Coincident with the 200th anniversary of Karl Marx’s birth, socialism is making a comeback in American political discourse. Detailed policy proposals from self-declared socialists are gaining support in Congress and among much of the electorate.
It is unclear, of course, exactly what a typical voter has in mind when he or she thinks of “socialism.” But economists generally agree about how to define socialism, and they have devoted enormous time and resources to studying its costs and benefits.
With an eye on this broad body of literature, this report discusses socialism’s historic visions and intents, its economic features, its impact on economic performance, and its relationship with recent policy proposals in the United States.
We find that historical proponents of socialist policies and those in the contemporary United States share some of their visions and intents. They both characterize the distribution of income in market economies as the unjust result of “exploitation,” which should be rectified by extensive state control.
The proposed solutions include single-payer systems, high tax rates (“from each according to his ability”), and public policies that hand out much of the Nation’s goods and services “free” of charge (“to each according to his needs”). Where they differ is that contemporary democratic socialists denounce state brutality and would allow individuals to privately own the means of production in many industries.
In assessing the effects of socialist policies, it is important to recognize that they provide little material incentive for production and innovation and, by distributing goods and services for“free,” prevent prices from revealing economically important information about costs and consumer needs and wants. To this end, as the then–prime minister of the United Kingdom,Margaret Thatcher (1976), once argued, “Socialist governments . . . always run out of other people’s money,” and thus the way to prosperity is for the state to give “the people more choice to spend their own money in their own way.”
Whether socialism delivers on its appealing promises is an empirical question. We begin our investigation by looking closely at the most highly socialist cases, which are typically agricultural economies, such as Maoist China, Cuba, and the Union of Soviet Socialist Republics (USSR).
Their nondemocratic governments seized control of farming, promising to make food more abundant. The result was substantially less food production and tens of millions of deaths by starvation. Even if highly socialist policies are peacefully implemented under the auspices of democracy, the fundamental incentive distortions and information problems created by large state organizations and the centralized control of resources are also present in industrialized countries, as is currently the case in Venezuela.
Lessons from poorly performing agricultural economies under socialist regimes carry over to government takeovers of other modern industries: They produce less rather than more.
These countries are examples of a more general pattern of socialism’s negative output effects.
Such outcomes have also been observed in cross-country studies of the effect of greater economic freedom—quantified as an index of taxation and public spending, the extent of state owned enterprises, economic regulation, and other factors—on real gross domestic product (GDP). This literature finds a strong association between greater economic freedom and better economic performance.
It suggests that replacing U.S. policies with highly socialist policies, such as Venezuela’s, would reduce real GDP at least 40 percent in the long run, or about $24,000 per year for the average person.
Although they are sometimes cited as more relevant socialist success stories, the experiences of the Nordic countries also support the conclusion that socialism reduces living standards. In many respects, the Nordic countries’ policies now differ significantly from what economists have in mind when they think of socialism.
For instance, they do not provide healthcare for “free”; Nordic healthcare financing includes substantial cost sharing. Marginal labor income tax rates in the Nordic countries today are only somewhat higher than in the United States, and Nordic taxation overall is surprisingly less progressive than U.S. taxes. The Nordic countries also tax capital income less and regulate product markets less than the United States does.
However, the Nordic countries do regulate and tax labor markets somewhat more; thus, American families earning the average wage would be taxed $2,000 to $5,000 more per year net of transfers if the United States had current Nordic policies. Living standards in the Nordic countries are at least 15 percent lower than in the United States.
It may well be that American socialists are envisioning moving our policies to align with those of the Nordic countries in the 1970s, when their policies were more in line with economists’ traditional definition of socialism. We estimate that if the United States were to adopt these policies, its real GDP would decline by at least 19 percent in the long run, or about $11,000 per year for the average person.
The Nordic and European versions of socialized medicine have been viewed as so desirable by modern U.S. socialists that they have proposed nationalizing payments for the healthcare sector (which makes up more than a sixth of the U.S. economy) through the recent “Medicare for All” proposal.
This policy would distribute healthcare for “free” (i.e., without cost sharing) through a monopoly government health insurer that would centrally set all prices paid to suppliers such as doctors and hospitals.
We find that if this policy were financed out of current Federal spending without borrowing or tax increases, then more than half the entire existing Federal budget would need to be cut. Or if it were financed through higher taxes, GDP would fall by 9 percent, or about $7,000 per person in 2022, due to high tax rates that would reduce incentives to supply the factors of production. Evidence on the productivity and effectiveness of single-payer systems suggests that “Medicare for All” would reduce both short- and long-run longevity and health despite increasing somewhat the population with health insurance.
