mid-70s, capitalist
development went through a ‘Golden Age’ in terms of rapid economic growth, rise in
average consumption levels and minimisationof business fluctuations and unemployment.
The significant features of this golden capitalism were as follows:
(1) There was politico-economic equilibrium among and mutual acceptance of
business, especially big business, government and organised labour. Active
intervention of the government for stability, promoting growth and reducing
insecurity and inequality gained currency. In some countries, government
planning was deep enough to have substantial nationalised sectors.
Collective bargaining by organised labour was accepted by the employers.
(2) New managerial ideology in terms of professionalism on the part of the
management in large corporations for taking care of not only profit motive but
also responsibility to various elements within and without the corporations
(like employees, customers, suppliers, general public and stockholders).
(3) Declining militancy of labour which moderates its political goals by accepting
the social order.
Democratic Socialism in Europe
Social democracy or democratic socialism as the ideology of moderate, reformist
democratic socialist parties in countries such as Sweden and Germany was characterized
by the following features:
(i) Revisionism in terms of seizure of power through ballot (i.e. political
democracy);
(ii) Emergence of Christian Socialism based on the ethical teachings of
Christianity, especially of the Protestant type against individualism, greed,
inequality, poverty of working class, alienation, unemployment, distortion
of social and cultural values, crime, and war;
(iii) Respect for political freedom, democracy, individual security and
elimination of inequality of all kinds; and
(iv) Recognition of the middle class aspirations of the working class.

The means adopted by social democrats to achieve their goals were initially in
terms of welfare state and nationalization of most important industries. But later
on with the experience of excessive bureaucratization and enhancement of
government power, the social democrats abandoned their obsession with
nationalisation and opposition to private property and began to believe in the
control of industry for private and social ends. Ultimately, democratic socialism
shaping the mixed economic systems in Europe evolved to have the following
features: private ownership as a rule, public ownership only when necessary,
maximum reliance on market economy supplemented by government control and
welfarism, equality of opportunity in education and safeguarding of political
democracy.
 Lecture Notes 4
Features of Centralised Socialism
as a Pure Model and as a Case Study of the Former Soviet Union

Centralised Socialism as Pure Model

The following features characterize centralised socialism as a pure model:
(i) There exists public ownership of all nonhuman resources or means of
production. These are effectively controlled by the central government.
People as owners of their labour power cannot perform anything without
the use of complementary productive assets that the government controls.
(ii) There is no private decision making at all. All economic power is
concentrated in the government hands. Making and enforcing decisions,
general to minute, is done by the government.
(iii) The various separate economic activities of all people, given the
interdependence in terms of division of labour and specialisation of the
modern economy, are coordinated by the system of Visible Hand, i.e.
preparing a Common Plan which specifies everyone’s future actions in
detail and issuing verbal commands to various people who in turn execute
the government’s will passively and obediently. Productive enterprises
receive verbal commands with regard to output quotas, i.e. minimal
quantities of how much of what they should be producing and delivering
to designated recipients are specified. They also receive orders regarding
input norms, i.e. maximal quantities of inputs to be used per unit of
designated outputs. The productive enterprises are supposed not to use
input quantities more than the specified input norms. Verbal commands
specifying the quantities of nonhuman resources are also given to
administrators in charge of nonhuman resources. And households receive
orders regarding supply of labour. The government officials and
individual households are made to obey the output quotas and input norms
issued to them through positive and negative and material or moral
incentives. Positive incentives include praise, medals, tying distribution of
consumer goods to the proper performance of assigned tasks, etc. For
example, those who went willingly to their designated places of
employment and worked hard might get a larger share of consumer goods
than others who were less obedient. Negative incentives include
castigating (i.e. severe reprimanding), fining, jailing and shooting for non-
compliance.
Centralised Socialism as Case Study of Stalin’s Economic System in the Former Soviet
Union

The major features of centralised socialism under Stalin’s rule in the Soviet Union during
the early 1920s to early 1950s were as follows:
(a) The objective of the system was to achieve the most rapid pace of
industrialisation possible.
(b) There was predominantly public ownership of the means of production.
Outside agriculture, there were state enterprises, including enterprises which
were simply nationalized and put under the control of the managers appointed
by the state). Within agriculture, private property was eliminated by
collectivisation. Private property was transferred to three kinds of
government controlled institutions, viz. state farms (huge farms controlled by
government appointed managers, with the average size of 30,000 acres);
collective farms (large farms organised as compulsory producer cooperatives
by pooling of separate land and livestock holdings of numerous peasant
households); and machine and tractor stations (state enterprises which
controlled all the agricultural implements of the formerly independent
peasants. As peasants protested against collectivisation by destroying their
buildings/inventories and slaughtering livestock, the machine tractor stations
were created to give equipment to collective farms in order to protect the
agricultural capital stock from damage that peasants might inflict upon it
whether out of ignorance or malice. Those peasants who resisted were exiled
or exterminated. Around 5 million peasants were killed for opposing
collectivisation.
(c) The central planning process was one of a hierarchically organised system of
central planning wherein the leaders of the Communist Party to took
decisions at the top as all economic and political power was wielded by them.
The Party leaders determined the objectives of the plan to be achieved on the
basis of the collection of data on the past performance of the economy and
the Party directives were conveyed to the Gosplan, the state planning
commission. Gosplan prepared the tentative Central Plan in terms of output
targets and input requirements which were conveyed to productive enterprises
producing thousands of ‘important’ (i.e. high priority) commodities. And on
getting feedback from the enterprises officials from below, the Gosplan
undertook revisions and finally made the Plan into a law.
(d) A mixture of command-love-money incentives was used by the Party
leadership in order to get the country’s peasants, managers, administrators
and workers to act precisely as specified in the final Plan. Positive incentives
included a system of Awards and Decorations (e.g. ‘Order of Lenin’, ‘Heroes
of Socialist Labour’) to individuals and groups who executed the commands
with great enthusiasm. Negative incentives were threats and often severe
punishment for disobedience. Punishments included, for example, demotion
of a manager to that of an ordinary worker, redeployment of a manager or
worker to a less desirable job in a less desirable location, criminal prosecution
 for mishandling of public property along with a sentence to a forced labour
camp in Siberia, etc. In order to make the people obey, punishments was
extended to parents, spouses and children, distant relatives, neighbours and
fellow workers! Love incentives basically amounted to propaganda asking
people to do self-criticism and drive out selfishness and instill in them the
inner need to serve their fellow citizens, their country, and the cause of
socialism. Money incentives included widespread use of money and
administrative prices.
(e) In order to influence the behaviour of the managers the following monetary
incentives were used. First, they were expected to do internal auditing by
keeping monetary accounts at government set prices, of the gross value of
output, input costs and profits in order to achieve technical efficiency.
Secondly, the Gosbank, the state bank which was the monopoly bank with
thousands of branches in the country did external auditing of the productive
enterprises by monitoring the inter-enterprise transactions and keeping a
running account of plan execution. Thirdly, managerial bonus system was
used as the most powerful incentive. According to this, the managers got
salaries plus bonuses for fulfilling and overfulfilling the output targets.
(f) In order to influence the behaviour of the workers, workers were given
money wages for labour performed and were allowed to spend it freely on
consumption goods either at the state retail stores or in the free collective
farm market. There were money wage differentials to account for the type of
work and geographical location. Individual and group bonuses were also
given to workers. There was also rewarding by in-kind distribution of
consumer goods.
(g) Stalin was clever enough to introduce powerful incentives in Soviet
agriculture. Millions of acres of land were made available to collective farm
households, state farm workers and certain others (such as factories, hospitals
and schools) as private garden plots. Each of these plots was less than 1 acre
in size. Their owners were free to grow anything they liked on these plots
and they could even hold some animals privately. More than that, they were
free to sell their privately produced output on so-called collective farm
markets to anybody at any price freely determined by supply and demand.
The consequences were amazing indeed in terms of larger output creation.

Problems with Managerial Behaviour

Managers’ greed for maximising their bonus payments led to the following problems:
(a) Managers understated the productive capabilities of their enterprises in order
to get low output quotas from the central managers. Whenever they
succeeded, available resources were underutilized even as they personally
benefitted.
(b) Managers overstated their input requirements and when they succeeded, they
hoarded the resources in warehouses and there were idle workers on payroll.
They drew on these resources to fulfil and overfulfil the output targets or
whenever they needed inputs which they did not receive.
 (c) As output targets were specified in physical quantities, the problem of low
quality of output emerged. For example, if a manager were given the choice
between producing 100 tons of perfect steel and 110 tons of brittle steel, he
tended to opt for the latter.
(d) There was shortage of spare parts and lack of service. Again, if there were to
be a choice between producing 500 tractors with spare parts and a good
service organisation to back up their future operations and 550 tractors
without spare parts and service, managers would opt for the latter.
(e) There was disregard of the wishes of the customers as to composition of
output. This was the so-called assortment problem which simply meant
mismatch between what is produced and what is wanted in the system.
(f) The timing of production and deliveries was badly affected. This was known
as the problem of ‘storming’. Production and deliveries did not occur on a
regular basis, given the quarterly accounting deadlines. In fact, it was typical
in the Soviet economy to produce at a fairly leisurely pace during the early
part of any calendar quarter, but later the pace of activities quickened and
turned into a furious tempo as the date of reckoning approached.

