Advocates and critics of capitalism agree that its distinctive contribution to history has been the encouragement of economic growth. Capitalist growth is not, however, regarded as an unalloyed benefit by its critics. Its negative side derives from three dysfunctions that reflect its market origins.
The unreliability of growth
The first of these problems is already familiar from the previous discussion of the stages of capitalist development. Many critics have alleged that the capitalist system suffers from inherent instability that has characterized and plagued the system since the advent of industrialization. Because capitalist growth is driven by profit expectations, it fluctuates with the changes in technological or social opportunities for capital accumulation. As opportunities appear, capital rushes in to take advantage of them, bringing as a consequence the familiar attributes of a boom. Sooner or later, however, the rush subsides as the demand for the new products or services becomes saturated, bringing a halt to investment, a shakeout in the main industries caught up in the previous boom, and the advent of recession. Hence, economic growth comes at the price of a succession of market gluts as booms meet their inevitable end.
This criticism did not receive its full exposition until the publication of the first volume of Marx's Das Kapital in 1867. For Marx, the path of growth is not only unstable for the reasons just mentioned—Marx called such uncoordinated movements the “anarchy” of the market—but increasingly unstable. Marx believed that the reason for this is also familiar. It is the result of the industrialization process, which leads toward large-scale enterprises. As each saturation brings growth to a halt, a process of winnowing takes place in which the more successful firms are able to acquire the assets of the less successful. Thus, the very dynamics of growth tend to concentrate capital into ever-larger firms. This leads to still more massive disruptions when the next boom ends, a process that terminates, according to Marx, only when the temper of the working class snaps and capitalism is replaced by socialism.
Beginning in the 1930s, Marx's apocalyptic expectations were largely replaced by the less-violent but equally disquieting views of the English economist John Maynard Keynes, first set forth in his influential The General Theory of Employment, Interest, and Money (1936). Keynes believed that the basic problem of capitalism is not so much its vulnerability to periodic saturations of investment as its likely failure to recover from them. He raised the possibility that a capitalist system could remain indefinitely in a condition of equilibrium despite high unemployment, a possibility not only entirely novel (even Marx believed that the system would recover its momentum after each crisis) but also made plausible by the persistent unemployment of the 1930s. Keynes therefore raised the prospect that growth would end in stagnation, a condition for which the only remedy he saw was “a somewhat comprehensive socialization of investment.”
The quality of growth
A second criticism with respect to market-driven growth focuses on the adverse side effects generated by a system of production that is held accountable only to the test of profitability. It is in the nature of a complex industrial society that the production processes of many commodities generate “bads” as well as “goods”—e.g., toxic wastes or unhealthy working conditions as well as useful products.
The catalog of such market-generated ills is very long. Smith himself warned that the division of labour, by routinizing work, would render workers “as stupid and ignorant as it is possible for a human creature to become,” and Marx raised the spectre of alienation as the social price paid for subordinating production to the imperatives of profit making. Other economists warned that the introduction of technology designed to cut labour costs would create permanent unemployment. In modern times much attention has focused on the power of physical and chemical processes to surpass the carrying capacity of the environment—a concern made cogent by various types of environmental damage arising from excessive discharges of industrial effluents and pollutants. Because these social and ecological challenges spring from the extraordinary powers of technology, they can be viewed as side effects of socialist as well as capitalist growth. But the argument can be made that market growth, by virtue of its overriding obedience to profit, is congenitally blind to such externalities.
A third criticism of capitalist growth concerns the fairness with which capitalism distributes its expanding wealth or with which it shares its recurrent hardships. This criticism assumes both specific and general forms.
The specific form focuses on disparities in income among layers of the population. At the turn of the 21st century in the United States, for example, the lowest fifth of all households received only 3.6 percent of total income, whereas the topmost fifth received 49 percent. Significantly, this disparity results from the concentration of assets in the upper brackets. Also, the disparity is the consequence of highly skewed patterns of corporate rewards that typically give, say, chief executive officers of large companies 50 to 100 times more income than those of ordinary office or factory employees. Income disparities, however, should be understood in perspective, as they stem from a number of causes. In its 1995 annual report the Federal Reserve Bank of Dallas observed:
By definition, there will always be a bottom 20 percent, but only in a strict caste society will it contain the same individuals and families year after year.
