A Brief History of Economic Thought
Ancient Economic Thought
Although economics is a young science, there have been individuals who have put forth economic theories for centuries. Below is a brief outline of some of the more influential thought from ancient times to the present.
Students have only been able to attend economics classes for the last century or so. Yet economics has been a concept under study for thousands of years. The term economics is derived from the Greek word, oikonomos, which means household management. Greek writers such as Plato talked about economic concepts such as division of labor and specialization. But the focus of the debate was largely on self-sufficiency. During the middle ages economic activity was less organized. The Catholic Church had some impact on economics by issuing edicts that declared certain economic activity to be against Church principles. An example would be usury laws, or the forbidding of charging interest on money lent.
As nation states began to form in Europe around the year 1500, new economic ways of thinking began to emerge. The economic philosophy of mercantilism emerged. Mercantilism is a system where government policies are established to accumulate wealth in the form of gold and silver by promoting exports and discouraging imports. This led many nations to establish colonies for the purpose of exploiting the wealth of the colonized nation.
With the advent of the Enlightenment in the eighteenth century, new ways of economic thinking took place. A group of economists called physiocrats developed a theory based on natural law. This theory believed that wealth derived from natural processes such as farming, miners, and fisherman, should be pursued, but that wealth derived from manufacturing discouraged. A segment of our Founding Fathers, most notably Thomas Jefferson, were influenced by the thoughts of the physiocrats.
Classical Economic Thought
Classical economic thought begins with the publication of The Wealth of Nations by Adam Smith in 1776. In his book Adam Smith describes an economic system based on free markets with little government intervention. Adam Smith argued for the end of mercantilist policies and government monopolies. His writings still influence economists today. Thomas Malthus is another classical economist. His book, Essay on the Principles of Population, published in 1798, describes Malthus’s belief that population would increase geometrically ( 2,4,6,8), while the food supply would increase only at a mathematical rate ( 1,2,3,4). Another classical economist is David Ricardo, who was a contemporary of Thomas Malthus. His major contribution was the study of international trade and the development of the concept of “comparative advantage”.
Socialist Economic Thought
The development of socialist thought came after the development of the Industrial Revolution. It was a response to the perceived abuses occurring under capitalism. Louis Blanc, a French socialist thinker, was among the first socialists. He coined the term, “from each according to his ability, and to each according to his needs.” And of course Karl Marx and Friederich Engels are the most famous socialist thinkers. Their two main works, Das Kapital and the Communist Manifesto, which were written in the mid 1800’s, are still influential today.
Twentieth Century Economic Thought
The field of economics experienced a tremendous growth during the twentieth century. Because there is enough material here for a separate course I will only provide a capsulized account. Many early 20th century economists questioned laissez faire capitalism. The Great Depression, urbanization, and other cultural factors provided economists with new viewpoints. The most famous, and most influential, was John Maynard Keynes. His book, The General Theory of Employment, Interest, and Money, which came out in 1936, influenced many governments. It called for a more active role of government involvement in managing employment, output, and prices.
The Economic Role of Government
There is a great deal of controversy in our society about the proper role of government in our economy. Some believe the government needs to play an active role in the economy to correct some of the deficiencies of capitalism. Others believe the government plays too active a role and prevents the market from functioning efficiently. Economists themselves are divided on this issue. The question of what is the economic role of government will be explored in greater detail below.
In the United States, our government over the last century has played an increasingly important role in our economy. In describing the role of our government I will attempt to use positive economic statements and not normative ones, to describe the role of government in the economy. In other words, I will focus on what is, not what should be. In the United States, local, state, and federal units of government have collected taxes, provided services, and issued regulations which have had a profound impact on our economy.
History is quite helpful in understanding our government’s involvement in the economy. In 1776 when Adam Smith wrote his influential book, The Wealth of Nations, many economic and political thinkers around the world believed in a limited government role in the economy. The French coined the term, “laissez faire” to emphasize their belief that the government should leave things alone with respect to the economy.
