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Welcome to ECON 372:

Comparative Economic Systems

By: Dr. Jacqueline Khorassani

Week Seven Lecture SlidesSource: Chapter 3 (pp 54-88) &

Jackie

Marietta College, Spring 2011

What is coming up? Team 1 paper is on Japan, Sweden

and France and is due on Monday, February 28– Presentation: Monday, March 14

Team 2 paper is on Germany, Russia & another country of their choice and is due on Monday, March 14– Presentation: Monday, March 21

Exam 2: Wednesday, March 16

  

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On Monday, February 21 Expect an ICA on last

Wednesday’s class material + first 15 lecture slides from this week

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Theoretical Foundations Saint Simon (French--

1800s)– Father of Constructivism

Social engineering– Advocate a social hierarchy

in which each man shall be placed according to his capacity and rewarded according to his works.

– Government has a spiritual or scientific role.

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Theoretical Foundations Marx and Engels (1800s)

– Criticized Utopian socialist– Called for a more scientific and

fundamental change in societies

5MarxEngels

Karl Marx

1818-1883 Born in Germany Studies philosophy in Berlin Radical journalist Spent time in exile in London Collaborated with Friedrich Engels

to develop the MARXIAN WORLD VIEW

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What influenced Marxian Theory?

1. German political philosophy◦ rational is real (as opposed to real is

rational) If the reality is not rational, it should be

changed.

2. French political sociology◦ French revolution was a conflict

between socioeconomic classes◦ Conflict between bourgeoisie

(capitalists) and proletariat (workers) ◦ Social classes and property ownership

would disappear automatically and naturally communism

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What influenced the Marxian theory?

3. British political economy David Ricardo’s labor theory

of value◦ Classical economics

Value of a good = Price and it is determined by supply and demand forces

◦ Ricardo (British, 1772-1823) Value of a good is determined by

the amount of socially necessary labor time it takes to produce it.

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Marxian Theory

Land and capital are productive but do not contribute to the value of a good◦Return to land is zero◦Capital is the product of past labor

W= c + v + s◦W = value of a good◦c= value of fixed capital (measured by

labor time to produce it)◦v= value of variable capital (labor)◦s= surplus value (created by workers but

taken by capitalist (profit) exploitation)9

Marxian Theory Organic compositing of capital, q

– q=c/(c+v)◦ q=dead capital/ (living + dead capital)

– Firms compete to increase q (key assumption)

How can q go up?– Invest in creating more capital, c– Hold v (value of labor) constant or decrease it

Rate of exploitation, s’– s’=s/v– How can it go up?

If v is constant and s (profit) goes up, exploitation goes up

Or, if s is constant and v goes down, exploitation goes up

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Marxian TheoryRate of profit, p’

◦p’= s/(c+v)◦p’=profit as a percentage of cost◦If c rises and s and v are constant, p’ declines

◦Since competition among capitalist result in increased c then Either capitalism is destroyed Or need to drop v for p’ to stay the same

or go up Labor is worse off class conflict rises and system collapses

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But what Marx predicted did not happen in Germany

Capitalism did not collapse Real wages were rising So, Marxists came up with Revisionism – No drastic changes– Just gradual reform (via

parliamentary democracy) to improve the welfare of workers.

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Another reason why capitalism did not collapse? Imperialism View

– Advanced capitalist countries avoided class conflict by

engaging in conquest of less developed nations (especially African nations)

– Got inexpensive raw material

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Lenin

Deficiencies in Marxian analysis (Can you thing of more?)

1. Applied mostly to the manufacturing rather than the service industry

◦ Service industry is more labor intensive than manufacturing industry

2. Value of a good was determined based on supply side (cost) factors only.

3. Because profits depend on productivity of labor and productivity of labor depends on how happy he/she is, firms (owners of capital) would not have an incentive to maximize the exploitation of labor.

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Marxism-Leninsim (1870-1924) Doctrine The idea is that

– workers in developed nations with colonies will not be exploited (due to ability of firms to make high profits because of their access to low cost of raw material in colonies)

– But workers in less developed nations (China, Cuba..) with no colonies will be exploited by capital owners (firms).

Need dictatorship in those nations

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More radical viewsAnarchism & Syndicalism

◦State should be abolished (Anarchism = more violent ideas)

◦No government Consistent with Utopian

socialism and modern libertarianism

◦Any connections to communism? Proudhon (French 1809-

1865, the first individual to call himself an "anarchist“) Says yes to this question

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Any connections between Anarchism and Marxism?

