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Overview of Comparative Economics


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Title: Overview of Comparative Economics

Overview of Comparative Economics
  • Chapter I
  • How do we compare economies?

Criteria for Classifying Economies
  • How do we classify economies?

Institutional Mechanisms
  • Allocation Mechanisms
  • Forms of Ownership
  • Role of Planning
  • Types of Incentives
  • The method of Income Redistribution and Social
    Safety Nets
  • Role of Politics and Ideology

I. Allocation Mechanisms
  • What good and services are produced?
  • How goods and services are produced?
  • For whom goods and services are produced?
  • Production ? allocating factor inputs
  • Distribution ? allocating produced goods and
  • Three basic kinds of allocation mechanisms
  • 1. Traditional Economy
  • 2. Market Economy
  • 3. Command Economy

II. Forms of Ownership
  • Who owns the means of production?
  • In capitalist economies, land and produced means
    of production (capital stock) are owned by
    private individuals or private firms (Market
  • In socialist economies the state owns the land
    and the capital stock (Command Socialism)

II. Other Forms of Ownership
  • Intermediate forms of ownership (like
    cooperatives or worker ownership)
  • Under socialism central government vs local
    government ownership
  • Religious groups ownership

II. Forms of Ownership
  • Market Capitalism vs Command Socialism
  • United States vs Soviet Union
  • ALSO
  • Market Socialism vs Command Capitalism
  • Yugoslavia and China vs Nazi Germany

III. Role of Planning
  • Centrally planned economy ? planners preferences
    dominate allocative decision-making
  • Market economy ? consumers sovereignty dominates
    allocative decision-making

III. Role of Planning
  • Centrally planned economy is usually correlated
    with command socialism (Soviet Union, there are
    exceptions command without planning ? Soviet
    Russia during 1910s and 1920s)
  • Market economy is usually correlated with market
    capitalism (there are exceptionsindicative
    planning ? France and Japan)

IV. Types of Incentives
  • Material Incentives ? paying people according to
    their productivity (their marginal product that
    maximizes profits for competitive firms hiring
    labor in such a system)
  • Under capitalism ? takes the form of rewards for
    entrepreneurship and capital investment as
    economic profits
  • Moral Incentives ? trying to motivate workers by
    appealing to some higher collective goal

V. Income Redistribution and Social Safety Nets
  • Social Market Economies (or some advanced
    capitalist countries) ? do their income
    redistribution through social safety nets
  • Command Socialist Economies ? did not have to
    redistribute income ? their governments
    controlled the distribution of income by setting
    wages and forbidding capital or land income

VI. Role of Politics and Ideology
  • Central controversy
  • Is democracy linked with market capitalism???
  • Is authoritarian regime linked with command

VI. Role of Politics and Ideology
  • Friedman libertarian laissez-faire ? lack of
    individual freedom
  • In democracies, social democrat parties exist
    (like Sweden)
  • They support income redistribution and extensive
    social safety nets
  • They support nationalization and central planning
  • They do not support dictatorship

VI. Role of Politics and Ideology
  • Authoritarian political regimes pursued market
    capitalism (East Asia and Latin America)
  • Market capitalism is not a guarantee of political
  • Islamic Fundamentalism
  • Imposition of an Islamic code-Sharia
  • It is not a liberal democracy ? individual rights
    and freedoms are subordinated to a Sharia and
    the religious authorities
  • Economically it does not follow neither
    capitalism nor socialism

Overview of Comparative Economics
  • Chapter II
  • Market Capitalism

Market Capitalism
  • Form of Ownership ? Most of the time land and
    produced means of production (capital stock) are
    owned by private individuals or private firms
  • Role of Planning ? Market capitalism is usually
    planned by the market (with demand and supply)
  • Material Incentives ? In market capitalism
    material incentives exist in forms of rewards for
    entrepreneurship and capital investment as
    economic profits

Market Capitalism
  • Income Redistribution ? is usually done through
    social safety nets in market capitalism
  • Role of politics and ideology ? Are market
    capitalist countries mostly democratic?
  • Social democrat parties exist in market
    capitalist countries supporting income
    redistribution, extensive social safety nets,
    nationalization and central planning

Why market capitalism popular?
  • End of communism ?most former communist countries
    are concentrating on market capitalist economic
  • Predominantly market capitalist economies are
    making efforts to move toward a purer version of
    this system

Advantages and Disadvantages of Market Capitalist
  • Experienced enormous technological advances and
    growth as they underwent the Industrial
    Revolution in the late 18th century
  • ability to revolutionize the means of
  • Experienced large macroeconomic fluctuations with
    serious downturns in the 19th century (unequal
    distribution of income and increasing
    concentrations of industrial monopoly power)

Pure version of market capitalist system
  • Pure version of market capitalist system does not
  • Closest to the ideal of pure laissez-faire market
    capitalism are
  • Hong Kong
  • Singapore
  • New Zealand

  • Static efficiency ? no one in society can be made
    better off without making someone else worse off
  • resources are being utilized to their best
    potential given the existing technology
  • Dynamic efficiency ? allocation of resources over
    time to maximize long-run sustainable growth
  • technological dynamism
  • destabilizing process of creative destruction

Theoretical Efficiency of Market Capitalism
  • Efficiency Theorem
  • The general ability of markets to allocate goods
    and resources efficiently through the law of
    supply and demand
  • A complete
  • competitive
  • full-information
  • general equilibrium is efficient