Problem faced by the Workers as Consumers

The typical problem faced by the people as consumers was the so-called ‘Supply
Problem’ in terms of the problem of shortages and surpluses faced by them in the state
retail stores through which the government distributed the consumer goods due to the use
of fixed prices instead of flexible pricing. As the figure below shows, it was a rarity to
find the price fixed by the government (10 rubles per unit) as the equilibrium price in
terms of the demand D2 in relation to the supply of 16, 000 units offered for sale.
Typically demand was more or less intense as indicated by D3 or D1 so that there was
either shortage or surplus which could have been avoided through flexible pricing, for
example 15 rubles in case of shortage and 5 rubles in case of surplus.

Problem faced by the Peasants in Collective Farms

The collective farmers produced and delivered according to the governmentally set
quotas. When they delivered, they were paid ‘agricultural procurement prices’ that were
fixed by the government. Whenever they purchased inputs from the government
administrators, they paid the so-called ‘enterprise wholesale prices’ which were again
fixed by the government for interenterprise transactions. Sales revenue (output produced
multiplied by agricultural procurement prices) minus costs (inputs purchased at enterprise
wholesale prices) amounted to residual income which was divided among the collective
farmers at the end of the year (in accordance with ‘labour-day’ points accumulated by
them during the year), and this dividend became their personal reward for working on
collective farms. By manipulating the prices involved, Stalin saw to it that the collective
farmers’ personal income was extremely small, which made it impossible for them to buy
any significant quantities of industrial consumer goods. Not surprisingly, the collective
farm residual income was a poor incentive to induce collective farmers to their best.
Collective farmers typically malingered on the collectively owned land.

The Underground Economy

The problem with the official economy was the ‘supply problem’, i.e. the inability of the
people to obtain the types of goods they wanted. People were frustrated because some
goods were simply not provided and others were not available at the right time in the
right amounts or in the right quality. And so people very soon figured out semi-legal and
illegal ways of getting what they wanted. Thus, there emerged an enormous underground
economy beyond the control of the official economy, i.e. outside the control of the
Gosplan. In this economy, people performed semilegal and fully illegal activities in order
to enhance their welfare. They allocated resources and acquired goods in ways not
specified by the Central Plan.
The managers were notorious for their semilegal behaviour, i.e. for their adoption
of illegal means to achieve legal ends. Officially, this was deplored but tolerated. The
managers resorted to three kinds of illegal means. First, they created and carefully
nurtured personal connections with influential people in order to get more input
allocations and lower ouput targets. Secondly, they promoted black markets barter. Most
enterprise managers surreptitiously employed special kinds of ‘expediters’ or ‘pushers’
who scoured the economy for needed supplies and arranged illegal exchanges of
equipment and rawmaterials among enterprises, given the problem of wrong deliveries
faced by each enterprise. Thirdly, managers resorted to ‘empire building’. This meant that
they they solved their ‘supply problem’ through self-sufficiency, i.e. their own
production.
A vast illegal enterprise sector came into existence due to stealing of all types of
inputs and using them in illegal enterprises. They came into existence in three ways: first,
as operations behind an official façade, i.e. as private firms behind state enterprises;
secondly, through the putting out system wherein some private entrepreneurs engaged
large numbers of workers all of whom did piecework in their own living quarters. They
provided the workers with the needed rawmaterial and marketed the product after
collecting it from them; and thirdly, as home-based operations, i.e. many commodities
and services were produced in their own homes by private producers
The underground economy thrived as bribery and corruption became a way of life
in the Soviet Union despite the bloody dictatorship of Stalin and his secret police.
 Lecture Notes 5
Performance Assessment of Centralised Socialism
as a Pure Model and as a Case Study of the Former Soviet Union

Introduction
Whether an economic system has fared well in fighting the scarcity problem is judged on
the basis of whether that system has done well in relation to the list of actions required to
be done to promote not only economic or material welfare through full employment,
efficient employment, growth, extensive and intensive and economic equity but also
noneconomic or non-material welfare through avoiding alienation from self, others and
nature. We elaborate this in respect of centralised socialism as follows.

Performance Assessment

(i) Full employment

In the pure model of centralised socialism, the central government defines and achieves
full employment. The central government achieves it easily because the central planners
can draw a plan the execution of which would utilize the available resources precisely.
But the critics think that this is not possible. According to them what is logically
conceivable may not be practically possible. According to the critics, in saying that the
central government can achieve full employment always, the central government is
treated as God with the characteristics of omnipresence, omnipotence and more
importantly, omniscience. But this is a mistaken view. Take the case of omniscience. This
is impossible due to the so-called ‘knowledge problem’ which means that knowledge is
not available to a single mind in its totality but is found in billions of dispersed fragments
in the minds of countless separate individuals. Moreover, workers and managers can give
false reports to the central planners.
The case study of former Soviet Union more than amply demonstrated that
unemployment was very much in plenty. There were three kinds of unemployment found
in plenty. First, there was seasonal unemployment. For example, agricultural and
construction workers faced forced idleness during winter which was not reflected in
unemployment statistics. These workers were on payroll and received 50 per cent of their
wages eventhough they did not do anything. Their unemployment was therefore hidden.
Teenagers looking for jobs during vacation were not hired by managers due to the law
that they should be paid full wages even for part time work. So, their unemployment too
was hidden. Secondly, there was frictional unemployment. This refers to unemployment
due to the long delays between leaving school and taking a first job and unemployment of
workers as ‘rolling stones’, i.e. those who made voluntary quits and hopped from job to
job. In Soviety Union, voluntary quits were not allowed till the mid-50s. In the pre-
1950s period, people were forbidden to quit jobs or absent themselves without permission
from enterprise managers. Moreover, there were penalties even for quitting with
permission (e.g. denial of sick leave for 6 months, loss of bonuses, etc.). Thirdly, there
was systematic unemployment due to the errors in plan formulation and execution
resulting in the so-called ‘supply problem’ in terms of shortages and surpluses. Due to
imperfectly formulated central plans, and delivery of the rawmaterials at the wrong time
or in wrong assortments, complementary workers and machines were idled.

(ii) Efficient employment

In the pure model of centralised socialism, there would be no technical inefficiency at all
since the central planners can enforce their decisions by commands backed by rewards
and threats. But the critics argue that technical inefficiency can arise for two reasons.
First, there could be misinformation from managers and workers. Secondly, in centralised
socialism distributive justice is pursued in such a way that people’s income is divorced
from their contribution to production and consequently the so-called incentive problem
arises. For example, if everybody get the same income, some may decide to work less
intensely.
The case study of former Soviet Union shows that technical inefficiency was very
common in that country for two reasons. First, given the monetary incentive of bonus,
the managers behaved in terms of understating output possibilities and overstating input
requirements in order to fulfil and overfulfil targets by deliberately hoarding labour and
other inputs and drawing on them as and when required. Consequently, resources were
apparently employed but actually redundant. In so far as some resources were not
utilised to produce output, there was technical inefficiency. Secondly, there was technical
inefficiency due to widespread lack of labour discipline in terms of workers working at a
snail’s pace, being absent for hours at a time, and being drunk on the job. Absenteeism
and alcoholism were two terrible problems in Soviet Union in that they could not be
successfully tackled despite major campaigns against them.
As regards allocative efficiency, the pure model says that it is very much possible
but the critics are sceptical about it due to the ‘knowledge problem’ mentioned above.
Scientific knowledge of general applicability can be centralized but unorganised
knowledge of particular applicability which is present in fragments in countless
individuals cannot be completely appropriated by the central government.