Moving from specific examples of distribution to a more general level, the criticism may be broadened to an indictment of the market principle itself as the regulator of incomes. An advocate of market-determined distribution will declare that in a market-based society, with certain exceptions, people tend to be paid what they are worth—that is, their incomes will reflect the value of their contribution to production. Thus, market-based rewards lead to the efficiency of the productive system and thereby maximize the total income available for distribution. This argument is countered at two levels. Marxist critics contend that labourers in a capitalist economy are systematically paid less than the value of their work by virtue of the superior bargaining power of employers, so that the claim of efficiency masks an underlying condition of exploitation. Other critics question the criterion of efficiency itself, which counts every dollar of input and output but pays no heed to the moral or social or aesthetic qualities of either and which excludes workers from expressing their own preferences as to the most appropriate decisions for their firms.
Various measures have been taken by capitalist societies to meet these criticisms, although it must be recognized that a deep disagreement divides economists with respect to the accuracy of the criticisms, let alone the appropriate corrective measures to be adopted if these criticisms are valid. A substantial body of economists believe that many of the difficulties of the system spring not from its own workings but from well-meaning attempts to block or channel them. Thus, with respect to the problem of instability, supporters of the market system believe that capitalism, left alone as much as possible, will naturally corroborate the trend of economic expansion that has marked its history. They also expect that whatever instabilities appear tend quickly to correct themselves, provided that government plays a generally passive role. Market-oriented economists do not deny that the system can give rise to qualitative or distributional ills, but they tend to believe that these are more than compensated for by its general expansive properties. Where specific problems remain, such as damage to the environment or serious poverty, the prescription often seeks to utilize the market system itself as the corrective agency—e.g., alleviating poverty through negative income taxes rather than with welfare payments or controlling pollution by charging fees on the outflow of wastes rather than by banning the discharge of pollutants.
Opposing this view is a much more interventionist approach rooted in generally Keynesian and welfare-oriented policies. This view doubts the intrinsic momentum or reliability of capitalist growth and is therefore prepared to use active government means, both fiscal and monetary, to combat recession. It is also more skeptical of the likelihood of improving the quality or the equity of society by market means and, although not opposing these, looks more favourably on direct regulatory intervention and on specific programs of assistance to disprivileged groups.
Despite this philosophical division of opinion, a fair degree of practical consensus was reached on a number of issues in the 1950s and '60s. Although there are differences in policy style and determination from one nation to the next, all capitalist governments have taken measures to overcome recession—whether by lowering taxes, by borrowing and spending, or by easing interest rates—and all pursue the opposite kinds of policies in inflationary times. It cannot be said that these policies have been unqualified successes, either in bringing about vigorous or steady growth or in ridding the system of its inflationary tendencies. Yet, imperfect though they are, these measures seem to have been sufficient to prevent the development of socially destructive depressions on the order of the Great Depression of the 1930s. It is not the eradication but the limitation of instability that has been a signal achievement of all advanced capitalist countries since World War II. It should be noted, however, that these remedial measures have little or no international application. Although the World Bank and the International Monetary Fund make efforts on behalf of developing countries:
Thus, some critics of globalization contend that the internationalization of capitalism may exert destabilizing influences for which no policy corrective as yet exists.
A broadly similar appraisal can be made with respect to the redress of specific threats that emerge as unintended consequences of the market system. The issue is largely one of scale. Specific problems can often be redressed by market incentives to alter behaviour (paying a fee for returning used bottles) or, when the effect is more serious, by outright prohibition (bans on child labour or on dangerous chemical fertilizers). The problem becomes less amenable to control, however, when the market generates unintended consequences of large proportions, such as traffic congestion in cities. The difficulty here is that the correction of such externalities requires the support and cooperation of the public and thereby crosses the line from the economic into the political arena, often making redress more difficult to obtain. On a still larger scale, the remedy for some problems may require international agreements, and these often raise conflicts of interest between the nation generating the ill effects as a by-product of its own production and those suffering from the effects. The problem of acid rain originating in one country but falling in another is a case in point. Again the economic problem becomes political and its control more complicated.
