Debate Concerning Economic Systems

The Debate Concerning Economic Systems

The debate concerning economic systems includes three subdebates: the trans­formation problem debate, the transition problem debate, and the rational allocation of resources debate. Each of these played some role in the broader socialism/capitalism debate, with the third being the most important.

The Transformation Problem Debate

Neoclassical economics had given up the labor theory of value of classical economics, replacing it with a theory of value in which both demand and supply determine prices. One of the reasons the labor theory was rejected was the transformation problem—when capital intensities differed among industries, one could not derive market prices from the labor theory if one also assumed a uniform rate of profit throughout the economy. Thus, one could not transform labor values into market values.

In the first two volumes of Das Kapital, Marx avoided the transformation problem by assuming that capital intensities were the same for all industries. With that assumption, it was possible to move from labor values to market prices; without it, this was not possible. Marx promised to remove that assumption and close his theoretical system in Volume III. But when Volume III appeared in 1894 and economists looked carefully to see if Marx had solved the transformation problem, it was clear that he had not. The Austrian economist Bohm-Bawerk quickly pointed out this failure. In Karl Marx and the Close of His System, Bohm-Bawerk argued that Marx had simply accepted that market prices would not be proportional to labor values when capital intensities differed among industries. Thus he had failed to show how the labor theory of value could explain market prices. In Bohm-Bawerk's view this undermined the logical underpinnings of Marx's entire system.

That was not the view of most Marxist economists, however. They argued that Bohm-Bawerk's view of economics was too narrow. The purpose of eco­nomic theory, they asserted, was not to explain market prices but to explain social phenomena. Marxists were not concerned with relative prices, moreover, but with the breakdown of capitalism as a result of its internal contradictions. They rejected the idea that the demise of capitalism depended on whether or not the labor theory of value could explain relative prices.

The Transition Problem Debate

Capitalism did not collapse in revolution because of contradictions between the forces and relations of production as Marx had predicted. Neither did it smoothly evolve, through peaceful political means, into socialism, as evolution­ary socialists such as Sidney and Beatrice Webb had predicted. The failure of capitalism to collapse as Marx had predicted elicited much discussion among Marxists during the late 1800s and early 1900s. A number of explanations appeared for why the revolution of the proletariat and the fall of capitalism had not occurred: Lenin argued that capitalist societies, being imperialistic, were saving themselves by their exploitation of less-developed areas of the world; others argued that capitalism was modifying itself and thereby slowing the process by which the internal contradictions were undermining the system; and still others argued that the death of capitalism would have to be helped along by revolutionary actions. Since the socialist system was a better system, these last held, it was appropriate to institute it by force.

Lenin led a communist revolution in Russia in 1917 and established a new society by fiat—a revolution not of a proletariat but of an elite who called themselves the vanguard of the proletariat. Russia seemed an unlikely place for socialism to begin, since it was not highly industrialized and was in many ways feudalistic. (Many today argue that the new society established at that time in Russia had little to do with socialism.) The Austrians and others viewed this Russian revolution as another failure of Marxian analysis to predict the future. The Austrians argued more forcefully than others, moreover, that the implemen­tation of socialism by force demonstrated that socialism was incompatible with individual liberty and thus was an undesirable system. The fact that socialism was first implemented in Russia, they pointed out, showed that it was not a response to the tensions in a capitalist society but was the artificial imposition of a small, powerful elite.

The Allocation of Resources Debate

A third debate that arose was how a socialist society would allocate its resources and carry on economic activities without free markets as the lead institution in that allocation. This debate about the allocation of resources under socialism had two parts—a broad-brush debate and a technical debate. The broad-brush debate, as it has filtered down to the general public, touched on all aspects of the economic and political system. The technical debate, while much narrower in focus, has sharpened our understanding of microeconomic theory and its limitations.

Since Marx had provided no guidance as to how a socialist society might allocate scarce resources, those who were interested in this problem turned to writers other than Marx and/or formulated new ideas on this issue.

Early work on the allocation of resources problem. Marx wrote about capitalism, not about how resources would be allocated under socialism. Nor, for the most part, did socialist writers following Marx address this problem until the 1920s. Though some interesting discussipns on this issue had appeared earlier, their impact was not felt until the resource allocation problem was examined more fully in the 1920s and 1930s. Although these writings had almost no direct influence on the subsequent literature, they laid down the essential framework for the great debate that began in the 1920s on the allocation of resources in a socialist society.

In 1874 Albert Schaffle (1831-1904), a German, published a book that was translated some twenty years later as The Quintessence of Socialism. Schaffle was a nonsocialist with an affinity for the German historical school who became interested in the issues raised by socialism. He advanced two questions, which have proved to be the chief issues in the succeeding literature on the economic theory of socialism. First, what mechanism will be used to allocate scarce resources? Schaffle contended that if a socialist economy based its prices on a theory of value that did not consider use value and focused exclusively on the cost side, presumably labor cost, it could not effectively allocate resources. The second issue raised by Schaffle addressed the possibility of conflict between socialism and freedom. His position was that the advantages of socialism might be offset by loss of individual freedom. Two of Schaffle's contemporaries, Lujo Brentano (1844-1931) and Erwin Nasse (1829-1890), extended Schaffle's ideas about socialism and freedom, maintaining that socialism and planning were incompatible with freedom.

The Swedish economist Gustav Cassel (1866-1945) became interested at the turn of the century in the marginal utility idea of the Austrians. Among the concerns examined in his Outline of an Elementary Theory of Price (1899), was whether an economy not based on private property could efficiently allocate resources. He concluded that a fundamental defect of socialism is that it cannot correctly price the factors of production and, therefore, cannot correctly direct production.
Vilfredo Pareto had turned his attention to the economics of socialism in Les systemes socialistes, published in two volumes in 1902-1903. Applying his Pareto optimal welfare theory to a socialist economy, he found no reason why maximum welfare could not be achieved under socialism. A follower of Pareto, the Italian Enrico Barone (1859-1924), further explored these questions. In 1908 Barone became the first economist to systematically examine the conditions necessary to achieve an optimum allocation of resources under a socialist regime.2 Barone first showed the conditions that lead to maximum welfare under capitalism with perfectly competitive markets and then built a model in which all resources other than labor are collectively owned and a ministry of production controls the economy. He concluded that if the ministry will set prices so that they are equal to costs of production and if costs of production are at a minimum, an optimum allocation of resources exists and maximum welfare is achieved. Writing in 1947, Paul Samuelson said that "it is a tribute to his work that a third of a century after it was written there is no better statement of the problem in the English language to which the attention of students may be turned."