(iii) Economic growth, extensive and intensive

According to the pure model, rapid growth can be achieved easily because the central
planners have total control over the composition of the set of final goods produced. The
critics argue that while extensive growth is possible, there is no scope for intensive
growth under centralised socialism insofar as the managers of productive enterprises
cannot deviate from the tasks assigned to them by the central plan and take risks of
trying new ways. Even if they were to try innovation through permission, it would be
futile due to the inherent delays.
 The case study of former Soviet Union demonstrates that the strategy of extensive
growth, i.e. achieving more output through more inputs was pursued during the 1928-
1940 period. Primary emphasis was given to growth of industry rather than agriculture.
Stalin was obsessed with the development of such basic and heavy industries as coal,
iron, steel, electric power, locomotives, tractors, machines, etc. Labour inputs in terms
of no. of hours worked increased due to pressure on adults not to remain voluntarily
unemployed and not to lead an ‘antisocial parasitic way of life’. Soviet Union witnessed
very high labour force participation rates of males and females—in fact, the highest in the
world—also because of shifting people from agricultural part time employment into
industrial full employment. Soviet Union also maximised the discovery and exploitation
of additional natural resources.
The 1940-1950 period was a terrible disaster, with enormous losses in productive
capacity and all resource base due to German invasion and retreat, for Soviet Union. The
country was reduced to a wasteland with around 20 million Russian dead.
There was a steady decline in the rate of growth since the 1950s due to (a) fewer
opportunities to pursue the favoured strategy of extensive growth; and (b) an inability of
the central planners to harness the potential of the alternative strategy of intensive
growth.
Extensive growth based on expansion in labour resources, capital resources and
natural resources could not be sustained due to the following reasons. In the case of
labour, the following barriers were found. As the labour force participation rates for men
and women were already pushed to their practical limits, this source of increased labour
supply was closed. The source of additional labour by means of shifting underemployed
agricultural labour to the industrial sector was also dried up. Further, unlike Stalin who
forced people to work more hours per week, his successors reduced weekly hours. Worst
of all, the great disasters of the Soviet past in terms of emigration, famine, purges and
Second World War decreased the ratio of males to females in the population and
produced remarkably slower annual increase in the potential labour force. In the case of
capital, there were two reasons why capital resources could not be expanded despite the
imposition of heavy sacrifices in consumption goods in order to ensure that a large
percentage of each year’s GNP consisted of new capital or investment goods. First, for a
given production of new capital goods, past increases in the capital stock were impossible
to repeat to the extent that an ever greater percentage of each year’s new capital goods
now just replaced the wear and tear of a much larger and older capital stock. Secondly,
unlike in the past, when investment was stressed in sectors with high marginal
productivity of capital, more of it was now channelled into sectors with low marginal
capital productivities. In the case of natural resources, new virgin lands could not be
brought under cultivation any more for increasing agricultural output. In the areas of old
land, more and more resources were required to get the yield per acre that was achieved
in the past. The same problem was experienced in the exploitation of minerals and fuels.
Intensive growth could not be achieved for the following reasons. First, despite
commendable progress in expanding high quality education relevant for economic
progress, output increases could not be obtained due to the motivational deficit as
reflected in widespread alcoholism, absenteeism and malingering. Productivity increases
based on improvements in health care could not be derived as there were many
drawbacks in health care provisioning. As regards, technical advance, the Soviets
organised the wholesale copying of the most advanced production techniques from the
West, but did not update them continuously. At the enterprise level, there was no
innovative activity on the part of the managers in terms of experimenting on a small scale
and continuosly with new improved methods of production. Moreover, innovation
decided upon and commanded by the central planners was a slow process as reflected in,
for example, the slow Soviet changeover from coal to oil and gas as major energy
sources.

(iv) Economic equity

The Soviet government did not pursue distributive justice according to need or equality
or hours worked, yet it maintained that equity was achieved because (a) no one received
income from the private ownership of nonhuman resources and (b) the differences in
people’s incomes were government determined and not the result of ‘blind’ market
forces. The empirical truth was that there were enormous differences in the incomes of
the people. At the top of the Soviet income pyramid were the political and economic
leaders, followed by the military brass, the professional managerial elite, and superstars
in arts and sports. Below them, in turn, were the industrial workers, followed by the
peasants at the very bottom. There was no scarcity problem for those at the top of the
pyramid.

(v) Avoiding alienation from self

People’s alienation from themselves surely existed in the Soviet Union no less than in
other industrialzed countries due to the division of labour and the consequent
enslavement of people to machines, to work outside the home, to rigid work schedules
and to mammoth workplaces. Moreover, alienation from self was much worse as people
were taught to submerge their individuality in the community at large, to be a willing cog
in the great central plan, not to go off and do their own thing. The Soviet society was one
where conforming to the Party line had the highest priority.

(vi) Avoiding alienation from others

Centralised socialism fares very badly in this respect. Powerful bureacracy with its
supposedly ‘supreme wisdom’, imposes its will on the people. In other words, people are
forced to accept the preferences of the central planners. There is no consumer
sovereignty, no worker sovereignty and no citizen sovereignty.

(vii) Avoiding alienation from nature

Although in the pure model of centralised socialism, the central planners hold the power
to preserve nature, the Soviet case study shows that the central planners were not
sensitive to nature. All kinds of pollution were everywhere in Soviet Union, and they
were as bad as pollution elsewhere.
Conclusion
Contrary to official propaganda, the Soviet case study shows that continuous full
employment does not exist. There is seasonal unemployment (due to weather) and
frictional unemployment (due to high labour turnover). Above all, there is widespread
hidden unemployment caused by errors in plan formulation and execution (the ‘supply
problem’).
Technical inefficiency is widespread, in part the result of managerial input
hoarding, in part caused by a general lack of labour discipline. Allocative inefficiency is
also ubiquitous.
Economic growth has been impressive until the late 1950s, but the overall rate of
growth has steadily declined since. This can be explained by vanishing opportunities for
extensive growth and an inability of central planners to harness the potential for intensive
growth (especially through technical advance).
There is no distributive justice. But the Soviet government claims that its highly
unequal distribution of income is just.
As to alienation, whether from the self, from other people, or from nature, Soviet
society scores poorly on all counts.
 Lecture Notes 6
Features and Performance Assessment of Market Socialism
as a Pure Model and as a Case Study of the Former Yugoslavia

Market Socialism as a Pure Model

The Polish economist, Oscar Lange, had conceptualised socialist market economy as a
pure model. It is a world in which the nonhuman resources are collectively owned but the
effective control of these resources is shared by numerous individuals throughout the
economy. Their actions would be coordinated by markets in which all resources as well
as goods would be bought and sold. In a nutshell, he imagined the possibility of socialism
in terms of ownership and its operation by economic rationality through market
competition.
In the Lange model of market socialism, there are four major types of actors, viz.
the central planning board; private households; socialist enterprise managers; and
socialist industry managers.
The central planning board oversees the economy. It performs 5 functions as
follows. First, it appoints tens of thousands of enterprise managers, one for each
productive enterprise. It also appoints a small number of industry managers, one for each
industry. Secondly, It determines the percentage of Gross National Product devoted to
investment and makes available investment funds through a loanable funds market. It
gives the enterprise managers loanable funds for investment against interest payments.
Thirdly, it supplies the available services of nonhuman resources (e.g. so many blast
furnace hours per year, so many acre hours per year) against the demand from managers
who pay rent for them. Fourthly, it taxes households and also collects net profits (total
profits minus total losses of the enterprises). The total income thus obtained is disposed
off in three ways: as loanable funds; as government spending (on defence, healthcare,
education, vocational training); and as social dividend (people’s share in interest, rent and
profit income). Fifthly, it plays a role in price setting. Prices of labour and private
consumer goods are established in free markets. But all other prices of inputs and
outputs are fixed by trial and error in the offices of the central planning board so that they
approximate to equilibrium prices: if there exists surplus, price is reduced and if there is
shortage, price is raised.
Members of the private households are free to work in the location and
occupation they liked for money wages. Their disposable income is wages plus social
dividend minus taxes collected by the government. They are free to spend the after-tax
income on consumer goods they liked.
The socialist enterprise managers make their own input and output decisions on
the basis of certain general rules. They determine optimum input quantitites to be used
by equating the falling marginal value product of the input used with the input’s price.
They determine the optimum output level to be produced by equating the rising marginal
cost of production with the output’s price. The monetary receipts obtained (on selling
goods to other enterprises, households, and government) minus the monetary
expenditures (i.e. costs incurred on buying services of resources in resource markets and
on buying capital goods in goods markets) is equal to profits. If an enterprise makes loss,
that is covered by the government from the profits made by the profit-making enterprises.
The job of the socialist industry managers is to expand, contract or liquidate
existing enterprises or to create new ones. They also follow certain rules of behaviour.
They exapnd the size of an existing firm or establish new ones when the firm makes
profits. And they contract or abolish a firm when it makes losses.

Market Socialism as a Case Study of Former Yugoslavia

In the 1950s, Yugoslavia was the first to emerge as a socialist market economy. This was
a nation formed by six republics coming together, viz. Slovenia, Croatia, Bosnia-
Herzegovina, Montenegro, Macedonia and Kosova. The charismatic leader of the
country, Tito was famous for two reasons. Not only did he unite the potentially
conflicting six republics but also did he abandon the Stalinist centralised socialism which
he embraced first. He angered Stalin and faced the threat of Soviet invasion not only for
this but also for opposing the domineering leadership of Stalin among the socialist
countries. The progress of market socialism under Tito can be appreciated by examining
three time phases, viz. 1950-1965; 1965-1971; and 1971 to 1980s.

(i) 1950-65 : Decentralisation, privatization and worker self-management

Tito executed brilliantly two ideas of Karl Marx, viz. that workers should collectively
manage, and that the state should wither away. The latter idea was implemented in terms
of dismantling of central planning board in favour of markets. Political power shifted
from central government toward republican governments and still lower-level
governments. The role of the central government was to bother about 5 issues: deciding
the composition of Gross National Product between investment goods and consumption
goods; regional balance; volume and direction of foreign trade; economic equity; and
provisioning of collective consumption goods like defence, education, and research.
Agriculture was privatized with the maximum size of a private farm being 25
acres. In industry and services, tiny private firms employing a maximum of 5 employees
were legalised in activities such as construction, handicrafts, retail trade, service sector,
etc. For example, private tailors, butchers, doctors, plumbers, restaurants, taxis, etc. were
encouraged in this regard.
All enterprises with staff more than 5 employees were categorised as socialist and
these were run like democracies, not as autocracies. In fact, larger socialist enterprises
were run like representative democracies. The workers elected and supervised their
representatives (managers) constituting a workers’ council which in turn elected a
management board which in turn in conjunction with officials of local government and
industry trade association appointed an enterprise director.

