Socialist Economic System Definition

The Operation Of a Socialist Economy, Socialism Economic

Any economic system must decide how to approach inevitable economic choices concerning production, technology, and income distribution. This chapter will deal with theoretical models of a socialist economy and with practical problems that an actual regime would be forced to consider. These are vital issu,es that must be treated before a wide-ranging critique of so­cialism can be made.

It will be recalled that our discussion of capitalism began with an abstract idealized version in which perfect competition prevailed, in which all prices were flexible, and in which all factors of production were re­warded according to their contribution to the productive process. These conditions have never occurred fully in the real world, but the pure model of capitalism proved useful because it enabled us to see the resulting har­mony of the entire system if market prices were given full rein.

The operation of the capitalist model resulted in a set of prices and quantities for each of the product and factor markets in the system. Our goal is to establish a corresponding model for socialism. If, in the pro­cess of manipulating prices and quantities under socialism, behavior in each individual market corresponds to that under capitalism, then the abstract socialist model is equally as efficient or optimal as the theoretical model of capitalism.

Economic Models Of Socialism, Socialist Economic

Price-Directed Socialism


One of the classic disputes in the history of economics centers on the question of whether rational economic choices could conceivably result from the functioning of a socialist economy. Several possible schemes have been developed, the best known of which is often called Lange socialism in honor of its author. Imagine a socialist economy allowing consumer and occupational freedom of choice and possessing the same resource en­dowment and structure of firms as an equivalent capitalist economy. Since the capitalist model assumes the costless entry and exit of firms in any in­dustry, the socialist model does also. Instead of a free market setting prices, there is a Central Planning Board that establishes the prevailing price for each commodity and factor of production. These prices serve as guides for consumers and suppliers of labor in freely choosing what to consume and which job to take; they also aid the manager of each socialist firm in de­ciding which goods to produce and which mix of productive factors (hence, which technology) to use in producing them.

Each socialist manager is an employee of the state, and the state supplies him with a set of rules that he must follow in making decisions concerning his establishment. The rules are threefold: (1) Figure out how to produce each quantity of your product or products as cheaply as pos­sible on the basis of factor prices existing at any given moment. (2) Choose to produce the specific quantity for which the additional cost of making the last unit just equals the existing price for that commodity. (3) Ignore all opportunity for monopoly gains. The first two rules are identical with those the manager of a perfectly competitive capitalist firm uses to max­imize his profits. The third makes doubly certain that the distorting effects of monopoly power remain absent.

The Central Planning Board is looking for a set of equilibrium prices that, once established, could continue unchanged until demand patterns or occupation preferences shift. The question is how to achieve a set of consistent equilibrium prices. Lange's answer was that a series of trial-and-error operations by the planning board could approach closer and closer to the ideal pattern. The key indicator in this adjustment would be the level of inventories in each market.

If undesired inventory buildup was observed, a downward adjust­ment in prices would reduce current output as managers eliminated high-cost production and simultaneously encourage greater current consumption at the more attractive price. On the other hand, higher prices would offset depletion of the inventory pool by turning up the production spigot while partially blocking the consumption drain. An identical procedure would prevail for each type of employment, although a lag between wage changes and the shift of workers into or out of particular occupations would un­doubtedly exist.

The Central Planning Board would also be charged with establishing the rental charge for the use of socialized land and the interest charge for the use of money capital by firms to expand their productive capacity. In both cases the object would be the same—to set the price so as to clear the factor market. This calculation is of crucial importance in the capital market, where the short-run decision of disposing of an arbitrarily deter­mined amount of capital gives way in the long run to a choice of how much to set aside for future growth in the economy and how much to al­locate for current consumption. This so-called social dividend, consisting of returns to factors of production that would be privately owned in a capitalist system, is what the socialist regards as the main economic bene­fit of socialism. Part of it would be plowed back into capital investment for future growth, part would be returned to the population in equal per-capita shares, and part would provide for public goods such as the educa­tional system or a symphony orchestra.

The point of this lengthy intellectual exercise is not that Lange so­cialism would operate easily in the real world. (A change in one market, for instance, would throw the whole system out of equilibrium.) Rather, the claim is that this system, in theory, can accomplish everything that the abstract model of capitalism accomplishes in theory, with the additional benefit of having the social dividend available to reduce income equality and to ensure the provision of public goods. Lange's system, in short, al­lows a set of equilibrium prices to achieve socialist goals without reliance on the profit motive as a source of economic incentives.

Critics of Lange generally concede the validity of his claim that it is theoretically possible for rational economic calculation to occur in a socialist economy. They argue, however, that the complexities of market interactions, the problems of data collection, and the human limitations of the members of the planning agency would create insurmountable obstacles to the actual operation of price-directed socialism. The devel­opment of modern computers makes that objection somewhat less com­pelling, although it is interesting to note that no modern socialist nation has actually attempted a planning strategy based entirely on Lange's model. The criticism that efficient social planning is impractical must be recognized as a retreat from the original position that such planning is theoretically impossible.