A number of remedies have been applied to the distributional problems of capitalism. No advanced capitalist country today allows the market to distribute income without supplementing or altering the resulting pattern of rewards through taxes, subsidies, welfare systems, or entitlement payments such as old-age pensions and health benefits. In the United States, these transfer payments, as they are called, amount to some 10 percent of total consumer income; in a number of European nations, they come to considerably more. The result has been to lessen considerably the incidence of officially measured poverty.
Yet these examples of successful corrective action by governments do not go unchallenged by economists who are concerned that some of the “cures” applied to social problems may be worse than the “disease.” While admitting that the market system fails to live up to its ideal, these economists argue that government correctives and collective decision making must be subjected to the same critical scrutiny leveled against the market system. Markets may fail, in other words, but so might governments. The stagflation of the 1970s, the fiscal crises of some democratic states in the 1980s, and the double-digit unemployment in western Europe in the 1990s set the stage for the 21st century by raising serious doubts about the ability of government correctives to solve market problems.
No survey of comparative economic systems would be complete without an account of centrally planned systems, the modern descendants of the command economies of the imperial past. In sharpest possible contrast to those earlier tributary arrangements, however, modern command societies have virtually all been organized in the name of socialism—that is, with the function of command officially administered on behalf of an ideology purported to serve the broad masses of the population.
Socialist central planning needs to be differentiated from the idea of socialism itself. The latter draws on moral precepts of concern for the needy that can be discovered in the Judeo-Christian tradition and derives its general social orientation from Gerrard Winstanley's Diggers movement during the English Civil Wars in the mid-17th century: “The Earth,” Winstanley wrote, “was made by Almighty God to be a Common Treasury of livelihood to the whole of mankind...without respect of persons.”
Socialism as a means of orchestrating a modern industrial system did not receive explicit attention until the Russian Revolution in 1917. In his pamphlet The State and Revolution, written before he came to power, Vladimir Lenin envisaged the task of coordinating a socialist economy as little more than delivering production to central collecting points from which it would be distributed according to need—an operation requiring no more than “the extraordinarily simple operations of watching, recording, and issuing receipts, within the reach of anybody who can read and who knows the first four rules of arithmetic.” After the revolution it soon became apparent that the problem was a great deal more difficult than that. The mobilization of human capital required the complex determination of appropriate amounts and levels of pay, and the transportation of foodstuffs from the countryside posed the awkward question of the degree to which the “bourgeois” peasantry would have to be accommodated. As civil war raged in the country, these problems intensified until production fell to a catastrophic 14 percent of prewar levels. By the end of 1920, the economic system of the Soviet Union was on the verge of collapse.
To forestall disaster, Lenin instituted the New Economic Policy (NEP), which amounted to a partial restoration of capitalism, especially in retail trade, small-scale production, and agriculture. Only the “commanding heights” of the economy remained in government hands. The NEP resuscitated the economy but opened a period of intense debate as to the use of market incentives versus moral suasion or more coercive techniques. The debate, which remained unresolved during Lenin's life, persisted after his death in 1924 during the subsequent struggle for power between Joseph Stalin, Leon Trotsky, and Nikolay Bukharin. Stalin's rise to power brought a rapid collectivization of the economy. The NEP was abandoned. Private agriculture was converted into collective farming with great cruelty and loss of life; all capitalist markets and private enterprises were quickly and ruthlessly eliminated; and the direction of economic life was consigned to a bureaucracy of ministries and planning agencies. By the 1930s a structure of centralized planning had been put into place that was to coordinate the Russian economy for the next half century.
At the centre of the official planning system was the Gosplan (gos means “committee”), the top economic planning agency of the Soviet state. Above the Gosplan were the political arms of the Soviet government, while below it were smaller planning agencies for the various Soviet republics. The Gosplan itself was staffed by economists and statisticians charged with drawing up what amounted to a blueprint for national economic activity. This blueprint, usually based on a five- to seven-year period, translated the major objectives determined by political decision (electrification targets, agricultural goals, transportation networks, and the like) into industry-specific requirements (outputs of generators, fertilizers, steel rails). These general requirements were then referred to ministries charged with the management of the industries in question, where the targets were further broken down into specific outputs (quantities, qualities, shapes, and sizes of steel plates, girders, rods, wires, and so forth) and where lower-level goals were fixed, such as budgets for firms, wage rates for different skill levels, or managerial bonuses.