For much of the United States history, the government did play a limited role. But with the Industrialization process of the late 1800’s and the Great Depression of the 1930’s, our government began to play a more active role in the economy. Today our government’s role is such that it influences the three main economic questions of what? how? and for whom?
Various Roles of the Government in the American Economy
This list below explains when the government becomes involved in the economy. It is a list of positive economic statements (the what is), not a list of normative economic statements (the what should be).
1. To safeguard the market place. Here the government intervenes in the market place to protect against the formation of monopolies. Our federal government has a branch devoted to anti-trust laws. Recently, the Bridgestone Corporation was convicted of conspiring to fix prices on automotive parts.
2. Provide Public Goods and Services. The cost of public goods is often beyond the ability of one individual to pay. Therefore, the government taxes community members collectively to pay for public goods such as street lights, roads, disease control, and national defense.
3. Protect Against Harmful Externalities. Sometimes the cost of something harmful is too much for individuals to pay. Once again the government will tax the community collectively. An example would be pollution. The cost of cleaning up pollution is distributed amongst the community, and everyone enjoys the benefit, even if they didn’t pay.
4. Assist Those in Need. Sometimes unfortunate and unplanned situations occur to members of a community. The government has helped a number of individuals or groups that suffer under unfortunate circumstances. Those who are poor, handicapped, elderly, or the victim of a natural disaster often receive government assistance.
5. Programs to Help Special Groups. Our society has over its history deemed that certain groups need special help. Our government offers patent and copyright protection to inventors, farm subsidies to farmers, and labor legislation for workers. Can you think of any others?
6. To Stabilize the Economy. If our economy is performing poorly, our government will intervene with programs designed to promote growth and minimize unemployment. President Bush enacted tax cuts during his presidency to stimulate the economy, while President Obama recently passed an economic stimulus package with the hope of jump starting the American economy.
7. Protective function. The government should protect individuals and their property from acts of aggression, such as force, fraud, and coercion. It helps to establish and maintain the rule of law, as well as to enforce private property claims and contracts. Our government plays the role of a referee or umpire to enforce rules, settle disputes, and penalize those who violate the rules. The market economy needs an underlying framework of laws, private property, contracts, and the “rule of law”, so that true voluntary exchange in the marketplace can occur.
Basic Economic Systems
An economic system is the way a society is organized to determine what goods and services are to be produced, how they are to be produced, and for whom they are produced. Many factors of a societies culture, such as laws, ethics, forms of government, and religion, influence the decision-making process of an economic system. Economic systems can be classified into four major types, which are discussed in more detail below.
The first type of economic system is called a traditional economy. In this system , the who, what, and how questions are answered by tradition. People in this type of system learn necessary skills from the previous generation. The reliance on tradition comes into conflict with the economic goals of efficiency and growth. It is also important to note that traditional economies support social injustices such as poverty and discrimination. As the world becomes more interdependent, there are fewer examples of traditional systems. Traditional economies don’t work well in a modern society. Modern economies need specialization and a division of labor. However, there are still examples to be found. Tribes of the Amazon rain forest and the Amish culture of the United States are examples of traditional economies.
The second type of economic system is the command economy. In a command economy, the central government makes the who, what and how decisions. These decisions are made by a small group of people and carried out by a large bureaucracy. Command economies have no mechanism for self-correction. Those in power use force to cover up mistakes and bad choices. The government owns all productive resources. Workers are assigned jobs and wages are set by the government. Because profit is not the motive of producers in a command economy, quality and variety of goods suffer. This type of economic system also does not handle the free flow of information well, which is vital to increasing productivity and economic growth. Examples of command economies are the former Soviet Union, Cuba, and North Korea.
The third type of economic system is the market economy. In a market economy, the who, what, and how much should be produced decisions are determined by market prices. Prices are determined by the interaction of the forces of supply and demand. A market economy seems to answer the who, what, and how questions more effectively. Examples of pure market economies are hard to find.
