Market Magic


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SOCIALISM | Market solutions

Market magic
Capitalists blame a naive socialist belief in equality for most of our
economic problems. Socialists point the finger at our market economy as
the source of inequality. Economist Peter Donaldson argues that market
forces could be made to work for socialism rather than against it.

SOCIALISM flies in the face of human nature. So goes the age-old argument against equality: it won’t work because no matter how much you shake up the bottle ‘The cream rises to the top and the dregs sink to the bottom’. The power of this argument lies in its simplicity. And upon it has been built an economic doctrine that seems natural and efficient.

Right-wing economists argue that people should be allowed to keep more of what they earn so that hard work, talent and ability are properly rewarded - and that is why economic policies in Britain, the United States and elsewhere have laid great stress on cutting taxation.

Strengthening incentives for the wealthy will deliberately increase inequality. Advocates of such policies would agree - and make no apology for it. This, after all, was what made Britain ‘Great’ and it led the way to modern economic growth. And hasn’t this well-worn path also been followed by the United States, other West European countries and Japan? Hasn’t their success been founded on the dynamic drive of entrepreneurs motivated by the chance of making their fortunes and on workers who want to ‘get on’ and better themselves?

Socialism, on the other hand, is about equality. And this, say critics, is its fundamental weakness - on three major counts. First, it can’t be achieved. Human talent and endeavour come in such variety that inequalities will inevitably survive any misguided attempts at getting rid of them. ‘Equal at dawn, unequal at dusk’.

Second, equality is unfair. This is a view that is held not only by the ‘haves’ with an obvious vested interest to protect - but also by the ‘have-nots’ who want to defend their opportunity to improve their lot in the future.

And third, equality means inefficiency - as can be seen in those ‘socialist’ countries of the Eastern bloc and other parts of the world where incentives are replaced by the muddled meddling of a planned economy.

The result of socialist planning and egalitarianism, the critics argue, is a loss of the will to work and innovate. Couple this with production that is all too often unrelated to demand and you have a socialist disaster - and a sharp contrast with ‘free market’ economies which flourish precisely because they are geared to meeting consumer wants.

This is the case commonly presented against socialism. In fact, as we shall see, it rests on three Great Myths. But first, very broadly, just how is a ‘pure market’ system supposed to work?

It’s all to do with prices, demand and supply. Prices act as two-way signals. They flash messages to producers about the relative strengths of consumer preferences. And they reflect, on the other hand, the relative scarcity of resources that go into making different types of products.

The system works like this. If consumers prefer one product to another, they will buy more of it. This will tend to push up its price, and producers (now making higher profits) will be able to buy more equipment and hire more labour to meet the higher demand. Those producing less popular lines, however, cannot lay their hands on as many resources because the prices they get for their goods will have fallen. Magically, without any intervention from government or planning bodies, resources will be shunted around so that they are used to maximum efficiency in meeting consumer requirements. It is the consumer who calls the tune.

Now to the Great Myths. The first is that capitalism and this kind of pure market economy are one and the same thing. They are not. Capitalism in practice does not consist of a host of small firms vigorously competing with each other for consumers’ favours. Instead it is dominated by giant multinational corporations often capable of setting their own prices, taking their profits where they choose, and moulding rather than responding to consumer tastes. Sometimes the companies are more powerful than the governments of the countries in which they operate.

The second Great Myth is that existing inequalities under capitalism correspond with the rewards and incentives required by the ‘market’ model. Some may, most certainly do not. The economic, let alone moral, justification of the vast disparities of income and wealth that prevail in today’s world have to be seriously questioned.

Some people do get much more than others - and there can be many reasons for this. At one extreme there’s the pop star or virtuoso violinist who can command a huge fee because of a natural talent that is in short supply. Trained and educated people also have higher than average earnings because, it is argued, of the ‘investment’ that has gone into development of their skills. Certain workers can also achieve high pay because of their powerful bargaining position in the economy.

Further up the social scale there are people who earn vast amounts because they are in occupations entry into which is limited to those of a privileged social background. Then there are the managers of companies who in effect fix their own levels of remuneration. And finally, there are those for whom a major source of income is the return of their inherited wealth.

But how far do these differentials perform an economic function in signalling the need for labour and resources to be shifted from one type of use to another? Do they serve as the crucial incentives that will induce people to move from being shop assistants, say, to merchant banking? The test of whether they do or not is a rather curious one. If income differentials are to be effective in bringing about movements of labour, they will tend to be reduced as a result of workers seeking better paid employment. The wages of the merchant bankers would fall as the check-out girls responded to the lure of the City.