Planning was not, therefore, entirely a one-way process. General objectives were indeed transmitted from the top down, but, as each ministry and factory inspected its obligations, specific obstacles and difficulties were transmitted from the bottom up. The final plan was thus a compromise between the political objectives of the Central Committee of the Communist Party and the nuts-and-bolts considerations of the echelons charged with its execution. This coordinative mechanism worked reasonably well when the larger objectives of the system called for the kind of crash planning often seen in a war economy. The Soviet economy achieved unprecedented rapid progress in its industrialization drive before World War II and in repairing the devastation that followed the war. Moreover, in areas where the political stakes were high, such as space technology, the planning system was able to concentrate skills and resources regardless of cost, which enabled the Soviet Union on more than one occasion to outperform similar undertakings in the West. Yet, charged with the orchestration of a civilian economy in normal peacetime conditions, the system of centralized planning failed seriously.
Because of its failures, a far-reaching reorganization of the system was set into motion in 1985 by Mikhail Gorbachev, under the banner of perestroika (“restructuring”). The extent of the restructuring can be judged by these proposed changes in the coordinative system:
This program represented a dramatic retreat from the original idea of central planning. One cannot say, however, that it also represented a decisive turn from socialism to capitalism, for it was not clear to what extent the restructured planning system might embody other essential features of capitalism, such as private ownership of the means of production and the exclusion of political power from the normal operations of economic life. Nor was it known to what extent economic perestroika was to be accompanied by its political counterpart, glasnost (“openness”). Thus, the degree of change in both the economic structure and the underlying political order remained indeterminate.
The record of perestroika over the rest of the 1980s was disappointing. After an initial flush of enthusiasm, the task of abandoning the centralized planning system proved to be far more difficult than anticipated, in part because the magnitude of such a change would have necessitated the creation of a new structure of economic (managerial) power, independent of, and to some extent in continuous tension with, that of political power, much as under capitalism. Also, the operation of the centralized planning system, freed from some of the coercive pressures of the past but not yet infused with the energies of the market, rapidly deteriorated. Despite bumper crops, for example, it was impossible to move potatoes from the fields to retail outlets, so that rations decreased and rumours of acute food shortages raced through Moscow. By the end of the 1980s, the Soviet system was facing an economic breakdown more severe and far-reaching than the worst capitalist crisis of the 1930s. Not surprisingly, the unrest aroused ancient nationalist rivalries and ambitions, threatening the dismemberment of the Soviet economic and political empire.
As the Soviet central government gradually lost control over the economy at the republic and local levels, the system of central planning eroded without adequate free-market mechanisms to replace it. By 1990 the Soviet economy had slid into near paralysis, and this condition foreshadowed the fall from power of the Soviet Communist Party and the breakup of the Soviet Union itself into a group of independent republics in 1991.
Attempts to transform socialist systems into market economies began in eastern and central Europe in 1989 and in the former Soviet Union in 1992. Ambitious privatization programs were pursued in Poland, Hungary, Germany, the Czech Republic, and Russia. In many countries this economic transformation was joined by a transition (although with varying degrees of success) to democratic forms of governance.
The socialist turn from planning toward the market provides a fitting initial conclusion to this overview of the typology of economic systems, for it is apparent that the three ideal types—of tradition, command, and market—have never been attained in wholly pure form. Perhaps the most undiluted of these modes in practice has been that of tradition, the great means of orchestration in prestate economic life. But even in tradition a form of command can be seen in the expected obedience of community members to the sanctions of tradition. In the great command systems of the past, as has been seen, tradition supplied important stabilizing functions, and traces of market exchange served to connect these systems to others beyond their borders. The market system as well has never existed in wholly pure form. Market societies have always taken for granted that tradition would provide the foundation of trustworthiness and honesty without which a market-knit society would require an impossible degree of supervision, and no capitalist society has ever existed without a core of public economic undertakings, of which Adam Smith's triad—defense, law and order, and nonprofitable public works—constitutes the irreducible minimum.
