An evolutionary take on: Market Vs Socialist Economies

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The disparity between the wealthy and poor is disturbing. And the gap doesn’t seem to be closing. It is less about the wealthy being crooks and more about the system in which we operate. Capitalism may have caused this gap. When I hear it, I instinctively think ‘money’. And for Socialism, I think ‘people’. We don’t conclude saying socialism is the way to go just because it sounds virtuous, because we know there is a reason why they are ideologies in their own right. But we might not know the reason itself.

They are not just theories from thought experiments, they are systems that have evolved over centuries. So instead of pitting them against each other, we’ll take an evolutionary approach to understanding them and draw out distinctions along the way.

Origins

Societies organize themselves to be able to solve for problems of production, distribution and consumption. Economic systems develop as a result. It is the study of the participants’ behaviour in this system that makes economics a ‘social’ ‘science’. That’s how systems got their names throughout history, by the study of behaviour.

In its most primitive forms, economic systems weren’t really systems. They were well tied into the tradition of the groups. The production or requirement was taken care of by adapting, migration, hunting and gathering, and distribution- simply by honouring the tribe’s code. Trust perhaps played a part in maintaining order. Examples are Bedouin and Kalahari tribes of the present day.

Then came systems operating on the command of a supreme authority. We’re talking about the emergence of Egyptian, Chinese and Indian civilizations during the 3^rd millennium BC, where the ruler could get its people to work as per his wishes. Typically, they used their power to cater to consumption or the fancies of the elites (monuments). But much like the primitive societies, there was no economic system separate from the cultural or religious principles of life. This can be due to the fact that there was high obedience to the culture and hence, the ruler.

This command system of a few elite at the top and slavery at the bottom gradually faded, starting with the fall of the Roman Empire. It was replaced by Feudalism in European societies- (Latin- feudalis meaning fee and feodum meaning land). It is a system where a landowner (lord or the King) gave a unit of fief (land) to nobles (a class ranked immediately below royalty) in return for military service, which was the most common and needed service at the time. The nobles could further rent it out to other nobles or to peasants in return for a portion of their produce.

Later, professional soldiers replaced nobles. The plague (a.k.a. Black Death), peasant revolt, and their migration to cities led to chronic labour shortage. Introduction of coinage meant payment for military service instead of giving land, which left peasants with no land to work on. All these factors led to the decline of feudalism by the 14^th century.

Seeds Of Capitalism Sown

The term ‘Mercantilist system’ was coined by Adam Smith (a.k.a. father of modern economics) in his seminal book ‘The Wealth of Nations’ published in 1776. It was perhaps derived from mercari– Latin for trade. This system dominated Western European from 16^th to late 18^th centuries.

Towards the end of feudalism, regional power centres were being consolidated by large countries and colonies (conquered countries) were established outside Europe. These factors coupled with growth of trade relative to agriculture paved the way for mercantilism.

The Mercantilist System

This system assumed the world’s wealth to be static, based mainly on precious metals like gold and silver. Hence, the goal of countries was to amass wealth by having a favourable balance of trade (exports greater than imports) to further strengthen their military force. The colonies were made sources of raw materials and export hubs for the products manufactured in the mother country (conqueror country). Gold and silver were received in return of its exports. To encourage activities of merchants and producers, the government would intervene to provide capital, tax incentives, and grant titles to new industries. Also, imports that competed with local manufacturers were restricted through quotas, taxed through tariffs and outright prohibited in some cases. Along the same lines, equipment exports and labour emigration to countries who could potentially compete with domestic industry in manufacturing goods, were also prohibited. Shipping industry also gained importance due to the emphasis on shipments of export goods and gold, and patrolling trade routes.