The fourth type of economic system is the mixed economy. In a mixed economy, the who, what, and how questions are answered through a mixture of traditional, command, and market economies. Most countries operate under a mixed economy. Think of the United States. We have aspects of a market economy in that there is competition between buyers and sellers, but citizens are also taxed to pay for things like national defense and social security.
Every society needs to choose an economic system that will answer the questions of what to produce, how much to produce, and for whom to produce questions. We have already learned that in a market economy these decisions are made by the forces of supply and demand. But it would be helpful to see how this system developed and how it is practiced. The information below should provide a better understanding of capitalism.
The first place to start with understanding capitalism is Adam Smith. Adam Smith is considered the father of modern economics or the father of capitalism. His book, The Wealth of Nations, published in 1776, described the beginnings of the free enterprise system. He noticed that the questions of what to produce and how much to produce were answered by the “Invisible Hand” of the market. Producers and consumers interacted to make decisions on price and production. At the time of his writing, the Western world was first moving towards industrial production. Adam Smith noticed that the division of labor used in the modern factories allowed for increased production. There are a few assumptions underlying Adam Smith’s economic philosophy. The first is that he declared people are selfish. In other words, people desire things for themselves. The second assumption, is that individuals are the best judge of their own interests. They don’t need other people or a government to tell them what they should buy and own. If individuals pursue their own interests, they will increase their wealth. If all individuals are allowed to pursue their own interests and increase their wealth, then the sum wealth of individuals becomes the wealth of a nation.
Adam Smith thought of himself as a philosopher, not as an economist. He was concerned about the impact of an unrestrained capitalism and government corruption on our moral compass. “This disposition to admire, and almost to worship, the rich and the powerful, and to despise, or, at least, to neglect persons of poor and mean condition (is)…the great and most universal cause of the corruption of our moral sentiments.”
How does one know when they are in a capitalist economy? There are certain features and institutions that need to be present in order to be considered a capitalist economy. These features are:
1) Private property. Individuals need to be able to own their own productive resources. Laws are created to define who owns property and what they can do, but essentially you can do what want with your property so long as it is legal. Property rights are essential for individuals and businesses to manage a business and plan for the future. For example, one of the problems of Russia today as well as other former communist countries is that they do not have a legal system establishing property rights. Thus it becomes very difficult to do business in these countries because you do not know who really owns things.
2) Freedom of Choice. Individuals need the freedom to decide what fields of employment to enter, what markets to invest their money in, etc..
3) Competition. In order for the market to work properly capitalism requires competition. This is the reason we assumed a large number of buyers and sellers so that no one buyer or seller can influence price and quantity. Competition allows for a more efficient use of capital and resources. It also encourages production and innovation of goods and services.
4) Large number of buyers and sellers. There needs to be a large enough population so that individuals can pursue their self-interests and provide a variety of goods and services to trade.
5) Freedom to enter or exit the market at will. If someone wants to produce a good, there should not be barriers to entry. Freedom of entry and exit does not mean it is cheap to enter an industry. It just means that it is not prohibitively expensive to do so.
6) Market system. The ability for consumers and producers to interact and make decisions on price and production.
7) Limited Government. Too much government involvement makes the features listed above difficult to function properly.
In addition to the features listed above, modern capitalist countries have other features. Capitalist countries today rely on the extensive use of capital goods in the production of their products. They also rely heavily on specialization in the production of goods and services. Finally, they also rely heavily on fluid money- checks and credit cards being examples.
Development of Capitalism
Modern capitalism gets its start in England. Wealth was no longer used solely as a display. It was used to create more wealth. Furthermore, the Enclosure Movement, which produced mass unemployment for small landowners, created the first surplus labor pool for the factories that were sprouting up throughout England.