Theoretical Efficiency of Market Capitalism
  • Complete
  • For any good or service that affects someones
    utility, there is a market
  • Competition
  • There are many buyers and sellers with free entry
    and exit
  • There are well-defined homogenous goods and
  • No individual supplier has any control over the
    price in his or her market

Theoretical Efficiency of Market Capitalism
  • Full information
  • All agents in the economy know everything about
    consumer preferences, production technologies,
    and prices
  • General equilibrium
  • Every single market is in equilibrium in the
    sense that the quantity supplied equals the
    quantity demanded of the good or service
  • If that does not happen
  • Surplus
  • Shortage
  • Partial equilibrium with a few markets being in

Theoretical Efficiency of Market Capitalism
  • Efficiency
  • Pareto optimality? no one in the economy can be
    made better off without making someone else worse
  • If someone can be made better off without making
    someone else worse off, then the economy is not
    producing as much as possible of what people want

Why is a complete, competitive, full-information,
general equilibrium efficient?
  • Adam Smiths invocation of invisible hand of the
    market working across all sectors to allocate
    goods in a way that maximizes the wealth of the
  • He founded classic laissez faire economics
  • He argued that the government should get out of
    the economy (minimal government intervention)
  • It is at the equilibrium price that the maximum
    amount will be both produced and sold and thus
    actually consumed by public

Invisible Hand
  • In the free marketplace an invisible hand
    regulates and self-corrects the economy
  • The market itself will regulate the economy
  • Efficient producers will prosper and the
    inefficient producers will lose
  • The public will get the best product for the
    lowest price
  • Supply and demand will determine prices better
    than any government official can

Limits to the Efficiency of Laissez-Faire Market
  • Monopoly Power
  • Externalities
  • Collective Consumption Goods
  • Imperfect Information

Source of InefficiencyMonopoly Power
  • Monopoly power prohibits competition
  • Monopolist will maximize profits by setting
    marginal cost equal to marginal revenue
  • Exceptions
  • Natural monopoly
  • Characterizing an industry with economies of
    scale (declining LRAC) even at level of output
    equal to total market demand
  • Technological dynamism
  • More competitive industries will be more
    technologically progressive

Source of InefficiencyMonopoly Power
  • Intermediate market forms
  • Monopolistic competition
  • Many firms, each having some price setting power
    as a result of product differentiation
  • Excess capacity theorem
  • Oligopoly
  • Small number of firms in industry with reaction
    to any action taken by others
  • Perfect collusion
  • Joint-maximizing cartel (OPEC in oil crisis)
  • Longest surviving cartel?

Source of InefficiencyExternalities
  • These are either costs or benefits that are born
    by or accrue to an agent other than the agent
    generating them
  • External costs negative externalities
  • External benefits positive externalities

Source of InefficiencyExternalities
  • External costs are negative externalities, such
    as environmental pollution
  • If the firm that generates pollution damages
    another industry but does not reduce that damage
    ? the private marginal cost to the firm does not
    equal the social marginal cost and too much
    pollution is produced, resulting in inefficiency

Source of InefficiencyExternalities
  • External benefits are positive externalities,
    such as technological invention without patent
    protection for inventors
  • If an inventor has no patent protection, then
    other firms can steal her invention and she may
    make no money even if her invention generates
    great social benefits
  • Private marginal benefit to the inventor does not
    equal marginal social benefit of the invention
    and too little inventing will occur, resulting in

Source of InefficiencyCollective Consumption
  • Consumption goodspublic goods ? such as national
  • Because of the nature of such goods, it is
    difficult for private markets to organize
    themselves to provide these goods in optimal
  • The characteristics of pure public good
  • Nonexcludability of consumption It is not
    possible to exclude this kind of consumption
  • Nondepletability of consumption Everyone
    consumes it simultaneously, and no individuals
    consumption reduces any other individuals
  • Free-rider problem

Source of InefficiencyImperfect Information
  • Unrealistic to have perfect information
  • When one party in a transaction knows more than
    another, special problems arise causing
    asymmetric information
  • Akerlof The market for Lemons
  • Principal agent problem
  • Sub-optimizing behavior

Macroeconomic Instability of Market Capitalism
  • The General picture
  • The major market capitalist economies have been
    less than perfectly stable over time
  • There was a general increase in unemployment
    rates after the early1970s in many countries,
    associated with a general stagnation of economic
    growth, that appears to have been reduced
  • The considerable variation in capital investment
    can be explained by factors
  • Exogenous fluctuations in new technologies that
    can serve as the basis for the investment
  • Fluctuations in government monetary policies
    affecting interest rates
  • Psychological fluctuations due to the animal
    spirits of those making investments

Macroeconomic Instability of Market Capitalism
  • Why do these variables lead to fluctuations in
    the unemployment rate, since in a perfectly labor
    market, wage rates should fall when the demand
    for labor falls, thereby preventing the emergence
    of any involuntary unemployment?
  • Keynesian School
  • Classical School

Macroeconomic Instability of Market Capitalism
  • Keynesian School
  • Rigidities of various sorts exist in labor
    markets and that capital investment can collapse
    and stay down for extended periods of time, as in
    the Great Depression
  • The implication is that government intervention
    through fiscal or monetary policies is advisable
    to stimulate the economy and to stabilize and
    smooth out business cycles

Macroeconomic Instability of Market Capitalism
  • The Classical School
  • Deriving from 19th century classical political
    economists such as David Ricardo
  • Market capitalist economies are powerfully
  • Conscious government intervention merely
    generates inflation and intensifies fluctuations
  • To minimize unemployment, unions should be broken
    up and a stable fiscal and monetary environment
    should be maintained within a laissez-faire