The Decline

However, certain developments over the 18^th and 19^th century led to the decline of mercantilism. When Britain defeated Napoleon, the need to strengthen its military forces reduced, thereby easing the pressure to gather wealth for that purpose. Modern entrepreneurs in trade, industry and finance objected to the system’s preferential treatment towards monopolistic firms. Technological advances that transformed manufacturing enabled industries to undercut competitors in most markets, making trade barriers irrelevant or even harmful. This is because reducing restrictions would enable import of cheaper inputs, thereby increasing demand for British goods. Industrialists believed that removing trade restrictions would increase world demand for British goods. London was becoming the world’s financial centre and allowing access to Britain’s economy would also mean repayment of debts owed to it. Opposition grew against the agricultural tariffs. And so, mercantilism saw its end in Britain and other economic powers followed suit.

Growth Of Capitalism

Over the course of the late 18^th and 19^th century, countries opened up to trade, integrated with the world economy and reduced government intervention. Railroads changed the speed and cost of carrying cargo over land. Steamships got faster and shipping capacity increased. Cost of land and sea transportation reduced. Europe exported manufactured products heavily, and received farm products and raw materials from Amazon and Australia. Trade multiplied.

Telegraphy allowed quick transmission of information to investment houses in London, Paris and Berlin, so new opportunities attracted international investments. Britain’s adoption of gold standard influenced other countries to use the same. And international financiers considered being ‘on gold’ as a sign of a country’s reliability. Industrial revolution spread from North-western Europe to the world. As cheap farm products were imported, farmers lost work and Europe suffered a prolonged agrarian crisis and millions moved to cities or abroad. Foreign competition proved threat to local producers. But prosperity outweighed problems, and the capitalist system (a.k.a. market economy) was in the making.

The Capitalist System

Adam Smith argued against mercantilism and was an advocate of ‘free markets’ and minimum government interference. The role of government in this economic system is reduced to providing national defence, ensure law and order, and provide public goods (welfare of people and protection of environment). This means more private ownership of factors of production- land and capital and compete to produce goods required by society. Market forces determined price: firms competing for consumers (supply) and consumers competing for scarce or limited products (demand). Competition encourages innovation in products and processes. Manufacturing costs reduce, profits improve, wealth increases, consumption and investment rises. Free trade (lesser restrictions) boosts this process with cheaper imports and more exports. The exponential growth in production requires commensurate labour supply thereby increasing employment, wages, and the overall standard of living. This goal of capitalism to accumulate wealth was inherent in mercantilist system itself, but the forces of free trade and lesser government intervention helped realize the goal. Capitalism seemed sorted.

Until we saw its defects.

Concerns with Capitalism

Firstly, instability. Growth in this system is driven by opportunities to amass wealth. When they see one, their incentive lies in investing there, resembling a boom. An economy is said to be in a ‘boom’ when production, demand, prices, jobs, investment and lending increase which could have been triggered by either public enthusiasm or false information. But it carries a risk of turning into a ‘bubble’ which happens when the enthusiasm (or demand) far exceeds the asset base it’s chasing. It then ‘pops’ when the society realizes it has gone overboard and the demand is saturated. This is followed by a bust (conditions opposite of boom), which depending on its severity can lead to a recession or in severe cases, depression. Recent examples are the 1990s Dotcom Bubble and the 2007 ‘08 Housing Bubble. Depression followed the Stock Market Crash (1929) and recession followed the Housing Bubble burst.

Secondly, social and ecological harm. It is common knowledge that industrial emissions and effluents have polluted the environment considerably. Additionally, people in unhealthy working conditions as well as neighbourhood of manufacturing plants are at risk of disease. It is a price to pay for continuous and sustained economic growth. And this is inevitable in socialist countries too, only it will be apparent later. But the companies across the globe are increasingly volunteering and are incentivized by government policies to invest in ‘green’ projects and shift to recycling and renewable energy sources. Rise in regulatory oversight and activist movements have made companies conscious about working conditions and treatment of its workforce.

Finally, Equity. Capitalism rewards people according to the value of their contribution to production. In that sense, there will be disparity in pay between the top and bottom rung of workforce. But a fair argument capitalism is inequity in opportunity to contribute due to inadequacy of basic needs- food, shelter, and education. This contributes to widening the rich-poor divide. It can be attributed to the ineffectiveness of government reforms.