(ii) 1965-71: Consolidation of self-managed firm

Government, social organisations, existing enterprises and groups of individuals were the
founders of the firms. They took initiative in choosing the kind of firm, its location, and
in providing for its initial plant and machinery and labour, but the effective control of the
firm was left to the workers. Thus the separation of the founders from subsequent
decision making characterised a salient feature of the self-managed firm.
The workers not only offered labour services but also carried out entrepreneurial
functions. And so wages and profits got mixed up. Their objective was to maximise
residual income per worker. Residual income is revenue from sales minus costs incurred
(on rawmaterials and services got from others, depreciation costs, interest to banks, taxes
to government).
The third feature of the self-managed firm was in relation to how the residual
income was disposed. Residual income could be used in three ways: (a) reinvestment;
(b) collective consumption (i.e. construction of housing, swimming pools, tennis courts,
etc.); and (c) distribution as personal income among workers on an equal or unequal
basis, whatever the workers decide, but subject to the central government’s condition that
workers must get an amount at least equal to the minimum hourly wage. In case the
personal income does not meet this condition, the government ensured it throw
borrowings from banks. When it comes to deciding on the disposition of the residual
income in the above three ways, the workers would obviously prefer maximising its
dispositon in terms of (c).

(iii) 1971 to 1980s: The bargaining society

While in the first phase Tito downgraded the central planning and preferred markets,
during this third phase, Tito downgraded the role of markets and instead preferred the
role of bargaining as a better coordination mechanism. Perhaps Tito thought that this was
a better way of preserving the unity of the Yugoslavian federation of six republics. How
to coordinate separate activities of people by means of bargaining which leads to
consensus via self-management agreements was the botheration of this phase.
Bargaining is at three levels. At the intra-enterprise level, representatives of
different activities will exchange information and arrive at consensus. At the inter-
enterprise level, representatives of different enterprises will do the same. At the inter-
regional level, representatives of different regions will also do the same. At the national
level, a similar procedure is followed by representatives of different economic, social and
political groups in order to arrive at consensus (social compacts) regarding
macroeconomic issues like balance of payments targets, inflation targets, regional
development, private versus public sector, etc.

Performance Assessment of Market Socialism

While the pure model says full employment is possible, the case study shows larger open
unemployment. Unemployment was severe possibly due to the incentives peculiar to
worker collectives, viz. that workers were interested in maximising residual income per
worker so much so that there is an incentive to decrease the number of workers in the
firm. Again, while the pure model does not allow for technical inefficiency and allocative
inefficiency, both inefficiencies were found to be high in Yugoslavia. For example,
agriculture was overpopulated and agricultural productivity was low. While the pure
model talks about achieving optimum growth by determining the investment share of
Gross National Product, the case study shows that high growth was achieved initially in
terms of extensive growth but later on growth rates declined. Workers had an incentive to
maximise their personal income rather than to maximise the reinvestment portion of the
residual income. As regards economic equity, the pure model points out a mix of
commutative justice and distributive justice as people get an equal share of property
income in the name of social dividend, people are free to choose jobs and change them as
they wish, and all people are equally free to avail themselves of the generous
opportunities for healthcare, education and training. But the case study shows
considerable inequality in the system.
As regards alienation from self, it was there in terms of division of labour and
specialisation but it was much less in terms of people having considerable freedom to
shape their lives.
As regards alienation from others, the record is mixed, but undoubtedly superior
to that of the Soviet Union. Consumer sovereignty is fairly complete as far as the make
up of the consumption portion of the Gross National Product is concerned. Firms cater
to the wishes of consumers as expressed in market demand. So far as the size of the
consumption portion is concerned, individual consumers have considerably less power.
On the one hand, governmental units at various levels have consistently pushed for an
extremely high rate of saving and investment, using taxation and persuasion for the
purpose. On the other hand, any individual workers can easily be forced through the
majority vote of fellow workers, to save more or to save less than is preferred. According
to the advocates of market socialism, worker sovereignty is more complete in Yugoslavia
than anywhere else in the world. But the critics say that it is a sham because the self-
management system did not emerge as a result of worker initiative but was imposed on
the workers from above. Furthermore, the workers soon realized that it was impossible
for an entire firm’s workforce to exercise direct control over everything. As a result, the
workers do not manage; management is done by professional executives considered as
‘the new class’. Citizen sovereignty was considerably more extensive in Yugoslavia than
in the rest of Eastern Europe. Although Yugoslavia was a one-party state and political
criticism was a taboo, at the same time, there were fewer signs of an all-devouring
bureaucracy and the secret police. Moreover, the Yugoslavs were the only socialist
citizens in Eastern Europe who could travel to the West in large numbers.
As regards alienation from nature, Yugoslavia did not fare well as pollution was
widespread.

Conclusion

It is clear that market socialism was relatively better than centralised socialism but it too
had many shortcomings with regard to both features and performance as highlighted
above.
 Lecture Notes 7
Communal Socialism
The Idea
Communal socialism is based on the vision of an intentional community or commune.
This is a voluntary and deliberate association of people who value togetherness above all.
They seek to extend intimate, sharing relationships beyond the immediate family. They
want to establish a whole new way of life in which all barriers among people are broken
down and individuals merge with other individuals to become as one.
There are two significant obstacles to achieving communal socialism. First, there
is the institutional barrier of private property in the means of production (i.e. nonhuman
resources) as well as consumption. Secondly, there is the psychological barrier in terms
of the ‘ego’ steeped in the ‘deadly sin’ of selfishness.
Karl Marx, the patron saint of all socialists, predicted, for example, that the
course of history would lead inevitably to such a society, i.e. communism. It would be a
society without scarcity. It would also be a society without egoism, i.e. it would be a
loving community of brothers and sisters who have shed self-centredness and are driven
by the inner necessity to serve their fellows and to do so to the best of their ability.
In this kind of society, there would be mass participation in all production
decisions as the means of production are collectively owned. Every one takes according
to need as the means of consumption are collectively owned. People contribute to the
maximum of their ability to the creation of goods but do not need very much in terms of
consumption. People are guided by internal incentives, i.e. stimuli arising from within
such as feelings of love, joy, goodwill or guilt. These internal incentives compel everyone
in the new society continually to serve the social body with which they become one.
There is no need for external incentives, i.e. stimuli coming from other people, such as
criticism or punishment or praise and money rewards, which ordinarily motivate people
to take or not to take an action. People in the new world live happy and joyful lives of
creative leisure and work They are self-reliant by producing a whole variety of goods in
small workshops, at their own pace, with hands and brain and simple tools. And they live
in harmony with nature.

Small Scale Communal Experiments

While history testifies to failure of numerous small scale experiments in communal
socialism, America’s Bruderhof and Israel’s kibbutz represent a two successful examples
of communal socialism on a small scale.
The Bruderhof is a particular type of Christian community which was originally
founded in Germany in 1920 and which later migrated to the U.K., Paraguay, and
Uruguay, and, finally, to the U.S. In the late 1980s, it had a population of 750 persons
who lived in three federated colonies in rural Connecticut, New York, and Pennsylvania.
They live like one large family, by owning all things together, making all decisions
together, having their meals together, working together, raising their children together,
meeting almost every night together, and spending their entire lives together—withing
the geographic confines of their estate (i.e. their ‘hof’). The community relies on ‘thought
reform’ in order to destroy egoism.
The Israeli kibbutz means ‘group’ in the Hebrew language. The first kibbutz was
founded in 1909. By 1987, there were 280 kibbutzim, containing a mere 3 % of the
Israeli population, but producing 10 % of the country’s Gross National Product. Most
consumption is collective. The means of production are jointly owned. Ultimate
decision making power rests in a General Assembly of Members. They elect executives
such as a Secretary, a Treasurer, and a Work Coordinator as well as an Economic
Committee. The latter draws up plans for production, consumption, and investment that
the General Assembly must approve. Everyone capable works. Incentives are mainly
external, but not monetary. Probably the strongest one is praise or disapproval by the
closely knit community. Nothing is more highly valued than being regarded as a good,
selfless worker. By the same token, nothing is more feared than being considered as a
laggard or a parasite. Occassionally, such people are expelled. More often, they leave by
themselves. In many ways, life is like the dream: in the countryside, near the home, in
small workplaces.

Large, Nationwide Experiments

Mao’s China and Castro’s Cuba experimented with fighting scarcity as well as
egoism through communal socialism in vain.