It is important to note the importance of technology in the development of capitalism. For a long time before Adam Smith, the development of technology slumbered. There was no incentive for change, and there were social forces, such as the Catholic Church, which restricted it. Finally, after a number of inventors began bringing there inventions to the market, technology began to have an impact on the new market economies. What effect did this technology have? It increased output, contributed to the rise in the standard of living for most people, increased the size of machines ( which helped increase efficiency) and increased the size of businesses ( in terms of the number of employees). This increase of technology led to the historical movement known as the Industrial Revolution. The Industrial Revolution has had four major stages throughout history. The first stage occurred during the late 18th century. Here we see advances in weaving, iron, and steam. The second stage came during the mid 19th century. Here we see the development of railroads, steamships, steel, and agricultural equipment. The third stage occurred in the early 20th century. It is at this time that the airplane, automobile, and electricity came into wide use. The last stage is the modern era, with the development of nuclear power, computers, and biotechnology.
Criticisms of Capitalism
There are a number of general criticisms of capitalism. They are described below.
1. Capitalism tends to create an unequal distribution of income. This criticism has received a great deal of attention over the last few years (Occupy Wall Street Movement). Private ownership of capital allows for wealth to be concentrated in the hands of a few individuals or firms. In other words, a small percentage at the top begin to own more wealth, as opposed to the masses who own less of the wealth.
2. A second criticism of capitalism is that it has a value system that prizes capital accumulation in the short-term, while de-valuing everything else in the present and in the future. This criticism can be understood through the phrase, “Profits over people”. The pursuit of profit in the short run means ignoring the needs of people, the environment and the future.
3. Finally, pure capitalism also does not do enough to protect the environment. There is an economic incentive (profits) to avoid spending money on protecting the environment. There is also an assumption by many capitalists that future generations will be wealthier and therefore it will be cheaper for our descendants to clean up our messes than it would be for us. Such a mentality is exemplified by Lawrence Summers’ infamous memo written when he was chief economist for the World Bank, in which he wrote: “I think the economic logic behind dumping a load of toxic waste in the lowest wage country is impeccable and we should face up to that…The costs of pollution are likely to be non-linear as the initial increments of pollution probably have very low cost. I’ve always thought that under-populated countries in Africa are vastly UNDER polluted.”
What do you think? Do you think these criticisms are accurate? Some of the problems associated with modern capitalism will be addressed in upcoming units, such as inequality in unit 6, deregulation in unit 7, the business cycle in unit 8, and the financialization of the market in unit 11.
Capitalism and the World Financial Crisis of 2008
The current economic crisis facing the world has caused many academics and lay persons alike to question the tenants of capitalism. One major criticism is that capitalism creates the formation of speculative bubbles. A crises of speculation always runs the same course: a particular asset (whether stocks or homes) continuously increases in its estimated value, which further stimulates demand for this asset, because everyone wants to share in the seemingly unstoppable rise in value. People use their own wealth, and ultimately take out loans, in order to acquire the object of speculation. Prices climb even higher on the basis of increased demand, which leads to a further increase in demand. But at some point the rise is exhausted. It becomes more difficult to find new buyers, and initial investors want to sell in order to realize their profit. The price of the object of speculation falls. Now everybody wants to get out of the market in order to avoid losses, which leads however to a further fall in the price of the object of speculation. Many who started speculating late in the game and bought at a high price now incur high losses. Since these losses are combined with a general slump in demand, such a speculative crisis can have effects on the entire economy. For a more detailed explanation of speculative bubbles please click on the link below.
Another criticism of modern capitalism is that individualism has been raised to an almost religious status. Success justifies greed, and greed justifies indifference to fellow human beings. In the modern capitalist age we are told relentlessly to compete, that people break the rules to gain an advantage, sabotaging others if necessary. This occurs, while masquerading as fair competition.
The growth of the financial sector relative to GDP is also a concern for critics. Finance is America’s leading industry at about 24% of GDP. Manufacturing has shrunk to 12%. Those with power on Wall Street grew so rich they were able to buy or manipulate most politicians and government regulators.
The current crisis in capitalism has led to new terms entering our lexicon to distinguish our changing attitudes. Phrases like “crony capitalism” and “casino capitalism” show up regularly in published articles. Many critics of modern capitalism believe that the bankers, brokers, traders and credit rating agencies responsible for the greatest fraud in U.S. history, the subprime and Alt-A mortgage scams, should be behind bars.
