Spotlight on Chapter 8: The “real competition” between systems

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This excerpt from Chapter 8 (Social Justice, Well-Being and Economic Organization) discusses the merits and flaws of various socio-economic systems, and analyzes the “real competition” between systems.

The textbook concept of ideal competition can mislead the discussion of markets, governance, and social justice. The concept of “real competition” is inspired by Joseph Schumpeter, who, in his book Capitalism, Socialism and Democracy (1942), coined the phrase “Creative Destruction” to emphasize how the new competes with, and eventually replaces, the old. This is the type of contest that is relevant for the feasibility of a more just society.

Schumpeter’s basic idea—which stems from Karl Marx—is that the newly created product, method of production, market, and industrial organization revolutionize “the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism. It is what capitalism consists in and what every capitalist concern has got to live in” (Schumpeter, 1942: 82).

Real competition is dynamic, but it is not only a race to create new products, new technologies, or new work organization where the winner obtains a temporary monopoly position that constitutes the private benefits of innovation. The distinction between real and ideal competition extends way beyond dynamic technological choices. Real competition takes place also in non-market areas including institutional change, organizational design, in politics, and between economic systems. In contrast to the personal incentives, individual solutions and shortsightedness of ideal competition, real competition often rewards complementary gains such as cooperation, trust, and long-term thinking. This is why global competitive forces can induce social equality that revolutionizes the political and economic structure from within.

Of course, the essence of all competition—real and ideal—is contest and rivalry. But here the similarity stops. Real competition is about innovation broadly defined. The contest is to be first to do something new where some contestants win and others lose, creating economic inequalities between them. Thus there may be great differences between winners and losers, and often the winners take all. Real competition may therefore require countervailing power to produce good results, and social organizations such as unions can be important to create the complementarity between capitalist dynamics and social security. A concern for social dynamics must be based on a perception of real competition, not its ideal textbook variants, concentrating on the small margins. Real competition is also over discrete choices, great leaps, and social and economic systems.

Socialism versus Capitalism?

Eric Hobsbawm characterizes the period from 1914 to 1991, from the First World War to the fall of Communism in Eastern Europe and the Soviet Union, as the short twentieth century[1]. The fifty years prior to that was a period in which the ideology of socialism spread rapidly in Europe, inspired by the writings of Karl Marx and Friedrich Engels (The Communist Manifesto (1848) Das Kapital, vol. 1 (1867)). Marx proposed a theory of historical materialism, which asserted that a mode of production would last as long as it stimulated technology (what he called the productive forces) to improve.

Each mode of production (slavery, feudalism, capitalism) had, Marx claimed, its progressive period, in which it fostered technological development (with concomitant increases in labor productivity). Eventually, however, the property relations that characterize a mode of production (e.g., the slave bond, the tying of the feudal serf to the lord’s manor, the worker under capitalism who voluntarily trades his labor for a wage to a capitalist who owns the means of production) become a fetter on the further development of the technology, and those property relations are replaced by other ones (‘burst asunder’), that will continue to foster technological development.

The mechanism through which this creative destruction of property relations occurs is class struggle. Thus, Marx claimed, feudalism eventually was transformed into capitalism as a result of serf revolts and the competition from a new merchant class in the towns and a growing class of independent workers not bound to feudal manors. In the process, bonded serfs became free laborers. Marx and Engels, in their 1848 manifesto, argued that the capitalist mode of production was reaching the end of its progressive period, and that it would be toppled and replaced with a system of property relations—socialism—which would foster the further development of technology, labor productivity, and human flourishing.

In this revolutionary transformation, capitalist workers, who own no capital, become workers who jointly own the capital stock of the country. The private and highly concentrated ownership of capital characteristic of capitalism would come to fetter technological development, and would be replaced by some kind of social or public ownership of capital.

We do not need to evaluate the logic of Marx’s theory here: interested readers are referred to G.A. Cohen’s Karl Marx’s Theory of History: A Defence (1978), the most rigorous treatment available of the theory. What’s salient is that the theory ignited a fuse in Europe—which eventually spread around the world—to organize socialist/communist parties to bring about the socialist revolution. In 1871, the workers of Paris occupied the city, establishing themselves as the Paris Commune, and attempted to organize Paris on a socialist basis. The Commune lasted a few months, until a massive military assault by the French army succeeded in overthrowing it.