Marx says no.

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More on SyndicalismTrade unions (workers) should run the society

Influenced Russian Bolshevik (Meaning "majority" in Russian) Party in Russia in 1917(revolution))◦Lenin (the main leader of the party)

Crushed the syndicalist uprising In favor of state power

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Other Views Trotskyism

– Leon Trotsky (Russian, 1879-1940) A member of the Mensheviks Party

(minority party split from the Bolsheviks in 1903).

True socialism must be achieved internationally (Can’t do it in isolation)

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Other Views Titoism

– Marshall Titio (1892-1980) Leader of Yugoslavia Developed Worker-Management Market

Socialism– Quasi – Syndicalist– One party– Little central planning– Market forces– Management appointed by workers

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Other Views Maoism

– Mao (1893-1976) Chinese Marxist military

and political leader, who led the Chinese Communist Party

Emphasis on rural agricultural development

Moral incentives But to succeed we need to

destroy first– Cultural Revolution

we have to destroy an old system of production, an old ideology and old customs first.

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The Theory of Economic Socialism(Page 66)

1908 Enrico Barone (1859-1924. Italian Economist)

▪ Proposed a no -money (barter) economy▪ In which the state determines exchange

rate (this for that)▪ Price = cost

No profit▪ Assumes that the cost of production, demand

functions, capital stock are known by state and state sets the price to force firms to minimize

cost and achieve competitive equilibrium result in all

markets

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The Theory of Economic Socialism

1920– Ludwig von Mises (1881-

1973, Austrian ) Barone’s plan is not practical

– Need money– Insufficient incentives

Need profit a major influence on the

modern libertarian movement

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The Theory of Economic Socialism

1936 – Oskar Lange (Polish, 1904-1965).

Need a Central Planning Board (CPB)

– Sets raw material, capital, and intermediate good prices (finds the efficient price by trial and error)

– Sets the level of investment Distributes social dividends

(yield on capital and natural resources)

Consumer goods – Produced by state firms but sold in

a free market P = MC (efficient)

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The Socialist Planning Controversy

1940– Friedrich Hayek (1899-1992,

Austria) the most influential members of the

Austrian School of Economics Influenced by Mises Lange did not address Mises’s

criticism regarding motivation in Barone’s model1. Cost minimization does not happen

if there is no private ownership and profit motive

2. The state can not gather all information required for efficiency

3. In the system purposed by Barone technology will not advance

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The Socialist Planning Controversy

János Kornai, (1928- Hungary) also criticized the Central Planning System – State owned firms may be

Subject to hard budget constraint in principle, and

Subject to soft budget constraint in practice1. Can continue operating at loss2. Can be inefficient3. No incentive to minimize cost

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The Socialist Planning Controversy

Proponents of central planning system respond to Kornai’s criticism

1. Pragmatic market socialism Market economy + Bureau of Public Ownership

To enforce hard budget constraint To distribute profits to workers as a

percentage of their wages

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The Socialist Planning Controversy

2. Copy Japanese keiretsu system▪ Group of tightly linked corporations +

bank▪ Bank will impose hard budget constraint▪ Bank is state owned▪ Social dividends are distributed by a democratic

political process3. Copy socialist market economy of

China▪ Town and village enterprises

▪ Owned by local governments▪ Operate in free market▪ Have hard budget constraints

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The Socialist Planning Controversy

Maurice Dobb (1900-1976) –Foremost Marxian

economist of his generation in Britain.

–Criticizes Lange’s CPB Investment should not be set

– It should be maximized To increase economic growth Economic growth is more

important than efficiency This policy was adopted by

Stalin in 1928

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The Socialist Planning Controversy

Recent thoughts on command economy

A democratic political system should plan the economy1. Use modern information

technology to maximize information and feedback to help plan better

2. Mixed economy (but closer to command). Planning is done by councils of consumers and worker

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Central Planning in Soviet in 1920s

Five year plan broken into 5 one year plans– One year plan

Monthly production quotas for firms By products of this system

1. Ratchet Effect If a firm exceeded its quota, future quota

will be higher Had adverse effect on productivity

2. Illegal Activity If near end of the month a firm is not

meeting its quota, it will buy more inputs from illegal markets to increase production.

