1 Performance of Economic Systems The comparative performance of the former planned economies is an important topic not only for what it says about basic performance issues, but also for what it says about decline of those systems. We will look at the performance issues by developing a performance profile of socialist and capitalist systems and taking into account, as much as possible, basic methodological issues.

2 I. Problems of Evaluation 1.Choice of criteria What criteria do we select to judge performance? –Different systems have different goals It is difficult to evaluate the overall performance of the different ES, when different ES pursue different goals and objectives. In one country econ growth may be important, in other full employment, or equal income distribution. Evaluating econ performance is not easy even if we isolate a single dominant objective, e.g. econ growth. 2. Statistical analysis a) Cannot just compare any capitalist country with any socialist country –no way to know if they are representative of all capitalist and socialist countries –something other than system is likely to be different: these other differences may be causing the differences in performance, not system b) Ideal solution is the natural experiment –random selection of large sample of countries in each of three systems with a large enough sample and truly random assignment, each sample will be identical except for system –any differences could then be attributable to system –but obviously, we cannot conduct a true experiment

3 c) Samples already exist –and they are small (the market socialism sample contains only one observation, Yugoslavia) –and they are very different in all sorts of ways other than just system How do we know that differences in performance are due to differences in system rather than other things? –This is the ceteris paribus problem 3. Ceteris paribus problem How do we account for these other differences so that we can attribute differences in performance to differences in system? The economies compared should be alike in all aspects except their ES: O = f (ES, ENV, POL) Two approaches: –compare countries that are as alike as possible in all other respects (e.g., East and West Germany, North and South Korea, India and China) –econometric approach—use regression methods to control statistically for these other effects

4 Given the difficulties of evaluating ESs, we will use the most important performance indicators: II. Measures of Performance. 1.Economic growth –a priori expectations –what the data tell us –sources of growth –costs of growth 2.Efficiency 3.Income distribution 4.Economic stability

5 III. Economic Profiles of the Sample Countries 1.Per capita GNP –market value of the sum of all goods and services produced in the economy a) Distribution very different for capitalist and socialist samples –no rich socialist countries (the richest socialist states are comparable to Italy, Spain, Greece, and Venezuela) –This is a problem (if there are differences in performance, how will we know whether the differences are due to economic system or level of per capita GNP?) –We could try comparing socialist countries to capitalist countries of comparable per capita GNP

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7 2. Level of economic development a) Socialist states at a lower level of development –lower per capita GNP –much larger agricultural sector as proportion of total output in spite of low priority of agriculture in resource allocation –much smaller service sector in part reflecting low priority of service sector 3. Economic diversity a) Capitalist countries much more diverse –note shares of industry & services in Denmark and W. Germany »22 vs 53 industry »73 vs 44 services –specialization according to comparative advantage b) Socialist countries much less diverse –not specializing according to comparative advantage –each trying to be as self-sufficient as possible –each emphasizing heavy industry and construction

8 4. Population a) Some large countries, some small in both samples –note how big China and India are –lower share of urban population in socialist countries 5. Feature of the socialist development model is: A high share of resources devoted to agriculture in recent years. Relative neglect of services. Emphasis on heavy industry. Relatively low rates of urbanization.

9 IV. Economic Growth 1.Prior expectation that planned socialism would generate more rapid growth a) state ownership of income generating resources b) high level of forced saving c) growth was a high priority of centralized allocation d) lower level of economic development It didn’t happen: sometimes socialist economies grew more rapidly, sometimes capitalist countries did, overall about equal— Figure 13.1 take out China and capitalist countries grew more socialist economies on average experienced continual slowdown starting late ‘70s

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11 2. Controlling for national income level– Table 13.2 a)Growth negatively correlated with national income –Countries with low per capita income have grown more rapidly as a group. b) Compare socialist economies with capitalist countries at similar level of national income Spain, Greece, Italy, Venezuela capitalist economies grew more rapidly for the entire postwar period; the unweighted average annual growth for the 4 countries –6% versus 4.5%, even with China included –4.25% versus 3.8% per capita c) Compare China and India similar level of income and development at beginning of socialist period in China very different culturally, however China grew more rapidly (6.9% versus 4.1% from 1960 to 1991) d) Compare China with other Asian, capitalist economies Taiwan, South Korea, Singapore more similar culturally the capitalist countries grew much more rapidly than China