The first socialist revolution that succeeded in a whole country was the Bolshevik revolution of October 1917 in Russia. The Soviet Union lasted until 1991, when it peacefully imploded and was replaced by a capitalist regime. Most of the formerly state-owned resources and firms, within a decade, ended up as the private property of a small group of new capitalist oligarchs, in a property grab organized by Boris Yeltsin that puts the nineteenth century American robber barons to shame.

It is fair to say that this ‘short twentieth century’ was a contest between capitalism and socialism, and by most accounts, capitalism won. Of course, China remains a huge country that has found a formula for escaping the economic sclerosis that characterized the eastern European and Soviet economies. China’s leadership continues to call its mode of production socialist. But certainly, with the possible exception of China, capitalism appears to be the only option on offer. Although economic inequality is extreme in the advanced capitalist countries in the west, and in the developing capitalist economies in the rest of the world, the present period is markedly different from 1850: no Karl Marx has emerged with an inspiring and radical vision for transforming capitalism into a system more effective at meeting human needs.

One of our tasks in this chapter is to ask whether, indeed, capitalism is the ‘end of history.’ Must we tolerate the extreme concentration of wealth and income—even after taxes—that characterizes advanced capitalism? That is to say, do the relatively high living standards of most people in these countries depend upon a system of economic organization that rewards those at the very top so lavishly?

Those lavish rewards would perhaps be tolerable if those who receive them were in other ways ordinary citizens. But they are not. With wealth comes power and political influence. Families with this kind of wealth will spend considerable resources to prevent democratic movements from confiscating their wealth through taxation. They will attempt to influence the state to protect their privileges.

One can ask whether a de jure democracy can possibly be a de facto democracy if the wealthiest one-thousandth of the population own almost one quarter of the total wealth of the country. Globally, the wealthiest 1% of households owns 50% of the wealth.

An important qualification to this perhaps pessimistic evaluation should be made. While capitalism continues to distribute income and wealth in highly unequal way, there are major differences between advanced capitalism today and its predecessors a century ago. Taxes comprise, on average, 35% of gross national product in the OECD countries, and in the Nordic countries, that fraction is either slightly above or slightly below 50%[2]. These tax revenues are spent on universally distributed private goods (such as education, health care and child care) and on public goods. That is to say, the welfare state has grown immensely in the twentieth century in the OECD countries, and this has massively improved the lives of citizens. Nevertheless, despite the security that the welfare state provides, the concentration of wealth is extreme in these same countries. In the United States, the wealthiest 1% of households owned 32% of total wealth in 2010. In France, they owned 25%, and even in egalitarian Sweden, they owned 20% of the wealth.

Even more dramatic is the concentration of wealth within the top 1%. In 2013, the wealthiest 0.1% of US households owned 22% of the wealth: that is, the average wealth of the 150,000 households in this slice of the population was 220 times as much as that of the average US household. In 1929, just prior to the stock market crash, the wealthiest 0.1% owned 25% of the wealth. So the advance of the welfare state does not appear to have done much to dent the portfolios of those at the very top of the wealth distribution[3].

Can the welfare state, and social equality more generally, help trigger real competition in a more just direction? How do more social equality and more worker security affect economic development, interpreted as a process of creative destruction? Does a more fair distribution of earnings come with a cost? Does social equality slow down or speed up the process? Shortly we provide answers to such questions. As we shall see, equality can be particularly good for economic development.

 Soviet Union—political dictatorship without markets

To explore what the possibilities are with respect to economic organization in the future, we must evaluate why the Communist experiments of the twentieth century failed (with the possible exception of China, which we will discuss later). To recapitulate, the Marxist vision was that the extreme concentration of wealth and income that characterized mid-nineteenth century capitalism, and its concomitant impoverished proletariat, would be replaced by an economic regime in which the capital stock of the country was owned by everyone.

