10

14-

CHAPTER 14

OTHER ECONOMIC SYSTEMS

Overview

As you read this chapter, look for answers to the following questions:

• How does socialism differ from capitalism?

• How did socialism develop and what are some of key differences in modern socialist economic

systems?

• How are the world's two most successful capitalist economies, Japan and the United States,

similar? How are they different?

• What are the special problems faced by the less-developed countries?

• How are the less-developed countries seeking to solve their problems?

Early in this course you learned that all countries face the problem of scarcity. Consequently, each nation develops an economic system to answer fun­damental economic questions:

• What goods and services are to be produced?

• How will the goods and services be produced?

• Who will receive the goods and services produced?

You have spent most of your time learning about the economic system of the United States and the ways it allocates its resources to answer the What, How, and Who questions. But American free enterprise is not the only economic system. While more and more nations are shifting to capitalist market economies, many continue to follow the principles of socialism.

14.1. Socialism

In a capitalist or free enterprise economy, proper­ty is privately owned, businesses compete to earn profits, and resources are allocated according to the laws of supply and demand. In socialist economies the principal means of production are owned by the state, and resources are allocated according to a plan intended, in theory, to meet the economic needs of most people. How much property the state owns and how much it plans to allocate resources varies enor­mously from one socialist country to another.

Socialism began in Europe during the 19th century. Working conditions in the factories of those times were very poor. Men, women, and children worked long hours for low wages in dangerous conditions. For one group of thinkers, who came to be known as Utopian socialists, the solution to these problems was to create small, ideal communities, or Utopias. Factories would be owned by the workers and profits shared by all.

Although several Utopian communities were estab­lished in both Europe and the United States, almost all failed. However, many socialist ideas were later incorporated into child labor laws and other laws designed to protect the health and safety of the fac­tory worker.

Today many socialist nations are as democratic as the United States, but their governments own and operate many, but not all, of the major industries. Such economic systems are often referred to as democratic socialism. At the other extreme are nations with communist governments in which almost all of the nation's resources are government-owned, and production is strictly managed according to a government-prepared plan. Communism is the form of socialism based on the writings of Karl Marx, and until recently, practiced in the former Soviet Union, China, Albania, and other countries. The following pages provide examples of three very different socialist economies: the Soviet Union, Hungary, and Sweden.

14.2. Communism in the u.S.S.R.

In 1917, a series of revolutions in Russia led to the overthrow of the Czar (emperor), and the establish­ment of a communist state. With its new name, the Union of Soviet Socialist Republics (or USSR), Russia and its neighboring republics became the first nation in history to formally apply the theories of Karl Marx to its political and economic system.

Following World War II, the Eastern European nations of Poland, Hungary, Romania, Bulgaria, Czechoslovakia, and East Germany fell under the influence of the Soviet Union and adopted commu­nist economic systems. Yet by the time 1991 drew to a close, all of these nations had announced their intention to replace communism with capitalism. As for the Soviet Union, the world's largest communist

empire had disintegrated.

What had been the Soviet Union was replaced by a loose association of republics that had once been part of the USSR. These newly independent states (NIS) include Armenia, Azerbaijan, Byelarus, Estonia, Georgia, Kazakhstan, Kyrgyzstan, Latvia, Lithuania, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan. Although some of these have formed a political alliance called the Commonwealth of Independent States (CIS), they all still have close economic ties. And, the CIS nations have announced their intention of adopting economic systems similar to those of the West.

The sudden collapse of communism in the Soviet Union and other Eastern European nations came as a shock to most Americans. Since the 1950s the Central Intelligence Agency (CIA) in the U.S. and other government sources had reported that the rate of economic growth in the USSR exceeded that of the U.S. Indeed, by the 1980s, the CIA considered the Soviet Union's economy larger than Japan's and sec­ond only to the U.S. In fact, as the world was to learn, the Soviet economy was not the major indus­trial power it seemed.

The communist economies had failed to raise, or even to maintain, living standards comparable to other industrial nations. For example, in 1990 when per capita income in the industrialized countries was $17,470, it was only $1,860 in Poland. In the Soviet Union, striking coal miners were demanding soap, toilet paper, and sugar in addition to improved working conditions. Economic difficulties in the USSR and the other Eastern European nations were shown in newspaper and TV accounts of stores with empty shelves on the inside and lengthening lines of consumers on the outside.

How did the Soviet economy function, and what led to its collapse? The answers lay in how the Soviet Union used the two key features of socialism: gov­ernment ownership of the means of production and central economic planning.

Government Ownership. Government ownership of the means of production was a fundamental eco­nomic principle in the Constitution of the Soviet Union:

"State ownership is the foundation of the USSR's economic system.... The land, its mineral wealth, the waters, and the forests, the principal means of

production in industry, construction and agriculture, transport and communication, as well as other property necessary to carry out the state's tasks, belong to the state."

Although the Soviet Constitution gave individuals the right to own homes, personal property, and some types of small businesses, in reality few were in business for themselves. The government owned and controlled most production.

Central Economic Planning. Decisions about What goods and services to produce in the Soviet Union were made by various government agencies. So were the decisions affecting How to produce those goods and Who would receive them.

The Soviet government was controlled by the Communist Party and the Politburo. The Politburo was the governing agency of the Party. The Com­munist Party set overall economic policy and turned it over to the Gosplan, the Soviet's state planning commission, to carry out.

Gosplan collected data from all over the country. It used the information to prepare a detailed plan to achieve the nation's economic goals. Most frequently, the plans were prepared to cover a five-year period and were called Five-Year Plans.

The Five-Year Plans set broad economic goals. For example, they may have specified how much an increase there would be in the production of con­sumer goods, capital goods, and investment. Other parts of the plan may have listed output goals in cer­tain major industries such as agriculture, home appliances, and clothing.

