Theory of Market Socialism

1. Theory of Market Socialism

2. Definition Market socialism is an ES that combines public/social ownership of capital and market allocation. Public ownership of non-labor factors of production Decentralized decision making structure (firms & hhlds) Decentralized information structure Coordination by markets Both material and non-material rewards

3. The most famous theoretical model of mkt socialism is the trial and error model proposed by the polish economist Oscar Lange 2. Theoretical Foundations—The Lange Model Combines public ownership and a trial & error approach to determine output and equilibrium State owns non-labor factors of production and consumer goods are allocated by market (state ownership and resource allocated by markets) A more centralized version of market socialism Three decision-making levels -central planning board (CPB) -industrial ministries -enterprises

4. CPB initially sets all prices arbitrarily enterprises face parametric prices just as perfectly competitive firms do Firms follow mkt type rules. Enterprises instructed to minimize costs produce output at which MC=P Result will either be a surplus or shortage if surplus, price adjusted downward if shortage, price adjusted upward The CBP sets the prices and would adjust prices to equilibrium until supply=demand Households supply labor The CPB allocates social dividends (rents and profits): to finance investment to achieve growth goals (state control over investment& the rate of econ growth) to achieve distributional goals (with state ownership, the rate & direction of econ activity would be determined in large by state; distribution will be more even) State decisions on sectoral expansion Control of pricing can be used to correct externalities Because the state manipulates prices, it will account for externalities. Decisions made at higher levels rather than lower levels will be better in terms of preventing environmental effects State control over savings and investment would reduce cyclical instability

6. Critics of the Lange Model Computationally inefficient Unmanageable in practice—information needs too great; many tasks of the CPB leads to large bureaucracy what motivates managers to follow the rules? what motivates managers of perfectly competitive firms to follow the P=MC rule? Or to use resources efficiently; How to make mrkts work when private individuals do not own capital. Lack of managerial incentives The Lange’s model has sparkled great interest b/c most existing socialist systems use a crude form of trial and error for the setting of prices at least for the consumer.

7. 3. The Cooperative Variant of Market Socialism Market socialist system in which labor participates in decisions at the enterprise level. The people should participate in making the decisions that affect their well being. Major features of participatory economy-Vanek describes the major features: enterprises managed by the workers equitable income sharing labor democratically decides how to distribute the enterprise’s income; labor do not receive a fixed salary but the profit is divided equally state owns non-labor factors of production the workers must pay a fee, and the fee should not be minimal, but should reflect the scarcity, or opportunity cost market coordination decentralized decision making, mkt prices are determined by ss&dd Producers make their own decisions based on mkt rules (as opposed to Lange, where CPB sets prices) freedom in choice of employment Where and what to work The firm is free to hire or not to hire

8. Closer to a true market system than the Lange version of market socialism prices set by markets, not by planners From these characteristics is clear that the objective of the labor-managed firm will be different from a capitalist firm or centrally planned firm Under capitalism, profit-max; centrally planned-the objective derives from the preferences of planners, communist party but not the workers. Still socialist because of state ownership of non-labor factors b) Modeling of the Cooperative Market Socialism. Resources with exception of labor are owned by the state & the enterprise pay a fee to the state. Ss& dd determine the prices of producer and consumer goods. Enterprises will be managed by workers (or may hire a professional manager). Given these conditions the cooperative firm behave: Objective to be maximized maximize per-worker (or average) dividend (= revenue minus cost, not including labor cost) Let Q be the quantity of output L is the quantity of labor K is the quantity of capital If labor and capital are the only two inputs, the production function, which shows the relationship between output and inputs, is: Q = f (L, K)

9. In short-run case -variable supply of labor L and fixed capital K The enterprise pays the government a tax (T) for the capital it is using Since K is fixed in the short run, T is fixed If we let Y = total dividend and P = the mkt price of the output, then Y= PQ - T The firm will max per worker dividend Y/L = (PQ-T)/L Max solution is: P MPL = (PQ-T)/L Maximum net income per worker will be achieved when the amount of labor hired is such that the value of the MP of the last worker hired is the same as the average net earnings per worker P MPL is the value of marginal product (VMP) of labor At L1,VMPL > Y/L adding an additional unit of L will raise Y/L

10. Thus, to maximize per worker dividend, the firm must employ just that quantity of labor such that the VMP of labor is equal to the per worker dividend Y/L. In long-run case-labor and capital are variable r=rental rate per unit of capital The firm will max Y/L = (PQ-rK)/L K-amount of capital; r-charge per unit of capital Max solution is: P MPK = r and P MPL = (PQ-rK)/L Where P MPK is the value of marginal product of capital If the VMPK is greater than r more capital should be hired to utilized until the return and the cost are equal (perfectly competitive firm) Firm maximizes net revenues per worker Households maximize utility to supply labor services.

11. Comparison with Capitalist Firm Assuming profit (Π) maximization Π = PQ - wL - T where w = wage At the profit maximizing employment of labor P MPL = w Value of labors’ marginal product equals wage The cooperative model has been analyzed by Jaroslav Vanek (defend) and Benjamin Ward (criticized). Strong support for the cooperative features comes from Vanek who argues that the participatory economy is element of social evolution Positive Features of Cooperative Model Eliminates capitalist dichotomy between management and labor Enterprises are managed by the workers; Workers participate in decision making Greater social justice in distribution of income distribution according to decision of the workers involve Firms will be more socially responsible E.g. environment (pollution) The workers who control a participatory firm live locally, they are more likely to “internalize” the externality of pollution and trade lower monetary awards for a better environment.

12. Criticism of the Cooperative Model (Ward) theoretically rigorous , but its real world applications are limited cooperative monopolist, inefficiency If supplies big quantities of product and realize that, behaves as monopolist—hires less labor, produces less output and charges a higher price. misallocation of labor Ward argues that if two cooperatives, producing identical product, use different technologies there will be misallocation of labor that would not occur if the two firms were capitalist. if VMPL = w and all firms face same wage, then all firms’ VMPL will be the same no such mechanism to equate VMPs in market socialism if VMP1 > VMP2 then greater value can be produced by reallocating labor from Enterprise 2 to Enterprise 1 motivation of managers When the cooperative hires professional management how to motivate to follow the rules

13. 4. The Performance of Market Socialism: Hypotheses a. Income Distribution State ownership, capital belongs to the state; worker-managed enterprises, the state must be paid a fee for use of capital, and the state would presumably divide such income among the population on a fairly equal basis. more nearly equally under mkt socialism than capitalism b. Economic Growth Relatively high rates of growth since the earnings from capital will go back into economy, but need to consider if there is pressure on the state to put “social dividends” into current consumption and subsidy Not sure of high investment rates ? c. Efficiency Individual participation in decision making, lack of monopoly, attention to externalities; therefore more efficient than capitalism However motivation problems ? d. Stability Greater econ stability since the state will have greater control over the investment rate But if it is difficult to adjust prices to equilibrium, macroecon instabilities associated with nonequilibrium prices might be experienced