China

Mao Zedong came to power in 1949 in China. And since then Chinese economic policies
followed a zig-zag course that mirrored an intense struggle between the ‘pragmatists’ or
‘experts’ on the one hand and the ‘reds’ or ‘purists’ or ‘revolutionary zealots’ on the other.
The former wanted to fight scarcity whereas the latter wanted to destroy egoism.
During the First Five Year Plan (1952-57), Mao adopted Stalin’s system of
planning and managing the economy. But during the Second Five Year Plan (1957-62),
Mao rejected the crass materialism of the Soviet Union and sought to achieve ‘Great
Leap Forward’ in industrialisation by destroying egoism. Most material incentives were
abolished in order to meet the pressure to increase output at exceedingly high rates. This
was done with a ruthlessness and a disregard of the individual that would have put even
Stalin to shame. In agriculture, an army of 100 million peasants was organised on ‘mass
irrigation projects’, building canals, dikes and reservoirs in ceaseless day and night shifts
under unbelievably harsh conditions. 99 per cent of all peasants were forced into
communes, institutions in which they were to live and work together and to own jointly
all the means of production and consumption. Peasants lost title to their private family
plots and with it the age-old hope for independence. The free private farm markets were
closed. All private property was abolished. Peasants were made to work more and
harder on the collective land, and for less, and they were virtually treated like draft
animals. Even the individual family unit was abolished. Women were forced to work at
all jobs as equals with men. Children were raised in government nurseries. People ate in
common mess halls and slept in common barracks. Wages were mostly received in kind
and in no way related to the amount of work performed. “From each according to his
ability, to each according to his need’ was put into practice here and now; and ‘need’ was
defined as physical subsistence. Outside agriculture, the same principle of mass
mobilisation of labour was used. Organised by military principles and driven to the limit
of their endurance, 60 million students and women were to supplement the new modern
industrial complexes by producing ‘steel’ (actually pig iron) in ‘backyard furnaces’.
Others set up numerous tiny and widely dispersed factories to make fertilizer and
agricultural tools. They, too, worked in night and day shifts.
The above efforts for ‘Great Leap Forward’ were successful at first but very soon
turned into ‘Great Crisis’ with disastrous fall in agricultural and industrial output.
During 1962-66, anti-Mao forces (including the government bureaucracy) refused
to cooperate with Mao and in order to revive output levels, they replaced Mao’s ‘purism’
in the realm of incentives by ‘selfishness’. But Mao retaliated through the ‘Great
Proletarian Cultural Revolution’ during 1966-69. This meant mobilisation of youth of the
country to destroy bureaucracy and revive internal incentives. The Great Cultural
Revolution which sought to destroy egoism through equalisation of incomes and
equalisation of status, came to an end as the struggle between the Maoists and the anti-
Mao forces became intense and the latter gained ascendancy in Chinese politics.
China after Mao’s death in 1976 gave up on communal socialism. China was led
by Deng Xiaoping, the pragmatist leader who ushered in market oriented reforms in
conjunction with political and cultural liberalization.

Cuba

Cuba also went through a zig-zag. Cuba experimented with communal socialism, gave it
up and embraced the rigid Soviet model of central planning instead.
Led by Castro and Che Guevara, Cuba turned to socialism during 1959-61.
During 1961-64, Cuba adopted Stalin’s method of planning but rejected his ways of
motivating workers through money and material incentives. But this turned out to be a
failure. During 1964-1970, Cuba concentrated on sugar and foreign trade and sought
progress in this regard not through the Stalinist 'superplans’ but through ‘miniplans’ and
the pursuit of egalitarianism in incomes and status. But even this failed and consequently
the Cuban leadership once again turned to Soviet methods of central planning but with
material incentives. In the late 1980s, once again, Castro endeavoured to destroy egoism
through moral incentives and equalisation of incomes and status.

Critical Evaluation of Communal Socialism

Communal socialism, small-scale or large-scale, did not turn out to be a viable alternative
to either centralised socialism or market socialism. Most small-scale experiments failed
because people were not selfless enough. First, when everyone was free to take
consumption goods ‘according to need’, people took too much and there was not enough
to go around. Then rationing by money or command became inevitable. Secondly, when
internal incentives were relied upon to make people contribute ‘according to ability’,
such contribution fell in an environment wherein real income could be had for nothing.
Thus, people had to be induced to work by money or command. Thirdly, when living in
cities and working in large workplaces and the like were replaced by working in small
workplaces in the countryside, the inevitable fall in output and the total unavailability of
some goods caused dissatisfaction and abandonment of the scheme. Fourthly, even in
small experiments, it became physically impossible to have everyone participate directly
in all decisions. And so there was a lot of hierarchical decision making about
consumption and production.
All this surely holds good for nationwide communism as well, as demonstrated by
the Chinese and Cuban examples.
In a nutshell, the small scale as also nationwide experiments in communal
socialism more than amply demonstrated the truth that any determined effort to destroy
egoism interferes with the creation of abundance, while any determined effort to create
abundance interferes with the destruction of egoism. As a result, none of the nationwide
experiments survives today.
 Lecture Notes 8
Features and Likely Performance of
Market Capitalism as Pure Model
Features

Individualism and free markets

Market capitalism as an idealised economic system is based on the vision that champions
individualism. The objective of this system is to maximise welfare by letting all the adult
individuals in society define their own happiness in their own way and take whatever
actions seem appropriate to achieve it.
The advocates of this system suggest that coordination of independently decided
but interdependent economic activities of millions of people engaged in a division of
labour can easily be achieved by letting self-interested people follow the guidance of
price signals generated in free markets. In other words, they point to the possibility of a
spontaneous coordination or market coordination or to the working of the Invisible Hand
advocated more than 200 years ago by Adam Smith, the father of economics. Thus, the
advocates of this system see no need for any central economic planning.
Coordination of the actions of different people is achieved and maintained by the
price system, the set of interdependent prices in all the markets for goods and resources.
These prices change as long as the independent actions of households and firms are not
perfectly coordinated, making households and firms, in turn, change their behaviour until
coordination is achieved. Being keenly aware of how their welfare is affected by the
prices they can get for what they sell and by the prices they must pay for what they want,
all people are habitual price watchers. For example, when people look for 16 million
tons of apples, while only 8 million are being offered, anxious would-be buyers of apples
will compete against each other and drive the price up. In response to these higher prices,
two changes will occur: (1) some price-watching households will change their minds and
decide to seek fewer apples at the higher price (using, perhaps, oranges instead); and (2)
some price-watching owners of firms will change their minds too, and decide to offer
more apples a the higher price(producing more apples at the expense of something else,
reducing apple inventories, increasing imports, and so on). Before long, a balance will be
achieved between the production and consumption of apples. Similar adjustments will
occur in all other realms of activity.

The role of government

Although the advocates of this system glorify individualism, they believe that
government has to play a limited but crucial role. The government would have to set the
framework for private choice. And it would have to fix the conditions under which
widely dispersed resources could be used by their private owners for their private ends.
In other words, a well-functioning capitalist market economy requires not only
that economic power—the capacity to make and enforce decisions on the allocation of
resources and the apportioning of goods—is put in the hands of private individuals but
also that it is carefully distributed in such a way that all of them have as equal a share as
possible. For this purpose, the government would have to tackle at least 3 subsidiary
tasks as follows:
(i) the government would have to assign property rights—rights to the
exclusive use—for all scarce things. Otherwise, there will be chaos as
people would try to take more of scarce things than was in fact available
so much so that the strong and cunning would then end up with most
scarce resources and goods at the expense of the weak and no so clever; or
the usefulness of scarce things would be destroyed by too many people
attempting to use them at the same time.
(ii) the government would have to assign property rights in scarce resources
as rarely as possible to itself and as often as possible to private individuals,
and it would have to do the latter in such a way that all individuals came to
hold, upon reaching adulthood, as nearly equal quantitites of resources as
possible. Just like in the game of cards, every participant receives the same
number of cards initially, so also in the game of choice which scarcity
forces upon every society, every participant would start with an equal
endowment of economic power. What does this mean? This might mean
that government, at the time of death of all individuals, would redistribute
their holdings of natural and capital resources to other individuals reaching
adulthood, and it might mean that opportunities to gain labour skills would
be made freely and equally available to all citizens, as in the form of
publicly provided health care, general education, and vocational training.
(iii) the government would have to guarantee to all individuals an equal
opportunity to the freest possible use of the property rights it had assigned.
In other words, having distributed the cards in the great game of choice, it
would have to set up general rules of the game that applied equally to all.
Anything one person was allowed to do, all others would have to be
allowed to do, and anything forbidden to one person, would have to be
equally forbidden to all others.