Thus, it is not surprising that the Soviet Union's efforts to find a more flexible amalgam of planning and market were anticipated by several decades of cautious experiment in some of the socialist countries of eastern Europe, especially Yugoslavia and Hungary, and by bold departures from central planning in China after 1979. All these economies existed in some degree of flux as their governments sought configurations best suited to their institutional legacies, political ideologies, and cultural traditions. All of them also encountered problems similar in kind, although not in degree, to those of the Soviet Union as they sought to escape the confines of highly centralized economic control. After the Soviet Union abandoned its control over eastern Europe in 1989–90, most of that region's countries began converting their economies into capitalist-like systems.
Something of this mixed system of coordination can also be seen in the less-developed regions of the world. The panorama of these economies represents a panoply of economic systems, with tradition-dominated tribal societies, absolute monarchies, and semifeudal societies side by side with military socialisms and sophisticated but unevenly developed capitalisms. To some extent, this spectrum reflects the legacy of 19th-century imperialist capitalism, against whose cultural as well as economic hegemony all latecomers have had to struggle. Little can be ventured as to the outcome of this astonishing variety of economic structures. A few may follow the corporatist model of the Asian tigers and the economies of the Pacific Rim (a group of Pacific Ocean countries and islands that constitute more than half of the world's population); others may emulate the social democratic welfare states of western Europe; a few will pursue a more laissez-faire approach; yet others will seek whatever method—either market or planned—that might help them establish a viable place in the international arena. Unfortunately, many are likely to remain destitute for some time. In this fateful drama, considerations of culture and politics are likely to play a more determinative role than any choice of economic instrumentalities.
Problems with socialism
The socialist experiments of the 20th century were motivated by a genuine interest in improving life for the masses, but the results instead delivered untold suffering in terms of economic deprivation and political tyranny. Nonetheless, the egalitarian values that inspired the socialist experiments continue to possess great intellectual and moral appeal. And while socialism has proved less attractive than democratic capitalism, many of the most normatively attractive elements of socialism have been incorporated into democratic systems, as evidenced by public support for spending on social programs.
The chief economic problem of socialism has been the efficient performance of the very task for which its planning apparatus exists—namely, the effective coordination of production and distribution. Modern critics have declared that a planned economy is impossible—i.e., will inevitably become unmanageably chaotic—by virtue of the need for a planning agency to make the millions of dovetailing decisions necessary to produce the gigantic catalog of goods and services of a modern society. Moreover, classical economists would criticize the perverse incentives caused by the absence of private property rights. Precisely such problems became manifest in the late 1980s in the Soviet Union.
The proposed remedy to the problems of socialism involves the use of market arrangements under which managers are free to conduct the affairs of their enterprises according to the dictates of supply and demand (rather than those of a central authority). The difficulty with this solution lies in its political rather than economic requirements, because the acceptance of a market system entrusted with the coordination of the bulk of economic activity requires the tolerance of a sphere of private authority apart from that of public authority. A market mechanism may be compatible with a society of socialist principles, but it requires that the forms of socialist societies as they now exist be radically reorganized. The political difficulties of such a reorganization are twofold. One difficulty arises from the tensions that can be expected to exist between the private interests, and no doubt the public visions, of the managerial echelons and those of the political regime. The creation of a market is tantamount to the creation of a realm within society into which the political arm of government is not allowed to reach fully.
Another political difficulty encountered in the move from socialism to the market is the impact on the working class. The establishment of a market system as the major coordinator of economic activity, including labour services, necessarily introduces the use of unemployment as a disciplining force into a social order. Under socialist planning, government commands were used to allocate employment and thereby did not permit the hiring or firing of workers for strictly economic reasons. The problem with this was inefficient production, underemployment, and misallocations of labour. The introduction of a market mechanism for labour is, however, likely to exacerbate class tensions between workers and management. Some socialist reformers tried to overcome these tensions by increasing worker participation in the management of the enterprises in which they worked, but no great successes have been reported. Finally, socialist governments will tend to encounter problems when they come to rely on market coordinative mechanisms, because economic decentralization and political centralization have inherent incompatibilities.