Laissez-faire Economic Policies
  • Shift toward supporting more laissez-faire
    economic policies
  • There is a tension between asserting the
    efficiency of competitive equilibria and
    recognizing the limits of the applicability of
    that theorem
  • Chicago Schools (Milton Friedman) argument draws
    directly from the efficiency theorem and follows
    by asserting the irrelevance or unimportance of
    the various exceptions and limits

Chicago School
  • Markets are almost always efficient, so
    government should keep its hands off
  • The most externalities will be resolved by
    private markets if property rights are properly
    defined and enforced free market
  • Many of the goods provided by the public sector
    are not really collective consumption goods and
    could be more efficiently provided privately
  • Information costs are inevitable and cannot be
  • The Chicago School supports the Classical School
    approach in macroeconomics
  • Friedman is the most prominent advocate of
    monetarism in the US
  • With respect to distribution of income, people
    should be allowed to keep what they earn from the
    free market
  • Inequalities are the necessary outcome of
    providing sufficient incentives for production,
    investment and growth

Austrian School
  • They reject equilibrium analysis and emphasize
    dynamic market processes
  • Entrepreneurs are the most important agents in
    the economy
  • They must be allowed to function freely, without
    government restriction, so that they can lead the
    market to evolve in conjunction with the
    evolution of consumer preferences through process
    of innovation
  • Static efficiency is relatively unimportant
  • It is the dynamic success of market capitalism
    that is its most important economic feature

Overview of Comparative Economics
  • Chapter III
  • The Theory and History of Marxism and Socialism

Command Socialism
  • Form of Ownership ? Most of the time the state
    owns the land and produced means of production
    (capital stock)
  • Role of Planning ? Economy is planned centrally
    and the planners preferences dominate allocative
  • Incentive Structure ? Moral Incentives-trying to
    motivate workers by appealing to some higher
    collective goal
  • Income Redistribution ? The governments control
    the distribution of income by setting wages and
    forbidding capital or land income

Command Socialism
  • Role of politics and ideology ? Are command
    socialist economies usually linked with
    authoritarian regimes?
  • Authoritarian political regimes also pursue
    market capitalism
  • Command socialism can also support democracy

  • An economic system characterized by state or
    collective ownership of the means of product,
    land and capital
  • Not actually exists as a system until the early
    12th century
  • Its emergence based on criticism of feudal and
    capitalist systems that existed prior to its
    modern appearance
  • Criticism originated from religious sources
    favoring egalitarian income distributions and
    collective sharing
  • Became a secular theory of history and society in
    the writings of Karl Marx

Is Socialism still popular?
  • With the collapse of Soviet Union and end of
    communism, nowadays many countries that have
    identified themselves socialist are attempting to
    move toward market capitalism
  • Why examine the socialist economic system?
  • Many are still socialist in actual practice
  • Frustration with efforts to move toward some form
    of capitalism have led to a revival of socialist
    ideology in some of the countries
  • Difficulties experienced in the market capitalist
    world have stimulated reconsideration of limited
    elements of socialist model as reformist devices

Development of Socialist IdeologyReligious and
Philosophical Precursors
  • It is originated in religious and philosophical
    criticism of inequalities in existing societies
    and the formulation of ideal alternatives in
    which collective sharing and equality reign
  • In ancient Greece ? philosopher Plato described
    an ideal society of in his Republic
  • Christianity provided opportunity for socialism
    expecting the second coming of Christ ? when all
    would be judged and there would be heaven on
    earth for the saved (millennium)

Development of Socialist Ideology
  • Thomas More Utopia described an island where
    everyone shared and was equal
  • Enlightenment of 1700
  • Secularized version of egalitarianism in French
    philosophy by Jean-Jacques Rousseau led to French
    Revolution in 1789
  • The revolution was against feudal aristocracy and

Development of Socialist Ideology
  • In 1796 Francois Gracchus Babeuf is often
    identified as the founder of modern Communism
  • Conspiracy of Equals ? abolition of private
    property and the holding in common land
  • Communism ? local units of government in France
    are called communes
  • The term socialism originated in the early 1830s
    with the British utopian socialist Robert Owen

The Marxian Worldview
  • Marxian ? refers to the writings and views of
    Marx himself
  • Marxist ? refers to any view or idea strongly
    influenced by Marx

The Marxian Worldview
  • Karl Marx (1818-1883) was born in Trier in the
    German Rhineland
  • Studied philosophy in Berlin
  • Became a radical journalist
  • Participated the uprising of Rhineland
  • Spent most of his life in exile in London
  • Supported financially by his collaborator,
    Friedrich Engels, who owned a textile mill
  • Together Marx and Engels developed Marxian
    worldview in writings which influenced socialist

The Marxian Worldview
  • Marxs worldview constitutes a holistic system by
    seeking to explain virtually everything in a
    unified whole
  • His holistic theory is his integration of three
    major strands of 19th century European thought
  • German political philosophy
  • French political sociology
  • British political economy

The Marxian Worldview The Hegelian Dialectic
  • German Political Philosophy
  • Hegel developed the idea of dialectic
  • All phenomena reflect a conflict between pairs of
    unified opposites whose joint opposition evolves
    over time to critical breakpoints where reality
    qualitatively changes
  • These opposites are labeled as thesis and
  • At the critical breakpoint their opposition
    generates something brand new, the synthesis