When the government carries out the above three actions, all adult individuals
would have the maximum possible freedom to promote their own welfare as they
saw it—within the limits of inevitable scarcity and consistent with an equal
freedom given to all others. Hence, people could use their resources all alone,
hermit-like, without ever relating to others at all. Or they could enter into all sorts
of voluntary agreements of cooperation with others, exchanging—at any terms
acceptable to all parties concerned—the property rights to resources or to any
goods they had made with those resources. Thus, people could be their own
master, choose their own path, and do their own thing.
 Perfectly competitive market and equilibrium price

Under the conditions as mentioned above, the advocates of this system believe
that a multitude of perfectly competitive markets would quickly emerge and
equilibrium price be established in each.
The features typical of a perfectly competitive market are as follows:
(a) there would be many buyers and many sellers in each market. As a
result, no one person would buy or sell a significant percentage of the
total traded and be able, acting alone, to influence the price;
(b) all units of the traded item would be viewed as identical by buyers;
thus, no buyer would have any reason to prefer one seller over another;
(c) all buyers and all sellers would possess full knowledge relevant to
trading; and
(d) all buyers and all sellers would be free at any time to enter into or exit
from a market.

Under the above circumstances and given all other factors that might influence people’s
decision to buy or sell, a typical market would be one in which buyers would demand a
larger quantity at lower prices than at higher prices, and sellers would supply a larger
quantity at higher prices than at lower ones. This is illustrated by the sloping lines
labelled ‘demand’ and ‘supply’ respectively in the figure below. The figure shows that
the many buyers and sellers would interact in such a way as to establish an equilibrium
price of Rs. 5 per unit at which the quantitites demanded and supplied would be just
equal to each other (at 34 million units per year).
If the market price were to be higher than equalibrium price, say at Rs. 7 per unit, buyers
as a group would wish to buy 20 million units per year, while sellers as a group would
want to sell 48 million units per year. Thus, there would be a ‘surplus’ of 28 million units
per year. This is a situation wherein many would-be sellers would be very frustrated.
Before long, at least some of them would offer to sell the item in question for a
somewhat lower price. Immediately, the surplus would diminish. Buyers would buy a
larger quantity at the lower price; and sellers would offer a lower quantity. This process
of competition among frustrated sellers would continue until price and quantity
corresponded to the equilibrium values.
Similarly, if the market price were to be lower than the equilibrium price, say at
Rs. 3 per unit, then the buyers as a group would wish to buy 48 million units per year
whereas sellers as a group would want to sell only 20 million units per year.
Consequently, a ‘shortage’ of 28 million units would emerge. This is a situation wherein
many would-be buyers would be frustrated. Before long, some of them would offer to
buy the item for a somewhat higher price, and immediately the shortage would diminish.
Sellers would sell a larger quantity a the higher price and buyers would demand a lower
quantity. This process of competition among frustrated buyers would continue until price
and quantity corresponded to their equilibrium values.
Thus, in every market, an important piece of information would emerge: an
equilibrium price at which any buyer could be sure to find a seller and any seller could be
sure to find a buyer. The entire system of prices so emerging, furthermore, would serve
like a system of telecommunication among all households and firms. It would serve the
important function of continually coordinating the independent choices made by them.
This is what is meant by the ‘invisible hand’. The very competition among sellers or
buyers described above could be accepted as a valuable tool of cooperation. This is so
because that competition would generate signals in the form of equilibrium prices that
told everyone in condensed form what they could and could not do, if they wished to take
part in the joint enterprise of allocating resources and apportioning the goods made with
them. Surely, buyers would always prefer a lower price, and sellers a higher price. But,
in the absence of a practical way by which millions of people could sit together and
explain to each other why a lower or higher price would not work, the guidance of the
equilibrium price could be accepted on blind faith as that of an all-knowing Invisible
Hand.

Performance Assessment

Full employment

This economic system would produce a full utilization of resources. The meaning of full
employment would be defined simply as the undesigned outcome of a multitude of
independent decisions of all resource owners. This is expected to happen as follows:
All owners of resources would decide separately on the extent to which whey
would like to have their own resources utilized in the process of production. From these
independent decisions, a supply would emerge in each particular resource market, such as
the line so labelled in the above figure concerning a typical market. The slope of this line
reflects the likelihood that a given number of resource owners would be likely to offer
more units of a resource at a higher than a lower price. Similarly, private owners of firms
would independently decide on the quantities of various resources they wanted to utilize.
Thus, a demand would emerge in each particular resource market, such as the line so
labelled in the above figure concerning a typical market.. The slope of the line reflects
the likelihood that a given number of firms would be likely to demand more units of a
resource at a lower than at a higher price. Competition among buyers and sellers would
then establish some equilibrium price, and the corresponding employment of the resource
would be deemed as the desirable one. For example, consider a labour market wherein
the households supply labour and the firms demand labour keeping in mind the figure
above concerning a typical market. At the equilibrium price of Rs. 5 per labour hour,
anyone who wished to sell that particular type of labour at that price could find
employment. Involuntary unemployment could only be a temporary phenomenon because
it would represent a ‘surplus’ of the resource on the market. If the price of labour were to
be Rs. 7 per labour hour, people offer 48 million hours for sale but firms would hire only
20 million hours. The suppliers of 28 million labour hours could find no job. A fall in
the price of labour to Rs. 5 per labour hour, however, would quickly eliminate this
unemployment. As the price fell, firms would hire more labour and households would
voluntarily withdraw some of the labour previously offered. The same type of
adjustment would occur in all other resource markets. In the end, whatever rate of
employment the many resource owners had decided upon as desirable, that rate would
come to prevail.
The critics argue that the full employment adjustment process might require
unbearably large changes in prices or might take an unacceptably long time. But the
advocates of this model argue that the government would always be free to fight
unemployment by using Keynesian fiscal and monetary policy tools.

Efficient employment: Technical efficiency and Allocative efficiency

Technical efficiency is possible because self-interest would drive the owner-managers of

firms to minimize the use of inputs for any given level of output and, thus, to maximize
output for any given set of inputs. Acting otherwise would not enable them to maximise
profits. But the critics wonder whether this would happen if ownership were separated
from management. Similarly, as regards allocative efficiency, the advocates of this
system argue that it would be the accidental consequence of people seeking only their
self-interest.

Economic growth, extensive and intensive

Extensive growth in terms of optimal private capital formation would happen as the
undesigned outcome of all the separate decisions of all the people in society on the issue
of foregoing consumption now for future rewards. All income recipients would be free to
save part of their income and lend out the funds involved. Markets for loanable funds
would emerge and every rupee lent at the equilibrium price would be invested. Intensive
growth would also happen because the advocates of this system imagine the government
to collect taxes and to use them to provide all citizens with an equal opportunity for
health care, general education, and training. Further, many important innovations would
also occur as the result of random tinkering by a multitude of individuals engaged in the
productive process. However, the critics are sceptical about the possibilities for
innovation. If investment in basic and applied research and entrepreneurial innovation
results in technical failure, the investors alone would have to bear all the cost. If it results
in technical success, then production costs would be reduced and some profit will be
made in the short run. Soon new firms will enter the scence and imitate the innovator and
increase the supply and reduce the equilibrium price and eliminate profit. Thus, any
long-range, high-cost investment in research and innovation would be discouraged.

Economic equity

The advocates of this model talk about the possibility of equity in terms of commutative
justice. But the critics argue that it may not be possible or even desirable. The critics say
that the type of even-handed initial distribution of resources might, in fact, not be carried
out. Even if it were attempted, it would be quite difficult to carry it out with perfection.
For instance, the blind, the crippled and the mentally retarded would be excluded.
Moreover, it would be difficult to maintain over time the achievement of the initial
degree of equality in resource endowment simply because some people would save a lot
and others would not which will gradually shift the distribution of resource stocks. Thus,
there would emerge, sooner or later, unavoidable differenes in people’s economic power.
In addition, there would be people who would earn little or nothing due to the verdict of
the price system, and so they need help. The critics argue for a compromise between the
two conceptions of economic equity: to accept commutative justice in order to preserve
incenives, while reducing the extent of income differentials by guaranteeing to all a
certain basic minimum income through distributive justice in terms of a limited degree of
governmental redistribution.