Socialism: A Solution?

Socialism encourages communal ownership of factors of production- property and natural resources, rather than private ownership. It believes that this will lead to equitable wealth distribution and a more egalitarian society. In a pure socialist regime, a central authority takes decisions relating to production and distribution and people rely on it for their needs, from food to healthcare. The authority decides the desired output and pricing levels on the basis of needs of the society.

Socialism developed from moral discussions around equality, cooperation and frugality. The traits of communal ownership were depicted by Philosopher Plato in his work ‘Republic’ around 360 BC. Much later in the 16^th century, Thomas More wrote a book ‘Utopia’ based on Plato’s ideas. He describes an imaginary island where money has been abolished and people live and work communally. But as an economic system, socialism was first adopted in the Soviet rule.

The First Communist Government

In the early 19^th century, the Russian rule was in chaos. The nation suffered from costly wars, food shortages, rising inflation and rampant corruption. Protests against the monarchy led to workers being killed brutally. Once the monarch relinquished his throne, the provisional government’s policies too didn’t help.

With the ‘The Russian revolution’ 1917, the Bolshevik Party led by Vladimir Lenin launched a coup, seized power from the interim leaders and declared Soviet rule (from Russian word ‘sovet’ meaning council). This brought an end to Russian involvement in the war. Lenin called for a government ruled by councils of soldiers, peasants and workers, and ‘the Bolsheviks’ became the first communist government in the world.

[As an aside, communism differs only slightly from socialism. Socialism advocates control of factors of production by a democratically elected government, whereas communism, by a strong central authority. In that sense, communism is a rigid form of socialism.]

But this rule wasn’t a success. The 1917 revolution threw Russia into a three-year civil war, and Lenin passed economic policies as temporary measures to gain power. He nationalized all industries and ordered surplus grain from peasants for the army. Industrial and agricultural output fell, millions died of famine and poverty followed. To prevent disaster, Lenin introduced the New Economic Policy (NEP) in 1921 to create a market oriented system.

Stalin’s Rule

However, this didn’t change the communist system because the NEP was banned after Lenin’s death in 1924 and replaced by Stalin’s centralized planning. The planning committee’s blueprint would translate political objectives into required outputs. His five-year plans were focused on complete government control of the economy including seizure and consolidation of farms into large collective farms as part of industrialization drive. Resultant famine killed millions. Rebels were either sent to labour camps or killed. Stalin achieved rapid industrialization but at high human costs. The communist party was still active after he died, although his extreme practices were abolished. They then focused on cold wars with western powers engaging in costly arms race (augmenting military resources to demonstrate power).

Mikhail Ends It

Mikhail Gorbachev took over a stagnant economy as the USSR (a.k.a. Soviet Union) head in 1985. He introduced reforms aimed at: First, political openness involving eliminating information suppression and freedom to citizens. Second, economic restructuring involving reduction in government role. These radical reforms destroyed the communist economy and gave way to a market economy. USSR nations declared independence and the union was dissolved in December 1991.

What Went Wrong?

The Soviet Union was supposed to be a ‘true democracy’ and it turned into the very dictatorship which it tried to replace. How? Karl Marx’s theories inspired communist movements including the Russian Revolution. His works introduced socialism as a natural result of the conflicts inherent in the capitalist system, and envisioned workingmen as the new ruling class.

But I’m sure he wouldn’t have approved of more than 20 million casualties under Stalin’s rule, where silencing opposition became the most convenient way to the end goal of a ‘worker’s nation’. But the goal seemed to shift from worker’s triumph to world dominance. At all costs.

One problem with socialism is coordination of economic activities. The central planning authority will have to make millions of decisions to produce and distribute an enormous amount of products. It can become unmanageable and chaotic. Although the ancient civilizations had similarities to the extent of a ruler calling the shots, it worked because conformity was high. But as importance to self-interest grew in millenniums that followed, command economies became less feasible. But in a market economy, the very self-interest of consumers and producers drives activity. Prices too are determined by the market. This frees the government of a lot of burden to now focus on its fundamental functions in an economy- regulatory function and maintaining order.