The Marxian Worldview The Hegelian Dialectic
  • The ultimate Hegelian thesis is the Universal
    Idea ? God
  • The antithesis is the individual person
  • The synthesis is the state
  • The idea of emergent powerful and nationalist
    German state
  • These ideas influenced the movement for German
    unification that accelerated toward its
    culmination under Bismarck in 1871 and influenced
    the ultranationalist Nazi movement in the 20th

The Marxian Worldview Historical Materialism
  • Marx materialized Hegels dialectic by using
    the idea of French Revolution
  • The key to historical materialism ? the idea that
    the driving force of history is the dialectic
    between conflicting socioeconomic classes
  • The class conflict of the emerging industrial
    society between the bourgeoisie (capitalists) and
    the proletariat (worker)
  • The Communist Manifesto starts as
  • The history of all existing societies has been
    the history of class struggles

The Marxian Worldview Historical Materialism
  • The struggle concerns
  • ownership
  • controls of means of production
  • One class owns and controls the means of
    production and exploits the other class, which
    does not own and control the means of production
  • The technology of society ? forces of production
  • Combines with the structure of classes ?
    relations of production
  • To determine the mode of production ? the
    substructure or base of the society that
    determines everything else, the superstructure,
    that is religion, politics, culture and so forth

The Marxian Worldview Historical Materialism
  • The mode of production of ancient Greece and Rome
    was slavery, characterized by the struggle
    between master and slave
  • The fall of the Roman Empire was a result of this
    contradiction ? resulting in the mode production
    transforming from slavery to feudalism
  • In turn, feudalism was driven by the struggle
    between lord and serf and was transformed into
  • In capitalism, the struggle is between the
    capitalist who owns the means of production and
    the workers who does not

The Marxian Worldview Historical Materialism
  • As this struggle reaches its peak in the most
    advanced capitalist countries such as England and
    Germany, there would be a revolutionary
    transformation into socialism with
  • state ownership of the means of production
  • direction of a production by a common plan,
    income inequalities and wage payments
  • control by a dictatorship of the proletariat

The Marxian Worldview Historical Materialism
  • Marx claims
  • Once socialism is accomplished, communism would
    eventually develop
  • All classes and property ownership would
  • The state would wither away

The Marxian Worldview The Labor Theory of Value
and the Breakdown of Capitalism
  • Ricardos labor theory of value
  • The value of a commodity is determined by the
    amount of socially necessary labor time it takes
    to produce it
  • Contradicts the neoclassical economic theory that
    value is determined by supply and demand, with
    capital contributing to the supply side

The Marxian Worldview The Labor Theory of Value
and the Breakdown of Capitalism
  • Land and capital as productive but not as
    contributing to value
  • Capital goods as being the product of past labor,
    indirect labor
  • Core of Marxian doctrine
  • The true reality of capital was not the capital
    good itself but the social relation of
    exploitation between the capitalist and the worker

The Marxian Worldview The Labor Theory of Value
and the Breakdown of Capitalism
  • The value of commodity (W) cvs
  • Constant capital (c) fixed capital stock as
    measured in the labor time required to produce it
  • Variable capital (v) the value of labor power
    used in production that is the amount of socially
    necessary labor time it takes to reproduce labor,
    equal to subsistence wage
  • Surplus value (s) value created by the worker but
    taken by the capitalist, leading to exploitation
  • Marxs modification of the labor theory
  • Marx concentrated on the surplus value- profit

The Marxian Worldview The Labor Theory of Value
and the Breakdown of Capitalism
  • Capitalist ? capital investment ? raising the
    organic composition of capital
  • c rises while s and v are constant ? the rate of
    profit declines
  • The fundamental tendency of capitalism
  • Increase the rate of exploitation ? by lowering
    wages or by working longer
  • The class struggle and the commercial crisis
  • Concentration of capital in fewer hands and
    proletariat becomes more miserable
  • Eventually the contradiction between the forces
    of production and the relations of production
    becomes so intense that the system is overthrown
    by the revolutionary working class

Controversies in Socialism Theory of Imperialism
  • Capitalism had succeeded in transforming itself
    into imperialism, expanding overseas into
    colonies to exploit their raw materials, cheap
    labor and new markets
  • The domestic market could not absorb what the
    capitalists produced, so they found overseas
  • With the enormous profits capitalist made from
    their colonies, they started paying off their
    working class ? this changed this class into
    reformists rather than revolutionaries

Controversies in Socialism Marxism-Leninism
  • Vladimir Illich Ulyanov known as Lenin developed
    the Imperialism thesis
  • Lenin noted that imperialism was expanding
  • The revolution would come in capitalisms weakest
    link, Russia
  • Industrialized too late to participate in the
    conquest of Africa
  • Dominated by foreign investment from the leading
    capitalist powers like Great Britain, France and

Controversies in Socialism Marxism-Leninism
  • Refocusing revolutionary expectations on less
    developed countries became Marxism-Leninism, the
    official Soviet doctrine after 1917
  • It also became the guiding light of Marxist
    revolution in the 20th century in less developed
    countries from China to Cuba and to Vietnam

Some Divisions of Socialism since 1917
  • Trotskyism
  • Titoism
  • Maoism

Some Divisions of Socialism since 1917 Trotskyism
  • Leon Trotsky, founder of the Red Army in the
    Soviet Union, was Stalins chief rival for power
    after Lenins death in 1924
  • He was exiled in 1927 and founded the Fourth
    International, which fragmented into factions
    after his assassination in Mexico in 1940