Avoiding Alienation from Self, Others and Nature

Alienation from self is not possible, according to the advocates of this system, because
this system under conditions of equal economic power provides the greatest chance for
people to develop themselves.
Similarly, alienation from others is also unlikely because people have more
power, indirectly though, to participate in decisions on an equal basis with all others in
this system than in any other system. For example, there would be consumer sovereignty
—consumers, like sovereign voters in a democracy, jointly would have determined the
allocation of society’s scarce resources through casting their ‘dollar votes’ or ‘rupee
votes’ in the stores. Similarly, worker sovereignty is possible in a context where
ownership of resources is widely dispersed and a great many alternative opportunities
are available to any one person. Citizen sovereignty is also likely because all individuals
are free within a framework of general laws to make their own choices without coercion
by other people.
Finally, alienation from nature is unlikely; for example, problems of pollution or
the threatened extinction of animal species would not arise in this system because the
government would perform the function of assigning property rights in all scarce
resources. To illustrate, let us take the case of pollution due to dumping of wastes in a
river. Suppose there is a clean river which could assimilate a maximum dumping of 4
millions tons of sewage without harm to anything. This is shown in the figures below by
the vertical line labelled supply. Suppose people are free to just go ahead and dump
sewage whenever they liked. With no price to pay for dumping, they might dump 2
million tons per year. But if they were to be charged Rs. 2, 000 per ton of dumping, then
they might dump nothing at all. Now suppose, a hundred years hence, due to population
growth and industrialization, people might dump 4 million tons into the river when they
are free to do so whereas if they were to be charged Rs. 4, 000 per ton, they would not
dump at all. With zero price, suppose people dump 6 million tons which is more than the
absorptive capacity of the river. At that point, ‘no swimming’ signs would go up, fish
would die and drinking water would be hard to find. According to the advocates of this
system, the government would solve this problem by establishing property rights. The
government might simply print up each year 4 million certificates, each of them giving its
holder the right to dump 1 ton of sewage into the river during that year. And government
might announce that henceforth the river’s waste absorption capacity was private
property, belonging to the holders of these certificates. Under these circumstances, a
market for dumping rights would spring up at once among those who did dumping and
those who did not want to do any dumping. Before long, competition among demanders
or suppliers of these rights would push their price to the equilibrium level of Rs. 2, 000
per right. This process would exclude many would-be dumpers from the scence. Many
individuals, firms and local governments, who would have dumped sewage into the river
at a zero price, would then think twice about their behaviour. They would suddenly and
painfully confronted with the consequences of their action in terms of the price to pay.
The equilibrium price is a message to the dumpers: if you were willing to pay Rs. 2,000
per ton, you could dump all the sewage into the river you liked. Yet, as the sloping
demand line indicates, some would find it cheaper to change their behaviour as by
treating their sewage instead. Thus, harm to the environment could be prevented because
the overall amount of dumping would be restricted to the limited amount the river could
absorb.

Conclusion
Market capitalism as a pure model is the best of all worlds possible in terms of self-
interest producing socially beneficial results.
 Lecture Notes 9
US Capitalist System/American Capitalism
as Case Study of Market Capitalism: Features and Performance
Features

Imperfect competition

Like in the pure model of market capitalism, most resources in the US economy are
privately owned, and the separate decisions made by numerous individuals and firms are
spontaneously coordinated through markets. However, contrary to the pure model,
resources are not evenly distributed over the whole population and most markets are
imperfectly competitive.
Imperfect competition means the following:
(a) The number of buyers or sellers is small, or, when that is not the case,
large numbers collude rather than compete. As a result, market
participants are not price takers as the pure model points out, but can
exercise a lot of power over price.
(b) Differentiated rather than homogeneous products are traded in many
markets.
(c) Knowledge about market conditions is anything but perfect.
(d) Entry into and exit from markets is frequently restricted rather than
free.
Imperfect competiton on these lines characterises not only goods markets but also
resource markets in the US economy.

The monopoly game

In the US economy, many people play a ‘monopoly game’. This means that they try to
gain control over the prices at which they sell or buy in order to raise their own income at
the expense of other people’s income.
The most successful players of the monopoly game achieve a pure or genuine
monopoly which originates from a number of technological and legal reasons, including
increasing returns to scale, exclusive ownership of key resources, patents and copyrights,
and exclusive franchises. Whatever their origin, these monopolies attempt to create for
themselves a situation of permanent profit.
There are private cartels seeking permanent profit. A cartel comes into existence
when there is an agreement among all the existing sellers to charge an identical and
higher price and to restrict supply until it equals market demand at the cartel price.
There are also numerous successful examples of government sponsored cartels.
Typically, they involve legislating, separately or in combination, the setting of a higher
price, a cutback in supply, or even an increase in demand.
Sellers who fail to achieve monopoly or successful cartels often find themselves
in market situations lying in between the extremes of monopoly/cartel on the one hand
and perfect competition on the other. Examples include (a) oligopoly, in which the entry
of new firms is difficult and relatively few sellers compete with one another, offering
either homogenous or differentiated products, and (b) monopolistic competition, in which
the entry of new firms is easy and large numbers of sellers compete with one another,
offering differentiated products.
An example of imperfect competiton in resource markets is the monopoly power
on the selling side of a labour market frequently exercised by workers who have formed a
cartel for the joint sale of their labour, that is, a labour union. Unions, in typcial cartel-
like fashion, have tried to raise wages by reducing supply. They have tried to keep
competing workers out by restricting union membership (charging high initiation fees,
administering impossible entrance tests, or simply denying access to blacks, females,
Jews, or any other easily identifiable group). They have warded off the threat of
nonunion competition by forcing employers to establish closed shops (in which only
union members are hired) or union shops (in which all employees, soon after hiring, have
to pay union dues as a condition of continued employment). Sometimes buyers of
resource services restrict competition. For example, there exists only a single buyer—a
situation of monopsony—in the labour market. Monopsony can also arise when
numerous employers agree to act jointly in the hiring of labour and not to compete with
each other for workers.

The role of government

Government in the US hardly conforms to the role envisioned in the pure model of
market capitalism. Although there are attempts to promote a competitive environment for
business (e.g. antitrust laws or free trade legislation), such policies often pale in
significance when compared with those designed to aid would-be monopolists. Many
observers explain this schizophrenic behaviour of government by the ‘capture’ of
legislators and regulators by special interests.
Within the nation, there are many individuals whose interests conflict with those
of other individuals. For each of these individuals, income can be gained more easily by
taking it away from other people—given the overall degree of scarcity prevailing—than
by making genuine contributions toward reducing the realm of scarcity by working
harder, saving more, or making cost-reducing innovations. It is not surprising that some
of these individuals want the government to intercede for their special interest (which is
to gain power to raise the prices of whatever they sell in order to raise their income in the
easiest way). To the extent that government responds to such requests, it does not govern
in the national interest; it promotes a coalition of special interests. Sellers use many
devices to get government to promote their special interest in above-equilibrium
minimum prices, reduced supply, or increased demand for whatever they have to sell.
The ‘capture of legislators’ involves sellers inducing legislators at all levels of
government to rig markets directly—or set up appropriate agencies to do the rigging—by
channeling a number of rewards for them. Perhaps the most important reward is election
campaign contributions. The ‘capture of regulators’ means that the officials of the
regulatory bodies set up by the legislative branch of government are systematically
influenced by those they are supposed to ‘regulate’. They, too, receive rewards for being
compliant when approached by the special interests.

Performance Assessment

Full employment

Like in pure model of market capitalism, the definition of full employment in the US is
left to each private resource owner. But unlike in the pure model, resource prices are not
always free to adjust, or to adjust quickly enough, to their equilibrium levels. For
example, when labour unions inisist on, or governments prescribe, minimum wages
above equilibrium, a surplus of labour develops. As a result, all kinds of people who
would like to work at the going wage find themselvs involuntarily unemployed. Since a
decline in the wage is impossible, their unemployment persists. This situation can be
overcome, however, even if downward wage flexibility cannot be restored, by an increase
in the demand for labour. Recognition of this fact lies at the heart of the Keynesian
macroeconomic theory—born in the Great Depression of the 1930s. Keynes had noted
that an increase in overall spending on newly produced goods in an economy would
increase the demand for labour and, thus, reduce involuntary unemployment. This basic
insight was incorporated into the official policies of the US government for quite some
time.

Efficient employment: Technical efficiency and Allocative efficiency

There is allocative inefficiency although the extent of the resultant welfare loss is difficult
to estimate. Estimates of technical inefficiency in the US are highly controversial even as
some economists have come to view technical inefficiency as all pervasive and much
more significant in scope than allocative inefficiency. Firms with monopoly power, i.e.
the power to raise the selling price above the perfectly competitive level, not only incur
considerable expenses in obtaining, strengthening, and defending that power, but they are
generally lax on cost control because they do not face intense competitive pressure.
Before long, such extravagances as lavish offices, high entertainment budgest, and long
coffee breaks push costs to unnecessary levels. This type of conclusion has been
confirmed by a number of investigations in the US.
Economic growth, extensive and intensive

In the view of most observers, the US economy has exhibited a remarkable rate of
economic growth in the long run. Voluntary private saving and investing by individuals
and corporations have been a major source of this economic growth. A significant part of
the real economic growth has resulted from improvements in the general levels of
education, health, and training as well as from a rapid pace of technical advance. The
latter has become increasingly important over time.

Economic equity

Distribution of income is highly unequal in the US. The reasons for this inequality can
be understood by examining the determinants of income earned by households in the US.
The money income earned by any one household and the share of output it can
claim in the US depends on three things: (a) on the size and quality of the stocks of
resources owned; (b) on the rate at which these stocks are placed in the process of
production; and (c) on the prices that are established in the resource markets for the use
of the resources involved.
The US government has failed to disperse the private ownership of resources as
widely and as equally as is called for by the pure model of market capitalism which calls
for commutative justice. As a result, the private ownership of natural and capital
resources tends to be highly concentrated in the hands of a few. Household incomes
differ also because not only do some household members stay out of the labour force
entirely, but even those who do work do so for varying numbers of hours per year, simply
because they differ from other people when it come to choosing between leisure and the
goods its sacrifice can bring. Similar differences in voluntary choice occur with respect
to nonhuman resources. The third reason for income differences is that households
receive differential rates of pay for the resource services they do offer, and this is true
both in perfectly and imperfectly competitive markets. However, one should also note
that the government in the US has been increasingly involved in the redistribution of
income, through taxes and subsidies, toward the poor.