This formulation is, however, vague: should capital be distributed equally to all households, and held in private ownership? Should it be allocated to groups of workers who would organize their own firms? Or should it be held by the state, which organizes production with state-owned firms whose profits go into the state treasury? In the event, the formulation that won out with the Bolshevik revolution was the third one. The state would own the capital stock, allocated to state-owned firms. In the Soviet Union, this included agricultural land, upon which the economic units were collective farms and state-owned agribusiness.

We believe that there were two principal mistakes that, eventually, destroyed the Soviet-type economies. The first was a system of political dictatorship, which lacked even the imperfect mechanism of political accountability that characterizes capitalist democracies. In January of 1918, Lenin abolished the Duma, the Soviet parliament, which was the forum in which political parties could compete over policy.[4] From then on, the Soviet Union was a dictatorship, with the Communist Party in control.

The second error, which was not clearly visible for a while, was the refusal to introduce markets to organize production and distribution.[5] The fear that markets would bring with them a reappearance of capitalism was sufficiently strong among the leadership of the Soviet Union that markets and freely moving prices were never introduced, despite an active discussion of the question in the 1960s (see Evsey Liberman (1962)), and some economic reforms that did occur in the 1960s[6].

The reason that the system of resource allocation through central fiat was not initially seen as an error was that, for many years, the Soviet economy performed quite well. In particular, industrialization was sufficiently rapid in the 1930s for the USSR to build up a defense industry that was able, along with the Soviet military machine, to turn back Hitler’s onslaught on the eastern front. The Soviet Union was the only country that succeeded in repelling Hitler’s invasion, and it was eventually largely responsible for the defeat of Germany. (Twenty million Russians lost their lives in the war; the US lost half a million.) Industrialization was successful because it depended mainly upon moving millions of semi-productive farmers into factories and the cities, a process that did not require markets. Indeed, in the early 1950s, many in the west thought that the Soviet economy would soon outperform western economies[7].

Moving semi-employed farmers into factories, however, is the low-hanging fruit of economic development. The more subtle problem of organizing complex inter-firm trade, providing goods to consumers when and where they are needed and desired, and innovating, cannot be organized by centralized allocation—at least in a large, complex, modern economy. True, the Soviet economy was able to develop one or two sectors (such as space travel) by focusing a great deal of talent on the problem (much as the United States did in its centrally planned Manhattan project that produced the first atomic bomb), but there is no example of a centrally planned system solving the millions of problems that must be solved to innovate and allocate resources in a complex economy. When the Soviet economy reached the stage where it had to do so in order to advance, it hit a wall—sometime in the 1960s or 1970s.

Markets perform the function of allocating many kinds of goods and resources, even when there are millions of people who need the goods and hundreds of thousands of firms that use resources to produce them, in a relatively efficient manner. They do this by providing individuals and firms with material incentives—typically, the firms and entrepreneurs desire to maximize profits, workers desire to earn a decent living, and consumers (who are also workers) desire to meet their household needs within their budgets. There are a number of caveats concerning the efficiency of markets, but these should not obscure the fact that markets are an essential institution, one that has evolved over millennia, that we do not know how to replace. Any complex economy must use markets, at least in the foreseeable future.

The problem is that market systems, unless properly managed, lead to huge inequalities of income and wealth. Those who succeed in the competition to provide commodities to a public that desires improvements and novelty in its daily life can become fabulously wealthy (Bill Gates’s wealth is approximately $80 billion, more than the gross domestic product of 124 countries.) The key question we must address is whether it’s possible to have a high standard of living, fairly equally enjoyed in the population, with a large complex economy, where economic activity is organized using markets. The leaders of the Soviet-style societies of the short twentieth century elected not to introduce markets because they believed the answer was no. The only way of maintaining a semblance of equality was, they believed, to stick to the system of central allocation. In the end, this engendered economic sclerosis and implosion of the system.

China—market competition without political competition

The Chinese Communist leadership, learning from Soviet errors, decided they must transition to a market economy: this was the deduction of Deng Xiao-ping. They saw Japan, South Korea, Taiwan, Hong Kong and Singapore leaping ahead of them. In 1979, under Deng’s leadership, the Chinese began dissolving the collective farms and leasing land to peasant households on a long-term basis. At the same time, they gradually introduced markets for agricultural produce. This is not the place to recapitulate recent Chinese economic history, but the summary is that, with the gradual spread of markets throughout the economy, gross national product grew by perhaps 9% per year for a period of thirty years, implying that the average material standard of living grew by a factor of thirteen in a single generation. Hundreds of millions of Chinese people exited extreme poverty, perhaps the most dramatic episode of poverty eradication in history. Indeed, the increase in income of Chinese households significantly lowered global inequality—as measured by the Gini coefficient of household income globally—as the Chinese peasantry comprised a large mass of the poorest in the world.