Some Divisions of Socialism since 1917 Trotskyism
  • Trotsky and Stalin agreed about the need for
    rapid industrialization, but they disagreed
    whether this should be done in isolation or in an
    international context
  • Trotsky supported the idea of an international
    permanent revolution, believing that true
    socialism could not be achieved in the Soviet
    Union without an international revolution

Some Divisions of Socialism since 1917Titoism
  • Marshall Tito led Communist partisans in throwing
    the Nazis out of Yugoslavia during the Second
    World War, with little assistance from Soviet Red
  • A strong Stalinist Tito broke with Stalin in 1948
    and declared political independence of Yugoslavia
    from Soviet influence

Some Divisions of Socialism since 1917 Titoism
  • Tito developed a distinctive economic system for
    Yugoslavia ? worker-managed market socialism
  • State-owned enterprises in a one-party state
    operating with little central planning and with
    managements appointed by worker selected boards
  • After Titos death in 1981, the economic system
    in Yugoslavia deteriorated and eventually

Some Divisions of Socialism since 1917 Maoism
  • In 1949 a Communist insurgency led by Mao Zedong
    took power in mainland China
  • Rural guerilla movement that encouraged
    egalitarian economic development in zones of
    revolutionary control
  • Imitated the centrally planned command
    industrialization model of Stalin
  • More emphasis upon rural agricultural
    development, egalitarianism, the use of moral

Some Divisions of Socialism since 1917 Maoism
  • In the Great Proletarian Cultural Revolution
    (1966-1969), Mao emphasized
  • industrial decentralization
  • complete communalization of agriculture
  • total egalitarianism
  • moral incentives
  • After Maos death in 1976, a decline of support
    in his ideas

The Theory of Economic Socialism
  • The Socialist Planning Controversy
  • The Theory of Command Socialist Central Planning
  • The Participatory or Cooperative Alternative

Theory of Economic SocialismTheory of Command
Socialist Central Planning
  • Central planning first appeared in Soviet Russia
    with the 1920 electrification plan
  • Indicative planning instituted for heavy
    industrial sectors under state ownership such as
    electricity, steel and cement
  • Long-term planning was on a five-year time

Theory of Economic SocialismTheory of Command
Socialist Central Planning
  • Five year plans were broken down into one-year
    plans from which monthly quotas for individual
    firms were derived
  • Each firm had a technical-production-financial
    plan that specified
  • output quantities and prices
  • input quantities and prices including wages
  • levels and kinds of capital investment
  • One years overall general plan generally
    involved minor modifications of the previous
    years plan based in the outcome of that plan

Theory of Economic SocialismTheory of Command
Socialist Central Planning
  • For the first five-year plan, the material
    balances were based on the inherited structure of
  • Figure out
  • how much of which final goods were to be produced
  • the amounts of all the inputs required to produce
    those outputs
  • the inputs to produce those inputs
  • If a commodity was in deficit then either
  • one of the three previous mechanisms would be
    drawn on
  • or greater efficiency in its production would be
  • or demand for it had been cut back

Theory of Economic SocialismParticipatory or
Cooperative Alternative
  • Also known as the labor-managed
    economy-Yugoslavia is the example
  • Market Socialist System ? state owns the means of
  • Characterized by workers ownership or workers
  • Combination of capitalism and socialism,
    constituting a Third Way

Theory of Economic SocialismParticipatory or
Cooperative Alternative
  • Workers will manage the firms
  • There will be income sharing
  • Productive resources are not owned by the workers
    ? workers enjoy usufruct rights to the fruits of
    the operation
  • Market economy ? Any kind of planning is
    indicative planning rather than of the command
  • Workers can freely choose where to work

Transition from Socialism to Capitalism
  • Transition from command socialism to market
    capitalism requires
  • replacement of command economy with market
    mechanisms in decision-making
  • privatization of state-owned enterprises to move
    from socialism to capitalism
  • liberalization of the political system

Transition from Socialism to Capitalism
  • In adopting markets rather than command
  • Freeing prices from central control was the
    easiest thing
  • Macroeconomic stabilization was more difficult to
    achieve as sudden freeing of prices led to
    inflationary outburst
  • Total output declined sharply with unemployment
  • Establishment of the institutional framework that
    allows for the open and stable functioning of
    markets is difficult
  • Developing banking, financial and accounting
  • A proper competition policy
  • Laws of corporate governance and bankruptcy
  • Opening to trade and investment
  • Foreign currency convertibility

Transition from Socialism to Capitalism
  • Problems of privatization
  • Restructuring of enterprise management is more
    important than privatization
  • Countries that privatized quickly ran into
    serious problems (Russia and Czech Republic)
    compared to those that privatized more gradually
    (Poland and Slovenia)
  • Privatized firms in transition countries exhibit
    greater productivity that state-owned ones
  • The emergence of social problems as countries
    fell into deep recessions with high inflation and
    institutional instability

Varieties of Advanced Market Capitalism
  • Chapter V
  • The United States of America
  • The Market Capitalist Leader

Worlds Largest Economy
  • Not only the prime example of market capitalist
    economy but is technological leader of the world
    with very high per capita income
  • Its important role in developing distinctive
    institutions of market capitalism, such as modern
  • From a nearly pure laissez-faire economy in the
    mid-19th century has become a mixed economy, but
    still laissez-faire oriented
  • The darker side of market capitalism, with
    relatively high levels of income inequality and

