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Performance of Economic Systems

•The comparative performance of the former planned economies is an important topic not only for what it says about basic performance issues, but also for what it says about decline of those systems. •We will look at the performance issues by developing a performance profile of socialist and capitalist systems and taking into account, as much as possible, basic methodological issues.

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I. Problems of Evaluation1. Choice of criteria• What criteria do we select to judge performance?

– Different systems have different goals•It is difficult to evaluate the overall performance of the different ES, when different ES pursue different goals and objectives. In one country econ growth may be important, in other full employment, or equal income distribution. Evaluating econ performance is not easy even if we isolate a single dominant objective, e.g. econ growth.

2. Statistical analysisa) Cannot just compare any capitalist country with any socialist country

– no way to know if they are representative of all capitalist and socialist countries

– something other than system is likely to be different: these other differences may be causing the differences in performance, not system

b) Ideal solution is the natural experiment– random selection of large sample of countries in each of three systems

•with a large enough sample and truly random assignment, each sample will be identical except for system

– any differences could then be attributable to system– but obviously, we cannot conduct a true experiment

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c) Samples already exist – and they are small (the market socialism sample contains only one

observation, Yugoslavia)– and they are very different in all sorts of ways other than just system

• How do we know that differences in performance are due to differences in system rather than other things?

– This is the ceteris paribus problem

3. Ceteris paribus problem • How do we account for these other differences so that we can attribute

differences in performance to differences in system?• The economies compared should be alike in all aspects except their ES:

O = f (ES, ENV, POL)• Two approaches:

– compare countries that are as alike as possible in all other respects (e.g., East and West Germany, North and South Korea, India and China)

– econometric approach—use regression methods to control statistically for these other effects

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Given the difficulties of evaluating ESs, we will use the most important performance indicators:

II. Measures of Performance.

1. Economic growth

– a priori expectations

– what the data tell us

– sources of growth

– costs of growth

2. Efficiency

3. Income distribution

4. Economic stability

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III. Economic Profiles of the Sample Countries

1. Per capita GNP

– market value of the sum of all goods and services produced in the economy

a) Distribution very different for capitalist and socialist samples– no rich socialist countries (the richest socialist states are comparable to

Italy, Spain, Greece, and Venezuela)

– This is a problem (if there are differences in performance, how will we know whether the differences are due to economic system or level of per capita GNP?)

– We could try comparing socialist countries to capitalist countries of comparable per capita GNP

it

itqpGNP

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2. Level of economic developmenta) Socialist states at a lower level of development

– lower per capita GNP– much larger agricultural sector as proportion of total

output • in spite of low priority of agriculture in resource allocation

– much smaller service sector• in part reflecting low priority of service sector

3. Economic diversitya) Capitalist countries much more diverse

– note shares of industry & services in Denmark and W. Germany» 22 vs 53 industry» 73 vs 44 services

– specialization according to comparative advantage

b) Socialist countries much less diverse– not specializing according to comparative advantage– each trying to be as self-sufficient as possible– each emphasizing heavy industry and construction

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4. Population

a) Some large countries, some small in both samples– note how big China and India are

– lower share of urban population in socialist countries

5. Feature of the socialist development model is:

• A high share of resources devoted to agriculture in recent years.

• Relative neglect of services.

• Emphasis on heavy industry.

• Relatively low rates of urbanization.

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IV. Economic Growth1. Prior expectation that planned socialism would generate

more rapid growtha) state ownership of income generating resourcesb) high level of forced savingc) growth was a high priority of centralized allocationd) lower level of economic development

It didn’t happen:• sometimes socialist economies grew more rapidly,

sometimes capitalist countries did, overall about equal— Figure 13.1

• take out China and capitalist countries grew more• socialist economies on average experienced continual

slowdown starting late ‘70s

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2. Controlling for national income level– Table 13.2a) Growth negatively correlated with national income

– Countries with low per capita income have grown more rapidly as a group.b) Compare socialist economies with capitalist countries at similar level of

national income• Spain, Greece, Italy, Venezuela• capitalist economies grew more rapidly for the entire postwar

period; the unweighted average annual growth for the 4 countries – 6% versus 4.5%, even with China included– 4.25% versus 3.8% per capita

c) Compare China and India• similar level of income and development at beginning of socialist period

in China• very different culturally, however• China grew more rapidly (6.9% versus 4.1% from 1960 to 1991)d) Compare China with other Asian, capitalist economies• Taiwan, South Korea, Singapore• more similar culturally• the capitalist countries grew much more rapidly than China

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3. Conclusions concerning growtha) Capitalist economies grew at least as fast, on average, in spite of socialist

advantages (state ownership, high level of forced savings, growth a high priority of centralized allocation, lower level of econ development)

b) Controlling for level of development, capitalist economies appear to have grown more rapidly

c) Socialist economies (with the exception of China) experienced significant downturn starting in late ‘70s while capitalist countries continued on trend