However, China did not succeed in simultaneously preserving what any reasonable observer would call a socialist society. In 2015 there were 3.6 million millionaires in China. (Presumably, this figure refers to annual incomes in dollars; those with wealth in the millions would comprise a higher figure.) Inequality within China is quite severe: the Gini coefficient of household income is higher than that of the United States (see Figure 3, this chapter)[8]. While the public sector of state-owned firms continues to exist, the private sector is growing rapidly. The new Chinese bourgeoisie displays no semblance of a socialist mentality: indeed, they build palaces to live in, consume ostentatiously, and attempt to copy the behavior of the most decadent aristocratic Europeans of the nineteenth century[9].

So far China’s leaders have been unwilling to use tax policy, redistribution, and social empowerment to lead the development towards a more socially just society—perhaps because they believe that such measures are bad for economic growth and development.

The Nordics—markets with social democracy and the cooperative social ethos

Several European countries and the Nordic countries of Denmark, Finland, Iceland, Norway, and Sweden in particular pioneered a model based on political democracy, capitalist property relations (meaning: predominantly private ownership of firms), a market economy, a comprehensive organization of workers in labor unions, and high taxation financing a pervasive welfare state. The political parties that organized this experiment called themselves social-democratic, as opposed to the Communist parties of the Soviet-style countries and China. Rather than dictatorship by a single party, there has been democratic political competition between freely formed parties in these countries. More significantly, there has been a very limited use of public ownership: almost all firms are privately owned by families or shareholders.

Yet, the Nordic countries have achieved what is probably the highest degree of income equality in the world (see section 1.2), and the greatest security for ordinary people through a large welfare state. As we said, government economic activity is financed by about one-half the gross domestic product of the country, which is collected through various forms of taxation.

The Nordic system rests on a specific social ethos, which has made it possible for these countries to remain egalitarian. The Nordic cooperative social ethos is well summarized by a statement of Per Albin Hansson, a leader of the Swedish social-democratic party in the late 1920s. He said (in a speech in 1928):

“The basis of the home is community and togetherness. The good home does not recognize any privileged or neglected members, nor any favorite or stepchildren. In the good home there is equality, consideration, cooperation, and helpfulness. Applied to the great people’s and citizens’ home this would mean the breaking down of all the social and economic barriers that now separate citizens into the privileged and the neglected, into the rulers and the dependents, into the rich and the poor, the propertied and the impoverished, the plunderers and the plundered [italics added]. Swedish society is not yet the people’s home. There is a formal equality, equality of political rights, but from a social perspective, the class society remains and from an economic perspective the dictatorship of the few prevails.”

The italicized statement defines the kind of solidarity that the social-democratic parties attempted to teach the citizenry, with a great deal of success. This is one of cooperation and reciprocation: I will make my contribution to society, in full expectation that others will do the same. The concepts of trust and social capital do not cover the same phenomenon. (For instance, there were a lot of trust and social capital among the Hutus in Rwanda just before the genocide in 1994, but there was very little cooperative ethos.)

In any case, a cooperative ethos is a far cry from the individualistic ethos, which is the official creed of capitalism, and values only the individual’s advancement—in particular, the increase in his or her material wealth. One’s country should be one’s home, according to Per Albin Hansson, with all the connotations of mutual aid and respect that characterize a good home.

Now the success of Nordic social democracy, many say, is due to several of the special features of these countries: they are small and at the time their welfare states and social ethos developed, they were homogeneous—linguistically, ethnically and religiously. Some of this is clearly true, but the social and economic cleavages and the inherent conflicts in the Nordic countries at that time are also part of the story[10].  To appreciate the achievements we also have to recall that the economies that the social democrats inherited in the 1930s were far from affluent. There was open unemployment in the cities and disguised unemployment in the countryside. In Norway around half of the population lived in sparsely populated areas, where most made a living from farming and fishing. The real per capita GDP of Sweden and Norway was below the current real per capita GDP of low middle-income countries today. Thus it is clear that a majority of citizens in the Nordic countries became rich under the social democratic model of governance, not before.