The burden is on socialists to explain how their latest policy agenda would overcome the undeniable problems observed when socialism was tried in the past. As the sociology professor Paul Starr put it, “Much of [modern American socialists’] platform ignores the economic realities that European socialists long ago accepted.”
Marx’s 200th birthday is a good time to gather and review the overwhelming evidence.
The next section of this report begins by briefly reviewing the historical and modern socialist interpretations of market economies and some of the challenges with socialist policy proposals. The third section reviews the evidence from the highly socialist countries, by which we mean countries that were implementing the most state control of production and incomes.
Highly socialist countries experienced sharp declines in output, especially in the industries that were taken over by the state. Economies with less extreme socialism also generate less output, although the shortfall is not as drastic as with the highly-socialist countries, as shown in the fourth section for a wide cross section of countries. The fifth section’s more detailed examination of the Nordic countries reports a similar result. The sixth section applies the economic analysis to the headline American socialist proposal, “Medicare for All.”
The Economics of Socialism
Historically, philosophers and even some well-regarded economists have offered socialist theories of the causes of income and wealth inequality, and they have advocated for state solutions that are commonly echoed by modern socialists. They both argue that there is “exploitation” in the market sector and there are virtually unlimited economies of scale in the public sector. The solutions include single-payer systems, high tax rates (“from each according to his ability”), and public policies that hand out much of the Nation’s goods and services free of charge (“to each according to his needs”) (Marx 1875).
The Socialist Economic Narrative: Exploitation Corrected by Central Planning
When Marx was writing over 150 years ago, obviously exploitive practices were still familiar.
The modern socialist view is that exploitation remains real but is somewhat hidden in the market for labor. Much inequality arises, it is said, because market activity is a zero-sum game, with owners and workers paid according to the power they possess (or lack), rather than their marginal products. From the workers’ perspective, profits are an unnecessary cost in the production process.
As Karl Marx put it, “Modern bourgeois private property is the final and most complete expression of the system of producing and appropriating products, that is
based on class antagonisms, on the exploitation of the many by the few” (Marx and Engels 1848, 24).
The Chinese leader Mao Zedong, who cited Marxism as the model for his country, described “the ruthless economic exploitation and political oppression of the peasants by the landlord class” (Cotterell 2011, chap. 6). Expressing similar concerns, current American senators Bernie Sanders and Elizabeth Warren have stated that “large corporations . . . exploit human misery and insecurity, and turn them into huge profits” and “giant corporations . . . exploit workers just to boost their own profits.”
The French economist Thomas Piketty, whose 2014 book Capital in the 21st Century recalls Marx’s Das Kapital, asserts that inequality today is “terrifying” and that public policy can and must reduce it; wealth holders must be heavily taxed.
The socialist narrative names the oppressors of the vulnerable, such as the bourgeoisie (Marx), kulaks (Lenin), landlords (Mao), and giant corporations (Sanders and Warren).8 Piketty (2014) concludes that the Soviet approach and other attempts to “abolish private ownership” should at least be admired for being “more logically consistent.”
Historical and contemporary socialists argue that heavy taxation need not reduce national output because a public enterprise uses its efficiency and bargaining power to achieve better outcomes. Mao touted the “superiority of large cooperatives.” He decreed that the Chinese government would be the single payer for grain, prohibiting farmers from selling their grain to any other person or business (Dikӧtter 2010).
In describing China, the British economists Joan Robinson and Solomon Adler (1958, 3) celebrated that “the agricultural producers’ cooperatives have finally put an end to the minute fragmentation of the land.” Lenin stressed transforming “agriculture from small, backward, individual farming to large-scale, advanced, collective agriculture, to joint cultivation of the land.” Proponents of socialism in America today argue that the Federal government can run healthcare more efficiently than many competing private enterprises.
State ownership of the means of production is an often-repeated Marxist proposal for ending worker exploitation by leveraging scale economies.
This aspect of socialism is less visible in modern American socialism, because in most instances, socialists would allow individuals to be the legal owners of capital and their own labor.11 However, the economic significance of ownership is control over the use of an asset and of the income it generates, rather than the legal title by itself.
In other words, the economic value of ownership is sharply diminished if the legal owner has little control and little of the income.12 The concept of full ownership in the economic sense is rejected by socialists; they maintain that private owners left to themselves would not achieve full economies of scale and would continue exploiting workers. Public monopolies, “public options,” profit prohibitions, and the regulatory apparatus allow the socialist state to control asset use, and high tax rates allow the state to determine how much income everyone receives, without necessarily abolishing ownership in the narrow legal sense.