Worlds Largest Economy
  • Oldest constitution of any nation on earth 1787
  • Well established private property allowed the
    market capitalist economy to function flexibly
  • Greatest crisis and conflict was over the slavery
    system that divided the industrial North from the
    cotton-growing South
  • Civil War of 1861-1865

Worlds Largest Economy
  • Leading in technology with the emergence of the
    American system of interchangeable parts and
    standardization during the early 1800s
  • Innovator in economic institutional structures
    and organizational forms
  • The key organization of the modern world economy
    ? industrial corporation whose standard form
    emerged in the railroads

Worlds Largest Economy
  • Fordist assembly line production
  • US automobile industry ? modern multidivisional
    corporation ? General Motors Corporation
  • Mass production with rapidly rising productivity
  • Institutional foundation of modern American
    macroeconomic policy established in 1913
  • Federal income tax and the establishment of the
    Federal Reserve System
  • Development of a strong financial system

Worlds Largest Economy
  • After WW I displaced Great Britain as the worlds
    leading financial power
  • but avoiding a global role
  • Isolationist attitude ? refusal to join the
    League of Nations in 1920
  • The Great Depression of the 1930s and the
    presidency of Franklin Roosevelt ? expansion of
    the federal governments role in economy moving
    away from pure laissez-faire

Worlds Largest Economy
  • Change in attitudes with WW II
  • Took the lead at the Bretton Woods Conference
  • Washington D.C became the headquarters for the
    new postwar global economic institutions ? IMF,
    World Bank
  • New York City ? UN (successor to League of
  • The General Agreement on Trade and Tariffs (GATT)
    in 1948 ? tariff-reducing negotiations and moves
    to expand international trade
  • Establishment of World Trade Organization (WTO)

Worlds Largest Economy
  • 1980s ? a period of deregulation of the US
  • US leadership of the word economy challenged by
    other countries, especially Japan
  • The stagnation of Japanese economy after 1990
  • New Economy high technology development in US in
    late 1990s, led by the information technology
    sector ? reasserted its primacy position
  • A speculative bubble in the US stock market that
    peaked in early 2000 and high-tech sector has
    been in slowdown since
  • Recession of 2001 ? terrorist attacks

Historical Development of the US Economy Growth
and Reform
  • By the end of the 19th century ? the worlds
    largest aggregate economy with rapid growth and
  • Expansion of railroads
  • Development of the new corporate industrial
    organizational form
  • Major technological innovations
  • Light bulb by Thomas Edison ? General Electric
  • Telephone by Alexander Graham Bell ? ATT
  • Establishment of a strong patent system

Historical Development of the US Economy
Changing Trends
  • Rapid economic growth in the 1960s and early
    1970s dramatically slowed down after the first
    oil price shock in 1973
  • US economy only managed to recover in the late
    1990s with high-technology boom after inflation
    was brought under control
  • The Soviet Union, Americas greatest postwar
    ideological and military rival, ceased to exist
    in 1991
  • Japan, Americas greatest economic rival, went
    into severe economic stagnation after 1990
  • Americas high-tech sector emerged in the 1990s

Basic Ingredients of the American Economy
  • Natural Resources
  • Labor
  • Manufacturing and Investment

Basic Ingredients of the American Economy
Natural Resources
  • Rich in mineral resources
  • Fertile farm soil
  • Fortunate to have a moderate climate
  • Has extensive coastlines on both the Atlantic and
    Pacific Oceans and Gulf of Mexico
  • Rivers flow from far within the continent
  • Has Great Lakes ? provide additional shipping

Basic Ingredients of the American Economy Labor
  • Steady growth in the labor force ? led to
    constant economic expansion
  • Until shortly after World War I, most workers
    were immigrants from Europe, or African Americans
  • Beginning in the early 20th century, many Latin
    Americans immigrated
  • They were followed by large numbers of Asians

Basic Ingredients of the American Economy
Manufacturing and Investment
  • In US, the corporation has emerged as an
    association of owners, known as stockholders, who
    form a business enterprise governed by a complex
    set of rules and customs
  • Through the stock market, American banks and
    investors have grown their economy by investing
    and withdrawing capital from profitable

The American CorporationNature of the American
Corporate Form
  • Americas most important contribution to the
    world economy has been its development of the
    organizational form of the modern corporation
  • Anglo-American Corporate Form that is different
    from those found in Japan, Germany and other
  • Distinct internal hierarchies and divisions
  • Led by strong and highly paid chief executive
    officers (CEOs)
  • With relatively little control by banks, other
    firms, workers, and government
  • Ownership is by stockholders
  • Tendency in recent years to make CEOs or other
    top managers part owners by giving them stock
    options as part of their compensation
  • Reduces the principal-agent problem arising from
    the separation of ownership and control in large

The American CorporationNature of the American
Corporate Form
  • In 1819 the doctrine of the juridical identity of
    the corporation as effectively a legal person
    distinct from its owners
  • The emergence of the limited liability
    corporation, whose finances were legally distinct
    from those of the owners of the corporation

The American CorporationRegulation and
  • The rise of American corporations generated a
    broad movement to restrain their power and
    perceived excesses
  • This began in 1887 with the establishment of
    Interstate Commerce Commission (ICC) to regulate
    the rates charged by railroads
  • Anti-trust regulations started after the passage
    of Sherman Act of 1890
  • Federal Reserve System regulated the banking
    system after 1913
  • Civil Aeronautics Board regulated airfares and
    airline routes
  • Federal Communications Commission regulate
    allocation and the use of the radio spectrum