The social democratic model released an impressive development path of modernization and structural change. Over a period of more than 80 years economic growth has been at least on a par with that in the US, but with much more social involvement and egalitarian distribution of the proceeds (Barth, Moene and Willumsen 2015). As the system evolved, the earnings distribution became more and more compressed The low wage inequality and the increasing mean level have also induced more egalitarian policies of health, education, and social insurance against income loss and old age.

Throughout, the social equality has been sustained by external pressure on internal behavior. Global economic competition on the outside has led to local cooperation on the inside where the division line is the border of the nation state. In larger countries, a similar distinction between external and internal could be placed at a lower level than the entire nation. The resulting egalitarian practices and policies have had clear effects on the private sector as well. We will return to this. Policies that make workers more healthy and capable also raise profits from modern technology—and capitalists naturally respond by investing in it more. When this is the case, the productivity of sectors and enterprises becomes less dispersed, reinforcing the initial impact of the egalitarian policy. Some equality creates more equality.

As a result, the Nordic countries not only have the smallest wage differentials and the most generous welfare states, but also the most modern economies and the highest employment rates in the world. Like most countries, the Nordics have also recently experienced raising wage inequality—but the magnitudes are smaller and the level of wage inequality in the Nordic countries is still record low.


[1] E. Hobsbawm, 1994. The age of extremes: A history of the world, 1914-1991 (New York:Pantheon)

[2] The OECD comprises the 34 most economically developed countries of the world. The least developed of the OECD countries is probably Mexico.

[3] These figures are from Thomas Piketty (2014), Capital: In the 21st century (Harvard University Press) and other more recent publications by Piketty.

[4] The main competitors to the Bolsheviks in the Duma were other socialist parties. Lenin feared the Bolsheviks could not defeat them in the Duma, and hence some kind of coalition government would be necessary. He preferred the option of dictatorship by the Bolsheviks, doubtless underestimating the importance of political competition in keeping leadership attuned to the interests of the citizenry.

[5] There was indeed a period, beginning in 1921, called the New Economic Policy (NEP) when Lenin did introduce markets and limited capitalism because the economy was in such dire straits after the civil war in Russia. Lenin died in 1924 and Stalin terminated the NEP in 1928. Had that not occurred, it is possible the Soviet Union would have developed as a market–socialist economy (or perhaps made a transition back to capitalism).

[6] Liberman published his first proposals for market reforms in 1962. The earliest English language statement seems to be E. Liberman, 1972, Economic methods and the effectiveness of production, White Plains NY: International Arts and Sciences Press. Of importance is also Leo Kantorovich, the Soviet mathematician who won a Nobel prize in economics for development of the simplex method, a method for solving complicated mathematical programming problems. Kantorovich advocated using mathematical methods of planning that involved computing ‘shadow prices’ of commodities. According to the historical novel Red Plenty (Francis Spufford, 2010, London: Faber and Faber), he believed that mathematical programming could achieve a level of efficiency in central planning that was similar to that achieved by markets.

[7] In 1960, Conservative British Prime Minister Harold Macmillan concluded, “They [the USSR] are no longer frightened of aggression. They have at least as powerful nuclear forces as the West. They have interior lines [of communication]. They have a buoyant economy and will soon outmatch capitalist society in the race for material wealth [Tony Judt [2005, p. 248]].”

[8] This fact is not inconsistent with the earlier mentioned fact that the huge growth of Chinese incomes has lowered inequality globally.

[9] See The New Yorker article “China’s butler boom: Service in the style of ‘Downton Abbey’ has taken hold among Chinese elite.” (The New Yorker, October 2, 2015.)

[10] Between the first and the second world war Sweden, Norway and in part Denmark had the world record in strikes and lockouts measured by lost working days. Finland had a civil war in 1918 between the Reds, led by the Social Democratic party and the Whites, led by the conservative-led Senate. Almost 40 thousand people died. The war divided Finland politically for many years.