4. The Sources of Economic Growtha) Growth can come from having more resources with which to produce

more– extensive growth (expansion of inputs)

• for instance, population growth leading to increase in labor but not necessarily per capita growth

• increase in female labor market participation rate• increase in capital made possible by saving

b) Growth can come from making resources more productive– intensive growth (technological progress)

c) Intensive growth more desirable than extensive– extensive growth requires more work (less leisure) or more saving (less current

consumption) or both– intensive growth means working more efficiently

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5. Consumption Costs of Growtha) Consumption growth greater in capitalist economies

than in socialist– 4.7% versus 3.6% per annum

b) Recall that output growth was similar in both systemsc) Thus, cost in terms of sacrificed current consumption

greater in socialist economies

V. Economic efficiency 1. Dynamic -efficiency performance over time-the extent

to which output expands more rapidly than inputs, the difference being the growth rate of factor productivity

a) usually measured by comparing the growth of output and factor inputs

– growth rate of aggregate employment– growth rate of reproducible capital– growth rate of aggregate output– growth rate of labor productivity– growth rate of capital productivity– growth rate of total factor inputs

LK

Q

LQ

KQ

KL

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• wK –capital’s share of income

• wL –labor’s share of income

LK wLwKKL

)( KLQ

The rate of growth of total factor productivity (growth of efficiency)

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Example:

• GDP is growing at 11 percent per annum, labor at 2 percent per annum, and capital at 11 percent per annum.– The capital/output ratio is remaining steady

• the rate of growth of capital productivity is 11%-11%=0

– The rate of growth of labor productivity is positive 9%• 11%-2%=9%

– If labor accounts for 75 % of income and capital for 25 %, the rate of growth of total factor productivity is between the rate of growth of labor productivity and that of capital productivity, or 6.75%:

Rate of growth of total factor inputs:

Rate of growth of total factor productivity (growth of efficiency):

%25.475.25.1%11*25.0%2*75.0

LK wLwKKL

%75.625.411)(

KLQ

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2. Static efficiency • the effectiveness with which a system utilizes its available resources at a

particular time• Measure of static efficiency is how close the economy is to operating on its

production possibilities frontier.

VI. Data—Table 13.4 and Figure 13.21. Growth of labor and capital similar in both systems2. Productivity growth slows after 1960 in both

– Slowdown worse in socialist economies– output growth in socialist economies slows by 40%– yet input growth increases– thus socialist growth becomes more extensive after 1960

3. In socialist economies output growth was 5.2% per annum between 1950 and 1960 while productivity growth was 3.5%

4. Thus, growth was 67% intensive (3.5/5.2)5. After 1960, growth was only 30% intensive (0.9/3.0)6. In capitalist countries, growth was 65% intensive (3.0/4.8) in ‘50s and 49% (1.8/3.7)

afterwards. 7. Thus, growth similar in both systems during 1950-19608. During 1960-1985, growth becomes more extensive in both systems9. But growth becomes much more extensive in socialist economies than in capitalist10. Overall, growth in socialist economies has been more extensive than capitalist

growth

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VII. Income Distribution

1. Prior expectation is that socialist economies would have more equal distribution

– socialist goal

– state ownership of income-producing resources other than labor

2. Gini Coefficient: Czech 0.21 Sweden, UK 0.25

early 1970’s Hungary 0.24 Canada 0.34

Poland 0.24 USA 0.35

3. In general, socialist economies have more equal distributions

4. But UK and Sweden have distributions that are similar to socialist

5. Often considerable inequality in access to goods and services in socialist economies depending on one’s position in the Party hierarchy

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VIII. Economic Stability• Note that variability of growth less for socialist

economies, at least until 1980s• Socialist economies tended to exhibit greater stability

through most of the post-war period• Prices more stable in planned economies, on average.

IX. Summary1. Socialist economies unable to achieve higher growth in

spite of seeming advantages (if controlling for level of development, socialism did worse)

2. Capitalist countries appear to be more efficient (at least, their resources are much more productive)

3. Distribution of income tends to be more equal in socialist economies– (but some capitalist economies were able to achieve

distributions in line with socialist economies)

4. Socialist economies more stable at least until the 1980s

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X. Reasons for Economic Decline in the Planned Socialist Systems

1. Production function analysis – Diminishing returns to capital– Lack of technological progress

2. Problems with info and incentives3. Complexity 4. Development

– emphasized heavy industry at the expense of consumer goods.

XI. Collapse of Communism1. Gorbachev Reforms in Soviet Union (glasnost and perestroika, 1985)

– greater freedom of speech and press – elections to parliaments and city councils – emigration and travel permitted

2. Fall of Berlin Wall (1989)3. Reunification of Germany (1990)4. Dissolution of Warsaw Pact (1989-90) 5. Transition in Eastern Europe to market economies