Economic systems may lose some of the decisive differences that have marked them in the past and come to suggest, instead, a continuum on which elements of both market and planning coexist in different proportions. Societies along such a continuum may continue to designate themselves as either capitalist or socialist, but they are likely to reveal as many similarities as differences in their solutions to economic problems.
Historical analysis is presented in Robert L. Heilbroner, The Making of Economic Society, 11th ed. (2002). An excellent presentation along more functional lines, well-written but requiring some acquaintance with economic theory, is Frederic L. Pryor, A Guidebook to the Comparative Study of Economic Systems (1985). Morris Bornstein (ed.), Comparative Economic Systems: Models and Cases, 7th ed. (1994), a book of readings, is also recommended.
A history of the debate over the economic feasibility of socialism is available in Don Lavoie, Rivalry and Central Planning (1985). A comprehensive reference collection of the main texts in the socialist calculation debate (theoretical comparisons of centrally planned versus free-market economies) can be found in Peter J. Boettke (ed.), Socialism and the Market: The Socialist Calculation Debate Revisited, 9 vol. (2000). Other theoretical works include Alec Nove, The Economics of Feasible Socialism, 2nd ed. (1991); Branko Horvat, The Political Economy of Socialism: A Marxist Social Theory (1982); David L. Prychitko and Jaroslav Vanek (eds.), Producer Cooperatives and Labor-Managed Systems, 2 vol. (1996); and Jánus Kornai, The Socialist System (1992).
Discussions regarding China, eastern Europe, and the Soviet Union are in Andrei Schleifer and Daniel Treisman, Without a Map: Political Tactics and Economic Reform in Russia (2000); Jeffrey Sachs, Poland's Jump to the Market Economy: The Socialist Calculation Debate Reconsidered (1993, reissued 1999); and Barry Naughton, Growing out of the Plan: Chinese Economic Reform, 1978–1993 (1995).
The Soviet experience
The classic work on the economic history of the Soviet Union is Alec Nove, An Economic History of the U.S.S.R., 1917–1991, 3rd ed. (1992). A political history of the Soviet Union that pays significant attention to the underlying ideology, including political economy, is Martin Malia, The Soviet Tragedy (1994, reissued 1996). Ed A. Hewett, Reforming the Soviet Economy: Equality Versus Efficiency (1988), offers thoughtful criticisms and considered appraisals on reforming the Soviet-type economy. Peter J. Boettke, Why Perestroika Failed: The Politics and Economics of Socialist Transformation (1993), discusses systemic problems with the Soviet-type system.
Two broad treatments of capitalism are Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (1776); and Karl Marx, Das Kapital, vol. 1, trans. by Samuel Moore and Edward Aveling as Capital: A Critical Analysis of Capitalist Production (1886); both works are available in many later editions. Robert L. Heilbroner, The Nature and Logic of Capitalism (1985), treats the social formation of capitalism. Fernand Braudel, Civilization and Capitalism, 15th–18th Century, 3 vol. (1982–84, reissued 1992; originally published in French, 1979), is a wide-ranging overview. Nathan Rosenberg and L.E. Birdzell, Jr., How the West Grew Rich: The Economic Transformation of the Industrial World (1986, reissued 1999), discusses the Industrial Revolution and the rise of capitalism. John Kenneth Galbraith, The New Industrial State, 4th ed. (1985), is a modern classic. Milton Friedman, Capitalism and Freedom (1962, reissued 2002); and Milton Friedman and Rose Friedman, Free to Choose (1980, reissued 1990), are perhaps the most accessible treatments of economics and public policy from a market-oriented perspective.
Robert L. Heilbroner: Norman Thomas Professor Emeritus of Economics, New School for Social Research, New York City. Author of The Worldly Philosophers; The Nature and Logic of Capitalism; and others.
Peter J. Boettke: Associate Professor of Economics, George Mason University, Fairfax, Virginia. Editor of The Review of Austrian Economics and New Thinking in Political Economy.