But this is not what happens. In the world in which we live, the pecking order of income differences remains largely unchanged. If anything, the gap between rich and poor widens rather than narrows. As the song goes ‘the rich get richer and the poor get poorer’. And it is not difficult to see why.

It is mainly because in the real world labour is not able freely to move between areas, between jobs, and most of all between classes of jobs. There are a host of institutional and social barriers. Some movement is certainly possible. A shop worker may move to a factory if the wages there are higher. And such movements will indeed even out the differentials between these two jobs. But the fact that a merchant banker can earn far more doesn’t cause shop assistants to take up banking. The obstacles would be insurmountable. Even the children of the shop assistant will subsequently find it relatively difficult to jump such barriers - all the evidence shows that the offspring of the poor have less chance of entering highly paid professions.

There are many salaries which certainly include a payment over and above that needed to keep someone in their present occupation. They have come about and persist, not as the clear signals of a market economy, but because capitalism in practice is beset by blemishes which make it far removed from the pure market model. Income differentials are often far more a reflection of our implicit social values than of economic necessity.

But isn’t even this preferable to grey stagnation of the so-called ‘socialist countries’ where, it is suggested, the population is deprived of material incentives and therefore the will to work and better itself? Isn’t the essence of capitalism - and what gives it its dynamic drive - the fact that it is geared to producing what consumers want? Centralised socialist planning is painted as a nightmare of shortages and shoddy goods.

This is the contrast on which critics of socialism rest their case. But it relies on a third Great Myth - that socialism is necessarily synonymous with centralised physical planning and aims at absolute monetary equality.

Certainly under any socialist system several key activities like the provision of health care and education would necessarily be removed from the market entirely. Ownership of major industries and services would be transferred to the state or worker co-operatives. The economy would be run within the framework of an overall plan laying down objectives, targets and suggesting means of overcoming obstacles to achievement.

But with this done, there is no reason why the market should not then be allowed to come to play. It is a brilliantly simple mechanism for co-ordinating myriad decisions about consumption and production. And it has yet to be bettered by any alternative method of detailed physical planning.

The market would however work in a different way under socialism - more efficiently, in fact. A socialist government would determine overall levels of spending in the economy so that the wastage involved in paying millions of unemployed people to do nothing would be avoided. And a much broader view would be taken of the role of individual enterprises, evaluating their activities according to the wider effects of their policies on the rest of the economy, and society. Their profit (or surplus) maximising activities would now have to take into account social rather than narrowly private costs and benefits. The economic case for closure of a factory, for example, would have to take into account its likely effect on the whole community rather than just on the balance sheet of the company concerned.

It would be much more acceptable and productive to have market forces working within a socialist framework because of the new forms of distribution of income and wealth within which it would operate.

In a socialist system there would be inequalities. At a basic level, there is nothing unsocialist in the notion that those working harder at the same or a similar job should be rewarded for doing so. But beyond that, there would be three major differences from the sort of inequalities that we find under capitalism.

In the first place, some of the differentials that might arise would be the reverse of those that exist in our own society. A coal miner might well, for example, earn more than a university teacher - because a socialist economy would tend towards equality of net advantages (with the miner receiving higher monetary returns to compensate for the dirt and danger of the occupation as compared with the non-pecuniary rewards of the academic life).

Secondly, many pay differences would exist only temporarily. They would reflect relative demand and supply - in this case doing what the advocates of the free market say they should by signalling the scarcity of labour in a particular area of employment. Equality of opportunity from a starting point of broad equality would ensure the mobility of resources between various occupations that would eventually cause income inequalities to equalise themselves. Finally, inequalities would only arise from work. The notion of inherited wealth which causes the young to start from very different positions of privilege would have no place within a socialist ideology.

The fascinating fact is that only’ within a socialist framework can the market do its job efficiently and with a socially acceptable outcome. Only when the parameters within which it works are fundamentally altered from the present ones can it live up to the expectations of the kind of economists who have ardently advocated its merits for the past couple of centuries.

There are many on the left who are unable to distinguish the great potential benefits of the marker as an instrument from the distorted way that it works under capitalism. They are as blind as those on the right who see socialism as the negation of individual incentive and enterprise. This failure of the imagination is a deadly political trap. What socialism offers is the chance to use the market mechanism in a way that truly frees individual initiative - and allows it to work for the good of all.

Peter Donaldson is Tutor in Economics at Ruskin College, Oxford, UK and the author of numerous books - the latest of which is A Question of Economics published by Penguin.

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