Historical socialists such as Lenin, Mao, and Castro ran their countries without democracy and civil liberties. Modern democratic socialists are different in these important ways.
Nevertheless, even when socialist policies are peacefully implemented under the auspices of democracy, economics has a lot to say about their effects.
Whose Money Is Spent on Whom
Any productive economic system needs incentives: means of motivating effort, useful application of knowledge, and the creation and maintenance of productive assets.
The higher an economy’s tax rates, the more its industries are monopolized by a public enterprise, and the more its goods and services are distributed free of charge, then the more disincentives will reduce the value created in the economy
As the Nobel Prize–winning economist Milton Friedman demonstrated with his illustration of “four ways to spend money” (see figure 1), a challenge for socialism is thatthe persons deciding on resource allocations—that is, how much to spend on a product and how that product should be manufactured and delivered to the final consumer—are different from those providing the resources and different from the final consumer who is ultimately using them (Friedman and Friedman 1980). In the market system, people spend their own money, and are therefore more careful how much to spend and on what the money is spent. To the extent that they also use
what they purchased—the upper left corner in figure 1—they are also more discerning, so that the items purchased are of good value. They will gather and consider information that helps compare the value of different options.
The upper right hand corner of figure 1 gives the case of spending one’s own money on someone else, which introduces inefficiencies because the recipient may place a lower value on the spending.
For example, the recipients of Christmas gifts sometimes value the gifts less than they cost the giver, as exemplified by Christmas sweaters that are never taken out of the closet to be worn. The inefficiency of the lower left corner is exemplified by the larger spending that takes place when spending on oneself using other people’s money, as with fully reimbursed corporate travel or entertainment. The lower right category is the one applicable to government employees who spend tax revenue on government program beneficiaries; not only is there a tendency to overspend using other people’s money, but that spending may have little value from the perspective of program beneficiaries.
Many presentations of socialist policy options, even those by expert economists, ignore the distinction between spending your money on yourself and spending someone else’s money on someone else. The “Medicare for All” bills currently in Congress, for example, supposedly just swap household expenditures on health insurance that occur under a private system for household expenditures on taxes earmarked for the public program. 14 But this swap fundamentally changes the types of healthcare that are ultimately received by consumers, the size of the healthcare budget, and the size of the overall economy. In a private system, a consumer has some control over his or her spending on health insurance—by, for example, selecting a plan with different benefits, or switching to a more efficient provider.
Insurers in a private system must be responsive to consumer demands if they want to attract and retain customers and thus stay in business.
Individuals also have little reason to economize on anything that they can obtain without payment (Arrow 1963; Pauly 1968).
In a socialist system, the state decides the amount to be spent, how it is spent, and when and where the services are received by the consumer. A consumer who is unhappy with the state’s choices has little recourse, especially if private businesses are prohibited from competing with the state (as they are under “Medicare for All”). It may be argued that “giant” private corporations also limit consumer choice, but this comparison ignores how corporations are subject to competition. For example, a consumer can purchase goods from Walmart rather than Amazon, not to mention a whole host of other retailers. Amazon is legally permitted to entice Walmart customers, and vice versa, with low prices, better products, free shipping, and so on. Whereas retail customers are not forced to open their wallets, giant state enterprises are guaranteed revenue through taxation and are often legally protected from competition.
Those who maintain that Amazon and Walmart are too large might note that the single-payer revenues proposed in “Medicare for All” will be about eight times the revenue for either of these corporations.
Another problem with the socialist system is that “other people’s money” starts to disappear when the “other people” realize that they have little incentive to earn and innovate because what they receive has little to do with how much they make.
An important reason that people work and put forth effort is to obtain goods and services that they want.
Under socialism, the things they want may be unavailable because the market no longer exists, or are made available without the need for working.
Noneconomists sometimes claim that high taxes do not prevent anyone from working, as long as the tax rate is less than 100 percent, because everyone strives to have more income rather than less.
This “income maximization” hypothesis is contradicted by the most basic labor market observations, not to mention decades of research. 19 Earning additional income
requires sacrifices (a loss of free time, relocating to an area with better-paying jobs, training, taking an inconvenient schedule, etc.), and people evaluate whether the net income earned is enough to justify the sacrifices. Socialism’s high tax rates fundamentally tilt that trade-off in
favor of less income.