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13 3. Conclusions concerning growth a) Capitalist economies grew at least as fast, on average, in spite of socialist advantages (state ownership, high level of forced savings, growth a high priority of centralized allocation, lower level of econ development) b) Controlling for level of development, capitalist economies appear to have grown more rapidly c) Socialist economies (with the exception of China) experienced significant downturn starting in late ‘70s while capitalist countries continued on trend 4. The Sources of Economic Growth a) Growth can come from having more resources with which to produce more –extensive growth (expansion of inputs) for instance, population growth leading to increase in labor but not necessarily per capita growth increase in female labor market participation rate increase in capital made possible by saving b) Growth can come from making resources more productive –intensive growth (technological progress) c) Intensive growth more desirable than extensive –extensive growth requires more work (less leisure) or more saving (less current consumption) or both –intensive growth means working more efficiently

14 5. Consumption Costs of Growth a) Consumption growth greater in capitalist economies than in socialist –4.7% versus 3.6% per annum b) Recall that output growth was similar in both systems c) Thus, cost in terms of sacrificed current consumption greater in socialist economies V. Economic efficiency 1. Dynamic -efficiency performance over time-the extent to which output expands more rapidly than inputs, the difference being the growth rate of factor productivity a) usually measured by comparing the growth of output and factor inputs – growth rate of aggregate employment – growth rate of reproducible capital – growth rate of aggregate output – growth rate of labor productivity – growth rate of capital productivity – growth rate of total factor inputs

15 w K –capital’s share of income w L –labor’s share of income The rate of growth of total factor productivity (growth of efficiency)

16 Example: GDP is growing at 11 percent per annum, labor at 2 percent per annum, and capital at 11 percent per annum. –The capital/output ratio is remaining steady the rate of growth of capital productivity is 11%-11%=0 –The rate of growth of labor productivity is positive 9% 11%-2%=9% –If labor accounts for 75 % of income and capital for 25 %, the rate of growth of total factor productivity is between the rate of growth of labor productivity and that of capital productivity, or 6.75%: Rate of growth of total factor inputs: Rate of growth of total factor productivity (growth of efficiency):

17 2. Static efficiency the effectiveness with which a system utilizes its available resources at a particular time Measure of static efficiency is how close the economy is to operating on its production possibilities frontier. VI. Data—Table 13.4 and Figure Growth of labor and capital similar in both systems 2. Productivity growth slows after 1960 in both –Slowdown worse in socialist economies –output growth in socialist economies slows by 40% –yet input growth increases –thus socialist growth becomes more extensive after In socialist economies output growth was 5.2% per annum between 1950 and 1960 while productivity growth was 3.5% 4. Thus, growth was 67% intensive (3.5/5.2) 5. After 1960, growth was only 30% intensive (0.9/3.0) 6. In capitalist countries, growth was 65% intensive (3.0/4.8) in ‘50s and 49% (1.8/3.7) afterwards. 7. Thus, growth similar in both systems during During , growth becomes more extensive in both systems 9. But growth becomes much more extensive in socialist economies than in capitalist 10. Overall, growth in socialist economies has been more extensive than capitalist growth

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20 VII. Income Distribution 1.Prior expectation is that socialist economies would have more equal distribution –socialist goal –state ownership of income-producing resources other than labor 2.Gini Coefficient : Czech 0.21Sweden, UK 0.25 early 1970’s Hungary 0.24Canada 0.34 Poland 0.24USA In general, socialist economies have more equal distributions 4. But UK and Sweden have distributions that are similar to socialist 5. Often considerable inequality in access to goods and services in socialist economies depending on one’s position in the Party hierarchy

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22 VIII. Economic Stability Note that variability of growth less for socialist economies, at least until 1980s Socialist economies tended to exhibit greater stability through most of the post-war period Prices more stable in planned economies, on average. IX. Summary 1. Socialist economies unable to achieve higher growth in spite of seeming advantages (if controlling for level of development, socialism did worse) 2. Capitalist countries appear to be more efficient (at least, their resources are much more productive) 3. Distribution of income tends to be more equal in socialist economies –(but some capitalist economies were able to achieve distributions in line with socialist economies) 4. Socialist economies more stable at least until the 1980s

23 X. Reasons for Economic Decline in the Planned Socialist Systems 1. Production function analysis –Diminishing returns to capital –Lack of technological progress 2. Problems with info and incentives 3. Complexity 4. Development –emphasized heavy industry at the expense of consumer goods. XI. Collapse of Communism 1. Gorbachev Reforms in Soviet Union (glasnost and perestroika, 1985) –greater freedom of speech and press –elections to parliaments and city councils –emigration and travel permitted 2. Fall of Berlin Wall (1989) 3. Reunification of Germany (1990) 4. Dissolution of Warsaw Pact ( ) 5. Transition in Eastern Europe to market economies