The Solution

We’ve seen shortcomings of capitalist and socialist systems in extremes. So present day economic systems have found balance by blending features of each other. Hence we have variants of a Mixed Economy.

Capitalist Turned Mixed Economies

Typically, such systems operate through broadly three institutions. First, the private sector. Private ownership of assets gives individuals and firms the incentive to invest in assets, be productive with its usage, gain wealth and reinvest to keep the cycle going. Free trade boosts it further. Since it could come at the cost of social and ecological harm, we have the second institution, the Government which is supposed to have different goals- to minimize externalities (harm). It achieves this through regulatory laws that penalize undesirable behaviour- through fines and imprisonment, and redistribution of wealth to people who don’t have the opportunity to contribute to wealth creation- through tax rates, subsidies, and provision of basic needs. Redistribution happens also through voluntary donations to various causes. The government also invests in public goods, from which entities generally don’t find immediate benefits of investing. And the third institution to resolve disagreements among the first two- the Judiciary.

Mixed economies have evolved into this form to organize themselves optimally, although their implementation is debatable.

The U.S., UK, European countries, and India are good examples of such systems although the level of government intervention differs. According to data, government spending as a percentage of GDP in 2018 is around 55% for European countries like France and Finland. For UK it is 40%, U.S. 38%, and India 13%.

Socialist Turned Mixed economies

Cuba was a socialist economy. The government sponsored programs in healthcare, education, housing, and food. These programs compensate for low salaries of workers, but they fell short and there was poverty. So the president introduced reforms in 2010 which allowed free trade, removed government control over small business, and encouraged self-employment. This developed a parallel economy in tourism, export and international business sector. And this would help assist social programs. Roughly 80% of the workforce are employed in the state owned enterprises, and rest in private firms. This turned Cuba into a mixed economy.

China too transitioned from a socialist to a mixed economy. This helped it transform from a poor country to the world’s second largest country by GDP today. It owes it to 5 year plans borrowed from the Soviets, through which they gradually undertook industrialization and liberalization (free trade). It is now a manufacturing giant in textile, steel, cement, machinery, transport vehicles, electronics and pharmaceuticals sectors. However, this came at the cost of heavy pollution. China has also received criticism for being opaque with regard to its affairs, propaganda and suppressing opposition. This could be an extension of its communist nature of having a tight grip on the nation’s affairs.

Conclusion

Charles Darwin suggested ‘survival of the fittest’ in his work ‘The Origin of Species’. Capitalism works on the same lines, where the fittest are the ones who develop the ability to survive. ‘Wealth’ is the ability and its ‘optimum use’ equates to survival. Historically too, we have been capitalist to the extent tribes competed against each other for food and resources. But they have been socialist within their tribe, ensuring everyone gets an equal share of the killing.

Paraphrasing Naval Ravikant from the JRE podcast: “Larger the group of people who have different interests, lesser the trust. So incentives have to be aligned better for the system to work and you go towards capitalism. The smaller the group you’re in, your house or tribe, by all means, be a socialist… That’s the right way to live a happy, integrated life.”

And this is true as to how we operate. At an individual level, I have to compete with other employees. But the firm has to ensure equity among its employees (level playing field for people working at the same level). Firms compete against each other, but the government has to maintain equity among its companies (through fair taxation policies). Governments or nations compete for power, but international institutions (World Trade Organization, World Bank, International Monetary Fund etc.) have to maintain equity among its member nations (through agreements). And who knows whether our planet needs to compete with creatures out there, with universal organizations to oversee stuff? Only time will tell.

But it is in this blend of the two systems that we have found maximum efficiency yet. And we can only strive to work this blend in the best way possible, to try closing ‘the disparity’ and achieve ‘equity in opportunity’-led-growth.

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