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Input-Output Analysis (Page 70)

Developed by Leontief (1906-1999) To plan production To mathematically solve a general

equilibrium model– Links the quantities of inputs to quantities

of outputs– output of one firm is input of other firm

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Hypothetical Input Output Table Transactions in a Three Sector Economy

Inputs to Agriculture

Inputs to Manufacturing

Inputs to Transport

Final Demand Total Output

Agriculture 5 (example: cattle feed)

15 (example: cotton)

2 (example: sugar cane for ethanol fuel)

68 (coffee) 90

Manufacturing 10 (example: farm machines)

20 (example: tools)

10 (example: trucks)

40 (example: cars)

80

Transportation 10 15 5 0 30

Labor 25 30 5 0 60

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Shortcomings of input-output model

1. Assumes constant return to scale Always need 20 hours of labor to

produce one chair What if

technology improves and labor productivity goes up?

2. Two inputs are not substitutable 20 hours of labor + 2 screw drivers 1

chair 25 hours of labor + 1 screw driver 0

chair

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Participatory or Cooperative Economy

Labor–Management Economy– A third way of doing things– Characteristics1. A board of workers hires managers2. Income sharing

Your income may not only depend on your productivity but other workers’ productivity too.

3. Capital must be rented (not owned by workers)4. Market or indicative planning (no command)

Note: indicative planning planning based on forecasts done by various agencies to minimize information asymmetry to establish various targets (output, employment,…

etc.)

5. Workers choose where to work

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Participating or Cooperative Economy

Advantages1. No class struggle

But…Can labor exploit management?

2. More equal distribution of income? But…Can labor exploit management?

3. Increases worker motivation and productivity

4. Worker owners will make sure that there is a hard budget constraint

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Participating or Cooperative Economy

Disadvantages1. Tendency to hire fewer labor; why?

To maximize per capita income of workers May supply less as price goes upP

Q

S

P1

P2

P3

Q1

Backward bending supply curve

Q2Q3

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Disadvantages of Participating or Cooperative Economy

Or, there may be an upward sloping supply curve that is very inelastic (quantity supplied is insensitive to changes in price)

S’P

S

Q

• Which supply is less elastic?• S

• What does it mean?• Economic

Growth?P1

Q1

P2

Q’2Q2

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Disadvantages of Participating or Cooperative Economy

2. Tendencies to form monopolies To maximize labor income

3. Tendencies to disregard externalities To maximize labor income

4. Tendencies not to re-invest part of profits To maximize current labor income Result less growth

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Recall Marshall Titio (1892-1980)

– Leader of Yugoslavia Developed Worker-Management Market

Socialism How did it work?

– There were monopolies– Low labor mobility– Unemployment rose– Output fell– Hyperinflation– Income inequality rose

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But the capitalistic version of Cooperative Economy

Such as– Employee stock ownership plans– Profit sharing

Is still popular

Transition from socialism to capitalism

Began in 1989: The fall of Berlin Wall

http://www.youtube.com/watch?v=s5JdY8ENfVg&feature=PlayList&p=497C1FEC171B0B2A&playnext=1&playnext_from=PL&index=7

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Steps (not necessarily in this order!!!)

1. Privatize state-owned enterprises2. Replace command with market mechanism

Freeing prices Dangers:

1. inflation, why? Price ceiling and rationing is removed Not enough output, high demand

2. Rise in unemployment, why? Productivity matters; cost minimization matters

3. Rise in income inequality, why? Productivity matters

3. Liberalize political system

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Transition form socialism to capitalism

Difficulties Undeveloped banking system Undeveloped accounting system Undeveloped stock market No anti-trust laws monopolies No corporate laws the rules of the game are

not defined Trade rapid increase in imports due to high

domestic prices Quick change (Shock therapy) has not been

very successful corruption, stagflation, underground activities

Gradual change has been more successful 44

Who succeeded ???

Shock therapy or Gradualism

Heavy on their use of foreign aid and advisors

Economic growth per capita immediately after

Latin America

Shock therapy

Yes Close to Zero

Russia Shock therapy

Yes Negative

Africa Shock therapy

Yes Zero

China Gradualism No High positive

India Gradualism No High positive

When is the transition finished? Different opinions

1. Mostly market economy; more than one political party; mostly private ownership of resources

2. When country faces the same problems as market economies

3. When country joins EU (if European)

4. When country joins WTO (China?)46