Why “Free” Is Costly
Because market prices reveal economically important information about costs and consumer wants, regulations and spending programs that distribute goods or services at below-market prices, such as for “free,” have a number of unintended consequences (Hayek 1945). Fewer goods and services will be produced, and what is produced may be mis-allocated to consumers with comparatively little need.
We explain below why the very idea that a single-payer government program will use its market power to obtain lower prices is an acknowledgment
that the program will be purchasing less quantity or quality.
On the demand side of a market, people vary in their willingness to pay for the product or service, and their willingness varies over time. The market system allocates the available goods to consumers who are willing to pay more than the market price, while those not willing to pay the price go without. Willingness to pay is related to income, but it is also related to “need,” at least as consumers perceive need. Consumers are, for example, willing to pay more for food
when they are hungry and to buy health insurance when they are older.
In this way, the market has a tendency to allocate goods and services when and to whom they are needed.
If the government decrees that a product shall be free, then something other than a willingness to pay the market price will determine who receives the available supply. It may be a willingness to wait in line, or political connections, or membership in a privileged demographic group, or a government eligibility formula (Shleifer and Vishny 1992; Barzel 1997; Glaeser and Luttmer 2003).
By comparison with the market, giving a product away for free may sometimes have the effect of taking the good away from consumers when they need it most and
transferring it to consumers when they need it least.
As we show later in this report, single-payer healthcare programs tend to reallocate healthcare from old to young. Centrally planned agricultural systems have, in effect, taken food products away from starving people in rural areas and transferred the products to urban consumers or sold them on the international market.
Prices that are below their competitive levels also affect supply. Although a single government payer has market power that it can use to reduce the incomes of suppliers, the price reduction is accomplished by reducing the quantity or quality of what it purchases in order to squeeze its
This may be one reason why single-payer healthcare systems have longer appointment wait times than in the U.S. system (see the sixth section of this report), and why
“free” Nordic colleges yield lower financial returns than higher education in the United States, even though the Nordic returns include no tuition expense (see the fifth section below).
The Dismal Track Record of Highly Socialist Countries
Socialism is a continuum. No country has zero state ownership, zero regulation, and zero taxes.
Even the most highly socialist countries have retained elements of private property, with consumers sometimes spending their own money on themselves (Pryor 1992).
This report therefore begins with the historically common highly socialist regimes, by which we mean countries that implemented the most state control of production and incomes for at least a decade. 21 Of more than a dozen countries meeting these criteria, this section emphasizes Maoist China, Cuba, and the USSR, which are the subject of much scholarship, and Venezuela, which has been unusual as an industrialized economy with elements of democracy that
nonetheless pursued highly socialist policies.
Many of the highly socialist economies were agricultural, with state and collective farming systems implemented by socialist governments to achieve purported economies of scale and, pursuant to socialist ideology, to punish private landowners.
Agricultural output dropped sharply when socialism was implemented, causing food shortages. Tens of millions of people starved. It took quite some time for sympathetic scholars outside socialist countries to acknowledge that large state farms were less productive than small private ones.
The economic failures of highly socialist policies have been described at length by both survivors and scholars who have reviewed the evidence in state archives. Not only did highly socialist countries discourage the supply of effort and capital with poor incentives, but they also allocated theseresources perversely because central planning made production decisions react to output and input prices in the opposite direction from those of a market economy.
Although agriculture is not a large part of the U.S. economy, present-day socialists echo the historical socialists by arguing that healthcare, education, and other sectors are unfair and unproductive, and they promise that large state organizations will deliver fairness and economies of scale. It is therefore worth acknowledging that socialist takeovers of agriculture have delivered the opposite of what was promised.
Present-day socialists claim to not want the dictatorship or state brutality that often coincided with the most extreme cases of socialism. However, peaceful democratic implementation of socialist policies does not eliminate the fundamental incentive and information problems created by high tax rates, large state organizations, and the centralized control of resources.
As we report at the end of this section, Venezuela is a modern industrialized country that elected Hugo Chávez as its leader to implement socialist policies, and the result was less output in oil and other industries that were nationalized.
When evaluating the misalignment between the promises of highly socialist regimes to eliminate the misery and exploitation of the poor and the actual effects of their policies, it is instructive to look at a major guide economists use to determine value: the revealed preference of the population—in other words, voting with their feet. Implementation of highly socialist policies, such as in Venezuela, have been associated with high emigration.
Perhaps more telling is that historically socialist regimes—such as the USSR, China, North Korea and Cuba— have forcibly prevented people from leaving.
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James E Windsor, Overpasses News Desk
February 15th, 2019