But Five-Year Plans did not specify all the details. Annual Plans spelled out in great detail how the yearly production goals were to be reached. They allocated the raw materials, workers, power, and other resources that would be needed by the nation's factories, farms, and mines to achieve their goals.

Once the planning process had been completed, indi­vidual factories and business firms were given their assignments. Factory managers were told what they were expected to produce and the resources that would be available to them to achieve their goals.

Critics of this system have cited these shortcomings.

• The Soviet planning system was less efficient than a market. Unlike a market system, the Soviet system aimed at meeting government goals, not consumer demands. The planners decided the kinds and quantities of products to make.

• The Soviet system discouraged risk-taking and innovation. The main goal of factory managers was to fill their production quotas. They had little or no incentive to develop new and better prod­ucts and services or to anticipate consumers' future demands. Nor did they have strong incen­tives to develop new methods of production. Those who did risked failure to meet their quotas. On the other hand, if creative managers increased their output, next year's quota could increase.

Soviet agriculture also suffered. Before the Revolution, Russia was the world's largest exporter of grain. But due, in part, to central planning, it became the world's largest grain importer.

Among other mistakes, central planners failed to provide Soviet agriculture with adequate storage facilities for crops awaiting shipment and with roads to carry those crops. As a result, about 25 percent of Russian crops never found their way to food storage and processing centers.

Another problem was the role of prices under central planning. Since Soviet policy was to keep the cost of food sold in government-owned stores low, they sub­sidized (gave financial aid to) the food industry. The government sold imported meat and bread made with imported grain for less than their costs of pro­duction.

It became cheaper to buy a loaf of bread than to grow the grain necessary to make it. Some farmers found it more profitable to buy bread in the govern­ment-owned shops and feed it to their animals than to feed their animals the grain they had grown.

The result of these distortions was a serious short­age of grain and meat. Food rationing was imposed in several large cities.

Because the Soviet government set the prices low, quantities demanded often outran the available sup­ply of a product. This led to long lines at stores. Shoppers waited for hours at a time, hoping to reach the sales counter before an item sold out. In the United States there are also periodic shortages of food and merchandise. When this happens, prices increase, buyers look for substitutes, and sellers try to increase supply.

Other Problems. In addition to these basic struc­tural problems, the Soviet Union faced other economic problems. In the 1970s the Organization of Petroleum Exporting Countries (OPEC) sharply increased the world price of oil. Compared with most Western nations, the Soviet Union had vast supplies of petroleum. The Soviet government saw this as an opportunity to exchange its oil for Western technolo­gy, food, and other consumer products.

With oil prices skyrocketing from about $5 a barrel in 1970 to $40 in 1980, the Soviets reaped huge prof­its. The government covered food shortages at home by importing millions of tons of grain. It also opened its doors to Western clothing, electronics, and other products.

All went well for the USSR until the 1980s when oil prices began to decline. In 1986 disaster struck as oil reached a low of $10 a barrel, just as Soviet pro­duction sharply declined.

With the government unable to cover its shortages and unwilling to raise prices, consumer demand out­paced supply. This led to longer and longer lines at government stores and a growing black market—an illegal market where goods are sold for more than the legal price. In other words, despite price con­trols, the Soviet Union was in the midst of severe inflation and much unrest.

Glasnost and Perestroika: Gorbachev's Reforms. In 1985 Mikhail Gorbachev became General Secretary of the Communist party and the leader of the Soviet Union. Gorbachev startled the world by admitting the USSR's economic problems. He announced a series of reforms in 1987 built on the principles of glasnost, "openness," and perestroi­ka, "restructuring." They included:

• Business reforms to make Soviet enterprises pay their own way. Farms, factories, stores, and other state-owned units had to turn a profit. Those that did not could be declared bankrupt and closed.

• Price reforms to allow prices to be negotiated between buyers and sellers. In the past, all prices had been set by the government.

• Reforms to reduce or eliminate the involvement of government agencies in day-to-day operations of economic enterprises.

• Legalization of private enterprise.

Perestroika was a major breakthrough. It openly rec­ognized the structural problems of the Soviet econo­my. But while perestroika moved the economy away from central planning, it didn't create a market sys­tem.

Creating a market economy is a complex process. It requires widespread ownership of private property, enterprises free from government control, a system of law, and a stable currency. Yet perestroika did not transfer most state ownership to private individuals. Nor did it free state enterprises from government subsidy or create a sound currency.

The Soviet Union Collapses. Central planning had withered, but a market system had not taken its place. In August 1991 Communists opposed to Gorbachev's reforms overthrew him. But their revolt quickly collapsed, resulting in the disintegration of the Soviet Union. Its republics began declaring inde­pendence. The largest republic, Russia, was headed by President Boris Yeltsin. He announced his inten­tion to replace communism with an economic and political system similar to those in Western democ­racies.

Yeltsin's leadership reduced government control of prices, turned over many state enterprises to private owners, introduced land ownership to farmers, and reduced inflation. (Inflation had skyrocketed as the government financed huge budget deficits by print­ing rubles.) Yeltsin's government cut deficit spend­ing and reduced monthly inflation from 30 percent at the beginning of 1993 to 12 percent at the end of the year.

What Lies Ahead? Efforts to reduce government spending and inflation created a political backlash. Many state enterprises continued to depend on gov­ernment subsidies rather than on their ability to produce efficiently. They opposed efforts to cut gov­ernment spending because they wanted to preserve their subsidies.

Key government reformers resigned. They wanted to control budget deficits, continue to reduce inflation, and create a market system. The government, seem­ingly, was choosing to side with old-guard Communists who would spend freely and create inflation, but the fate of the Russian economy remains in question. Steps toward a market econo­my continue, but the pace of reform has slowed.