Alienation from self, others and nature

Although alienation from self is inevitably there due to division of labour and
specialisation, many surveys in the US have indicated that people are satisfied not only
with their jobs but also that their behaviour is satisfactory. Certainly the relationships of
most people with most other people are indirect, impersonal, businesslike, and cold,
rather than direct, personal, intimate and warm. But still people in the US are considered
better off in terms of consumer, worker and citizen sovereignties. As regards nature, the
US government has failed to assign property rights in such scarce things as the air, rivers,
lakes, or oceans and consequently, a host of unbearable pollution problems have cropped up.
 Lecture Notes 10
Mixed Economic Systems: Variation in Government Intervention
Common Feature

Many capitalist countries throughout the world have one thing in common: a significant
degree of government intervention in the economy.
Inspired by socialist thought, this government action is often designed to achieve
greater equality in wealth, income, and economic power. Yet, unlike in the erstwhile
Eastern Europe, the poltical parties that articulate such demands in countries such as
France, Great Britain, Sweden, West Germany, or Japan are committed to the
maintenance of political democracy. Given the stress on democracy, it is not surprising
that there exists a great diversity in the approaches different governments take when they
intervene in the economy.
In the post Second World War period up until the 1980s, continental European
countries such as France, Sweden, or West Germany often referred to themselves as
social democracies, which the British Labour Party preferred to call democratic
socialism. Even the communist parties in Western Europe, often referred to as
‘Eurocommunists’ condemned the Soviet-style or Stalinist dictatorship and the associated
repression of civil liberties.
The stress on democracy has two consequences: first, there exists a great variation
in the approaches different governments take with regard to the nature of government
planning and with regard to governmental policies; and second, there are frequent
changes in governmental philosophy so that for example when a labour or socialist party
is thrown out of office and a conservative party is elected, we should not be surprised if
the entire thrust of governmental intervention in the economy is halted or even reversed.

Differences

1. The nature of governmental planning

Unlike the Soviet-style central plans the fulfilment of which is commanded by the
government, French plans have been of an entirely different nature. They have not
carried the force of law; the French ‘toothless’ plans have in fact been elaborate forecasts
indicating to all concerned what the government expected to happen during the plan
period, given its own actions and those likely to be taken by private parties. That is why
Soviet planning has been called imperative planning, while French planning, in contrast,
has been termed indicative planning. The purpose of plans that the government cannot
enforce has been to eliminate the boom and bust of the business cycle by making the
future path of the economy ‘transparent’ to all, by reducing uncertainty and, thus, the
errors potentially associated with it. Some have described the French plan as a
generalized piece of market research simultaneously made available to all suppliers and
customers. All of them are free to make their own decisions, but they can do so with a
knowledge of the intentions of the rest of the economy. Thus, a steel industry executive
can compare the company’s production and investment plans with the authoritative
government forecast of national steel demand and can foresee a potential slippage in the
company’s market share. This ability to foresee the future, it has been argued, promotes
private actions that help achieve the national growth target. We cannot say that the
government is completely powerless to promote its plan. The government clearly has
direct control over the public enterprise sector and is free to carry out the portion of the
national investment plan affecting that sector. It can, in addition, affect the volume and
composition of private investment by selectively imposing credit controls, providing tax
breaks, withholding factory building permits, and more. And French governments have
‘persuaded’ private businesses in purely verbal ways as well to conform to its plan.
These ways have included threats of nationalization and many informal government-
business get-togethers.
In Great Britain, the British Labour Party has consistently denounced the ‘blind
forces of the market’ and argued in favour of a ‘collective organisation of the economy by
enlightened people’ who would seek to attain a ‘social purpose’. Yet, compared to
France, the machinery of governmental planning in Great Britain has been rather
primitive.
In Sweden, the Social Democratic Party has stressed group action over individual
action, and has attempted to instill in people the highest regard for the expert, technician,
and bureaucrat who might guide such group action. Planning here has been less specific
than the French, though.
In West Germany, the government has been concerned with the establishment of a
socially responsible market economy. While at the micro level, competitive markets have
been promoted, the self-regulation of the economy on the micro level has always been
supplemented by governmental steering on the macro level through Keynesian
stabilization policies.
In Japan, the Ministry of International Trade and Industry has been particularly
important in drawing up indicative central plans similar to those of the French and in
devising numerous strategies to ensure their fulfilment. The government has continually
deferred to the wishes of a potent lobby of some 700 large corporations that make up the
Federation of Economic Organisations and whose chairman is referred to as the Prime
Minister of Japanese Industry.
2. Governmental policies

Governmental policies have varies with respect to the nationalisation of resources, the
welfare state and the role of labour.

(a) Nationalisation of resources

The French have a long history of nationalizing privately owned resources. The reasons
for this were as follows. First, it was argued that the private ownership of non-human
resources had been too concentrated and that this unequal distribution of wealth had to
be corrected. Secondly, it was argued that nationalization would help correct an all-too-
unequal distribution of income in that it would remove interest, rent and profit income
from the affected wealth holders. Thirdly, it was argued that nationalisation would more
widely distribute the power of decision making. Indeed, public enterprises were to be run
by tripartite boards composed of workers, consumers and government officials.
Fourthly, nationalisation has been viewed as an ideal means to promote the goals set in
the national plan. Similarly, nationalization has been viewed as a means to promoting
extensive and intensive economic growth. Thus, tax receipts have been used directly for
investments in public enterprises. And the nationalised banks and insurance companies,
many of which hold equity positions in private firms, have been used to approve or deny
credit selectively, depending on whether private firms intended to carry out the types of
technology-advancing projects encouraged by the national economic plan.
In Great Britain, nationalizations with compensation have been carried out,
typically for the same reasons as in France. In Sweden, the social democrats, like their
French and British counterparts, have presided over a limited degree of nationalization as
well. In addition, the Swedes have stressed the establishment of consumer cooperatives,
usually retail stores owned and run by their customers. In West Germany, the prevalence
of government enterprise was somewhat less than in the countries discussed so far. In
Japan too, some government enterprises came into existence but their importance like in
West Germany remained low.

(b) The Welfare State

Over many decades, many political parties in capitalist countries have striven to create a
more equal distribution of income by means of a more direct route than the
nationalization of nonhuman resources. They have endeavoured to guarantee a certain
minimum income to every citizen, regardless of that citizen’s personal contribution to
current production. For this purpose, they have pursued policies of providing
governmentally financed general education, vocational training, and health care (to
disperse income-earning opportunities widely) and they have created elaborate systems of
direct income payments (for children or young mothers, for the disabled, sick or
unemployed, for the poor, the retired, and more). In the process, they have created the
modern welfare state—a capitalist society in which government pledges to protect people
not only from the rigours of the marketplace but, quite literally, from all types of
misfortunes that might befall them on their lifelong travel from the cradle to the grave. In
Great Britain, the Labour Party had long pushed for an expansion of social programmes
designed to create a ‘minimum practicable inequality of income’. Sweden is usually cited
as the most advanced example of the welfare state.

(c) The Role of Labour

In most capitalist countries, governments had taken steps to strengthen the hands of
workers vis-à-vis business, usually by protecting labour unions as well as by a variety of
laws reducing the rights of business. France is known for its industrial democracy
movement. In Great Britain, the Labour governments had encouraged aggressive
unionism to get the ‘unearned income’ (interest, rent, profit) of the capitalists and to gain
control nont only over wages but also over wage differentials among workers, over hours
worked, hirings, promotions, layoffs, and firings, the organization of work, and more. In
Sweden, collective bargaining was institutionalized to be carried on the national level
between an Employers’ Confederation and a Trade Union Confederation. Moreover, in
each plant, workers elect a work council that has the legal right to be informed and
consulted on company affairs and working conditions. In West Germany,
codetermination laws were created in order to bring about work councils like in Sweden
and also to put workers representatives in the corporate boardroom. Japan was unique in
terms of paternalistic management-labour relations based on employment security,
seniority based compensation systems and promotion based on experience and skills
accumulation.

Reversals

From the 1980s onwards, some capitalist countries have experienced reversals in the post
Second World War trends described as above. Privatization, shrinking the welfare state
and putting a leash on labour have been undertaken rapidly in the era of globalisation
over the last two decades.

The rise of neoliberalism

By the mid-80s, the term ‘neoliberalism’ gained widespread currency as a label to

describe the predominantly laissez faire, market driven economic policies sweeping
across the globe from advanced countries to the less developed countries and to the so-
called ‘transitional economies’ emerging after the collapse of the Soviet Bloc in 1989.
The pivotal point of neoliberalism is the essentially negative role of government. Their
argument is that nations are poor because of too much government interference and hence
the government should be downsized. Thus came into existence the new era of
neoliberalism in terms of the LPG (liberalisation, privatization and globalisation) model
over the last two decades almost all over the world.