Capitalism and Its Morphing Into Neoliberalism
Neoliberalism describes an economic doctrine that favors privatization, deregulation, and unfettered free markets over public institutions and government. The Neoliberalism doctrine holds that generating income through real estate and natural resource speculation, lending at interest, financial trading and betting (and asset-price gains) is as helpful to the economy as tangible capital investment in the means of production such as new factories, roads, and new capital equipment.
The idea of a “free market” from the Physiocrats and Adam Smith down through John Stuart Mill and the 19th century socialists was to free industrial capitalism from the rentier class. The rentiers are the financial class, landowners and natural resource owners at the top of the economic pyramid ownership of “tollbooths”: land, mineral rights, or basic monopolies and banks with the public privilege to create money. It is to these rentiers that the bottom 90% are indebted and must pay interest, rent, user fees and other access charges.
Supporters of neoliberalism defending this state of affairs turn the classical idea of free markets upside down. Their idea of “free” markets is one free from government price regulation, taxes on land rent, monopoly rent, financial interest and other categories of what the classical economists called “unearned income.” 1
There are two popular accounts of how this philosophy of free markets and minimal government came to determine the economic policies of many Western countries such as the United States and Great Britain. For the right, including the supporters of Milton Friedman, the failures of both state socialism and the Keynesian welfare state made the political triumph of neoliberal ideas inevitable. For the left, neoliberal policies were the expression of the interests of capital, which has systematically infiltrated government in order to reverse postwar regulations.
Neoliberalism is part of a broader economic and political project of restoring class power and consolidating the rapid concentration of capital, particularly financial capital. As an ideology, it casts all dimensions of life in terms of market rationality, construes profit-making as the arbiter and essence of democracy, consuming as the only operable form of citizenship, and upholds the irrational belief that the market can both solve all problems and serve as a model for structuring all social relations. As a policy and political project, it is wedded to the privatization of public services, the dismantling of the connection of private issues and public problems, the selling off of state functions, liberalization of trade in goods and capital investment, the eradication of government regulation of financial institutions and corporations, and the destruction of the welfare state and unions.2
Currently, neoliberal economic policies have dominated the world economic system. Many economists and social scientists have blamed neoliberal policies for the economic crisis that plagues the world.
Socialism and Communism
Socialism and communism mean different things to different people. During the last century, our world has had countries with a socialist economy where a fair amount of freedom exists (Sweden), and countries where there was very little freedom (the former Soviet Union). Socialism means many different things to many different people. In Europe socialism is seen in a positive light, while in the United States socialism is seen as a pejorative. The information below should help the student to understand the major precepts of socialism, as well as to distinguish it from communism.
The first place to start with understanding socialism is Karl Marx. Although he is not the inventor of socialism, his ideas contributed greatly to its spread. Marx looked at history and said that there has always been a struggle for scarce resources between groups in society. Marx noticed that in European society of the 19th century, there were two groups: the bourgeoisie (owners of capital) and the proletariat (the workers). The bourgeoisie were able to exploit the proletariat because they controlled almost all the means of production.
Marx put a heavy emphasis on the importance of labor in the production of a good. According to Marx, the owners of a business were able to make a huge profit off the workers by keeping the “surplus value” of the product. Marx defined profit as surplus value, the difference between the price of a good or service and the labor cost of producing it. Marx believed that this surplus value was unjust and contributed to the exploitation of the worker. Marx believed that because of the concept of surplus value, “labor” was the most important factor of production.
Marx’s Theory on Capitalist Crisis and Revolution.
Marx believed that as workers increased their production, it would lead to a decrease in wages because there would be no money to buy the surplus. This would force workers to be laid off. As more and more workers would be laid off, it would lead to a depression, which eventually would lead to a revolution. Marx predicted that the market system would destroy itself because wealthy owners’ greed for profits would lead them to exploit workers by paying starvation wages.
Marx believed that capitalists as a class would eventually own all private property. There would then be a violent overthrow by the proletariat. After the revolution, Marx thought the world economic system would evolve in stages, moving from capitalism to socialism and ending with communism. Communism would be a classless society, with no room for a government ( the state).