The American CorporationRegulation and
  • Monopolies are allowed in certain industries that
    were subject to rate regulation
  • ATT in telephone industry
  • Electric utility industry
  • During 1960s focused on safety and environmental
  • Monitoring food and drug safety
  • Consumer product safety

The American CorporationRegulation and
  • As the 1970s proceeded, movements to reduce
    regulations arose
  • The first deregulation is to deregulate the
    airline fares and routes (The CAB was eliminated
    in 1983)
  • The ICC was eliminated in 1996
  • In the early 1990s the FCC moved to auctioning of
    spectrum rights
  • EPA moved to the use of marketable pollution
    emission permits, notably for sulfur dioxide
  • Long distance telephone industry ATT
  • The deregulation of the electricity supply

Prospects and Problems of the American Economy
  • The Problem of Poverty and Inequality
  • The overall time trend of inequality
  • There was a gradual trend toward greater equality
    from the late 1920s
  • Increased dramatically during WW II
  • Continued until the mid-1970s
  • After the trend reversed and inequality has since
    tended to increase
  • The role of government in these trends
  • Transfer payments rising
  • Social security for elderly
  • Transfer payments to low income groups have raised

Prospects and Problems of the American Economy
  • The Rise of the New Economy
  • Second half of the 1990s
  • A steady decline of the unemployment rate
  • Low inflation
  • Decline in poverty
  • Acceleration in the economic growth rate
  • Increase in rate of productivity
  • The accumulated impact of computerization and the
    spread of new technologies as the internet

Prospects and Problems of the American Economy
  • The Mass Consumption Society and Its
  • High levels of consumption
  • Luxury fever never ending pursuit of more and
    more expensive luxury goods
  • Low savings rate and high personal debt/income
  • US become its largest net debtor by the mid-1990s

Back and forth From laissez-faire economy to
governments intervention in economy and back to
  • During much of the 19th century, US was almost a
    purely laissez-faire economy
  • In the 20th century, role of federal government
    increased on various stages
  • Progressive Era Reforms of 1901-1909
  • New Deal of 1930s
  • Great Society initiatives of the 1960s
  • Since 1960s US economy has experienced
    deregulation and other moves back to
    laissez-faire (although 1/3 of the economy is
    directed by some level of government)
  • US definitely has a mixed economy despite its
    strong orientation to market capitalism

Conclusion The United States of America The
Market Capitalist Leader
  • The worlds most dynamic and flexible society and
  • Immigrants from an increasingly diverse array of
  • Established institutions of contract and property
  • Evolving corporate forms, patterns of
    standardization and mass production
  • A tradition of entrepreneurship
  • Technologically leadership based upon basic
    science and solid RD within a financial and
    institutional framework
  • The darker side of market capitalism with high
    levels of income and wealth inequality

Varieties of Advanced Market Capitalism
  • Chapter VI
  • Japan A Planned Market Economy
  • with Traditional Elements

Japan As a New Traditional Economy?
  • Experienced the most rapid rate of sustained
    economic growth in the world
  • Maintained low unemployment and inflation rates
    and a greater degree of income equality
  • Leading many areas of technology

Japan As a New Traditional Economy?
  • Have large trade surpluses resulting in the
    largest accumulation of foreign reserves
  • Number One? ? stagflation in 1990s
  • Its conflicts with other nations on trade issues
    threatened to push the world economy into a trade
    war and depression

Japan As a New Traditional Economy?
  • Debates about the basis of Japanese success
  • Advocates of government economic intervention
    argue that bureaucratic guidance through
    indicative planning and industrial policy has
    been key to its success
  • Advocates of laissez-faire argue that these have
    been more a hindrance than a help, with the most
    dynamic sectors ignoring the government

Japan As a New Traditional Economy?
  • A mixture of structures and systems unique in the
  • A market capitalist economy
  • The government engages in indicative planning and
    exerts significant influence
  • The first society of non-European origin to carry
    out industrialization and modern economic growth

Japan As a New Traditional Economy?
  • Succeeded in adopting foreign technologies and
    practices without giving up its indigenous
  • Late 19th century slogan Japanese spirit and
    Western ability
  • Familistic groupism of Japanese society ? a
    feudalistic holdover
  • Harmonious labor-management relations and
    government-business relations
  • Planned market capitalism with strong traditional

The Microeconomic Foundations of The Japanese
  • The Three Sacred Treasures of Labor-Management
  • The Japanese Firm and the Keiretsu System
  • Managerial Decision Making
  • Industrial Policy by Government

The Three Sacred Treasures of Labor-Management
  • Highly educated and well-motivated labor force
  • Many quality-and productivity-improving
    innovations suggested by workers on site
  • Three sacred treasures
  • Lifetime employment
  • Seniority-based wages
  • Enterprise unions

The Three Sacred Treasures of Labor-Management
  • Japanese labor
  • Intra-enterprise job rotation by multifunctional
  • On-the-job firm-specific training
  • Bonus payments
  • Compensation flexible
  • Contracts negotiated annually
  • Employment stable
  • Large severance payments at retirement but few
  • Dualism

The Three Sacred Treasures of Labor-Management
Relations Lifetime Employment
  • The key to stimulating loyalty and drawing forth
    innovative, productivity-improving suggestions
  • Limited to about 30 of the labor force, mostly
    educated men in large firms that must retire at
    age 55 with large severance payments and assisted
    in getting other jobs in smaller firms
  • Japanese workers more likely to stay with a
    single firm for a longer period of time, even in
    small firms