Marx was a student of capitalism and had some criticisms of its effectiveness as an economic system. He had three main criticisms of capitalism: 1) that it offered no security to workers, 2) that it is unstable ( business cycle) and 3) that bigger businesses would gobble up smaller businesses, leading to a high concentration of wealth. Were his criticisms accurate?
Marx did have shortcomings in his observations of capitalism. First, and most important, capitalism has not failed. Marx predicted its demise, and yet as we move into the 21st century it seems to be thriving. Marx also failed to notice the importance of labor unions. Their activity over the last century has improved working conditions for many workers. Workers’ skills can be used in bargaining. Workers with skills in high demand have a lot of leverage in negotiating wages and benefits with employers today. Marx predicted profit rates would decline, but in capitalist countries they have remained relatively stable.
Definition of Socialism
Now that we have moved past the history of socialism, it would now be appropriate to define it. Socialism is an economic system in which the people (government) own and operate the principle means of production. This means things such as communications, railroads, steel, oil, and so on. Under socialism there is room for business owners, since all but the largest businesses are privately owned. This description refers to how socialism has been practiced in countries in Europe.
What are the major characteristics of socialism? They are: 1) Central or group planning and decision making, 2) Equality of condition, and 3) Group or collective ownership. Socialism tends to believe that production for profit leads to both the oppression of workers by producers and the exploitation of consumers in the marketplace. Under socialism, everyone in society pays for a benefit (through taxes) and everyone enjoys the benefit. An example of socialism in the United States would be our highway system. Supporters of socialism would say that socialism is superior to capitalism in achieving an equitable distribution of income. This is because government ownership of capital and other resources prevents a few individuals or groups from acquiring a disproportionate share of the nation’s wealth.
Socialism as a system rejects the capitalist emphasis on the profit motive and private ownership of property and the accumulation of wealth. It is also distrustful of individual freedom that interferes with the protection of the rights of all members of society. Socialism supports common ownership, group decision making, elimination of the profit motive, and the emphasizing of cooperation over competition. Under socialism, the government (by elections of voters/workers) make decisions to increase the national income without interfering in the individuals’s freedom to choose an occupation.
Socialists assert that wealthy people who own the means of production are able to exploit workers in order to make more money and become even richer, thereby increasing their power over the workers. By eliminating private ownership of factories and companies, socialists believe, the workers can be paid more. With more of the wealth going to workers, society becomes more equal. As a country transitions form capitalism to socialism, there should be more ownership of the means of production by the people, and less by private individuals. This does not mean that individuals can not own private property such as clothes, electronic appliances or cell phones. Just that the large businesses are collectively owned.
Definition of Communism
Communism is an economic system in which all the means of production are government controlled. Marx believed communism to be the ideal system, which evolve in stages from capitalism through socialism. Communism is a stateless, classless economic system in which all the factors of production are owned by the workers. True communism has never existed. No government has been able to completely rid itself of market activity. The former Soviet Union was theoretically not a communist state. It was a totalitarian economic state (state socialism) with an elite class (communist party officials) getting greater privileges than other people. No government can ever claim to have established a communist system, since the very existence of that government shows that the system is not communist. The term “communist state’ is an oxymoron. With the exception of countries such as North Korea and Cuba, centrally planned or communist countries no longer exist.
Economic Activity Under Communism
Historically, when communist regimes assumed power they began a process of converting a market economy into a government controlled economy. Under communism, no private property exists to encourage self-interest. Many private businesses would be taken over by the government in a process called nationalization. Economic decisions about what to produce, and how to produce are now being made by a government bureaucracy. Production of most goods take place at state enterprises. Virtually all workers become employees of the state. In agriculture, almost all private property was abolished and farmers put to work on collectivized farms, where the government owned the land, the equipment, and the livestock.