The Three Sacred Treasures of Labor-Management
Relations Lifetime Employment
  • Depending on
  • Stability of employment
  • Rapid growth of the economy between 1945 and 1990
  • Synchronized annual negotiating system
  • Bonus system ? a form of profit sharing

The Three Sacred Treasures of Labor-Management
Relations Lifetime Employment
  • Development of firm-specific human capital by
    rotating workers from job to job within the firm
  • Workers know all about the firm but lack skills
    that are transferable to other firms
  • On-the-job training of blue-collar workers ? but
    white collarization in larger firms
  • Greater loyalty to firm ? Confucian code
  • Firms more willing to engage in firm-specific
    training if they believe workers will remain for
    a long time

The Three Sacred Treasures of Labor-Management
Relations Seniority Wages
  • Confucian view of respect for elders
  • Steeper age-wage profile for blue-collar
  • Seniority wages reinforcing loyalty to the firm
    among lifetime employees
  • Expectations of performance-based pay

The Three Sacred Treasures of Labor-Management
Relations Enterprise Unions
  • If one is committed for life to a specific
  • One has been working at several different jobs
    with the company, thus not being tied to a
    particular skill or craft
  • ? it is logical to belong to a union that
    negotiates directly with that company and only
    that company
  • Stability of labor-management relations
  • Happy family of the firm
  • Critics Inefficiency

The Japanese Firm and the Keiretsu System
  • The existence of interlocked associations of
    firms ? keiretsu
  • Horizontal keiretsu
  • Revivals of the prewar zaibatsus (single holding
  • Firms in different industries all linked to a
    common bank and trading company maintaining their
    formal independence
  • Vertical keiretsu
  • A set of suppliers and distributors linked to a
    major industrial producer by long-term contracts

The Japanese Firm and the Keiretsu System
  • Toshiba Corporation
  • At the center of a vertical keiretsu including
    distributors, suppliers and suppliers of direct
  • A member in Mitsui horizontal keiretsu

The Japanese Firm and the Keiretsu System
  • Horizontal keiretsus practice three sacred
    treasures of labor-management relations
  • Peripheral firms in vertical keiretsus tend not
    to do so
  • Keiretsus ? cross-holding of stocks
  • In horizontal form ? much stock ownership by the
    bank and a large proportion of loans from the

The Japanese Firm and the Keiretsu System
  • Network externalities
  • Group membership may have a negative impact on
    profitability relative to independents run by
  • Vertical keiretsus may achieve efficiencies
    because their stable long-term contracts allow
    for just-in-time delivery, kanban system that
    minimize inventory costs and encourage superior
    quality control

Managerial Decision Making
  • J-mode depends on both long-term relationships
    between workers and firms and long-term
    relationships between banks and firms which tend
    to hold for keiretsu members with lifetime
    employment systems
  • Top managers risen from within the firm increase
    the loyalty
  • Management as the representative of the employees
  • Labor-managed firms

Managerial Decision Making
  • Horizontal coordination through processes of
    consensual decision making
  • Dependence upon workers for suggestions for
    improving the firms performance
  • Seniority-based rank hierarchies
  • Given long-term nature of employee-firm relations
    and of bank-firm relations, managers use longer
    time horizon for strategic planning
  • Emphasis upon maximizing market share subject to
    minimum profit constraint, rather than maximizing
    short-run profits

Industrial Policy by Government
  • Government-business relations labeled industrial
  • Ministry of International Trade and Industry
  • The state being the driving force of the Japanese
    economy ? supremacy of government bureaucrats
  • High-level bureaucrats to high-level employment
    in top firms

Industrial Policy by Government
  • MITI intervention in markets ? product cycles
  • Beginning stage of an industry
  • Infant industry tariffs
  • Subsidies for special capital investments
  • Rationalization cartels that carry out
    MITI-financed RD
  • At the end of product cycle
  • To reduce closeout using depression cartels

Industrial Policy by Government
  • Overall rapid growth
  • Export success of targeted industries
  • Shipbuilding, steel and computers
  • MITI failed in the late 1950s to cartelize the
    automobile industry down to two firms
  • Honda ? the most technically innovative of the
    automobile companies and a great export success
  • Sony ? rejected to produce transistor radios
  • Both founded and led by strong-willed
    entrepreneurs operating outside of the planning
    and keiretsu system

Why Japan Failed to Become Number One
  • Macroeconomic Performance
  • High rate of growth
  • High capital investment rate backed by a high
    savings rate
  • After bursting of the Japanese stock market
    bubble in 1990
  • Growth rate fell below those of other leading
    market capitalist economies with unemployment
    rate increasing

Why Japan Failed to Become Number One
  • High savings rate
  • Confucian ideals
  • High growth rates as consumption increases lag
    behind income increases
  • Individuals save to make down payments on homes
  • Workers save for old age because of the
    combination of early retirement with low pensions
    and low social security payments
  • The lumpiness of large bonuses
  • No capital gains tax except on land
  • Most of the postwar period, a relatively young
  • But rapidly aging population

Why Japan Failed to Become Number One
  • Macroeconomic Planning Policy
  • Market capitalist economy with elements of a
    traditional economy and indicative planning
  • Sectoral and technological planning ? MITI
  • Macroeconomic plans ? Economic Planning Agency
  • Relatively low levels of government spending and
  • Low level of social transfer payments
  • Low defense spending, due to US demilitarization

Why Japan Failed to Become Number One
  • Quality of Life
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