A brief examination of the former Soviet Union would be helpful to understand how communism operated. When the Communists took over power following the Russian Revolution, they established the Gosplan. Gosplan was the central planning agency of the Soviet Union. By 1928, Gosplan was issuing five year plans. Five year plans were a government document that set production goals for the entire Soviet economy for five years. To meet the goals of the five year plans, the state enterprises and collective farms mentioned above were given production targets. Production targets were goals set in the production of specific goods and services. For example, a production target would be set for the number of shoes to be produced in one year. Managers of the state owned businesses were rewarded for meeting the quotas established by Gosplan. If they failed to meet these quotas bad things could happen, such as a trip to Siberia. Just as Gosplan set quotas on how much to produce, it also established prices. Managers of firms did not have the ability to raise or lower prices. Prices for some consumer goods were set below the market price, which often times created shortages. Managers of state enterprises had no incentive to introduce technological changes. Such changes would require risky start-up delays, which could lead to not meeting quotas, which meant trouble for the managers. One of the main reasons the Soviet Union was not able to keep up with the West , was because of this inability to incorporate new technologies into the production process.
Differences Between Socialism and Communism
Socialism and communism are not the same. As you can see in the definitions, socialism wants to control the major means of production, communism wants to control all production. Socialism is more concerned with overcoming the defects of capitalism ( lack of planning, conserve resources, balance growth). Communism is more ideological. It has a distrust of private ownership. Communists believe that the concentration of private property and wealth into just a few hands means that the mass of workers will be exploited. For them, an economy with little or no ownership of private property is the only way to ensure equality. Socialism is the broader category, and communism is a sub category of socialism. This means that all communists are socialists, but not all socialists are communists. This is a distinction that most Americans don’t seem to understand. Many socialists are strongly opposed to communism.
Socialist Economies in Transition
As we enter the twenty-first century, the battle between market economies and command economies seems to be over, with the market economies having won. Since the early 1990’s, former command economies have attempted to switch to market economies. The question for economists, is, how does a country change from a command economy to a market economy? Countries such as Russia and Poland are finding the road difficult, because there is no blueprint or plan on how to do it. Former command economies have used two approaches to make this transition. They are discussed below.
1. Shock Therapy. This approach refers to the abrupt or quick transition from a command economy to a market economy. The idea is to institute reform while the public support for reform is high. This was the approach used in Poland. Shock therapy allows for reform to occur at many levels simultaneously, such as privatizing state enterprises to lifting price controls.
2. Gradualism. Under this approach, reforms are slowly phased in. Supporters of this approach say there needs to be time to absorb changes such as legal reform, property rights, and tax collection. This is the type of approach used in China.
Regardless of which approach is used, countries making the transition from command economies to market economies face a number of problems. These problems are briefly outlined below.
1. Property Rights. As you recall from our discussion above, the right to own private property is essential in a market or capitalistic economy. When the government owns everything, how does one go upon deciding which citizens get to own what? A legal system with the power to enforce property and contract law needs to be established. In the turmoil of change, there may be different parties contending for the same property rights. Criminal elements emerge, as they have in Russia, which extort money for protection.
2. Banking. Banks in former command economies did little more than hold on to savings for individuals. Banks in market economies provide many more services, such as checking accounts, advancing loans to businesses and individuals, and providing investment strategies. Banks in these new transitional economies need to learn new skills, such as determining low risk versus high risk loans.
3. Inflation. Under command economies, the government set prices. One of the first steps in transitioning a command economy to a market economy is to free prices to the market. Prices typically surge upward in the early stages of transition. Prices in Poland increased over 400 percent in the first few months following the transition.
Below are a list of books that exhibit economic concepts learned in this unit.
Parkin, Michael 2000 Economics (5th Edition) New York: Addison- Wesley
Slavin, Stephen L. 1999 Economics (5th Edition) New York: Irwin McGraw-Hill
Taylor, John B.
2001 Economics. Boston: Houghton Mifflin Company
2000 Economics (2nd Edition) New York: Worth Publishers
Tucker, Irvin B. 1995 Survey of Economics New York: West Publishing Company
1 Michael Hudson: How Neoliberal Tax and Financial Policy Impoverishes Russia – Needlessly, November 23, 2012
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