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What is 'Socialism'

Socialism is a populist economic and political system based on the public ownership (also known as collective or common ownership) of the means of production. Those means include the machinery, tools and factories used to produce goods that aim to directly satisfy human needs. Communism and socialism are umbrella terms referring to two left-wing schools of economic thought; both oppose capitalism, but socialism predates the "Communist Manifesto," an 1848 pamphlet by Karl Marx and Friedrich Engels, by a few decades.

In a purely socialist system, all legal production and distribution decisions are made by the government, and individuals rely on the state for everything from food to healthcare. The government determines output and pricing levels of these goods and services.

Socialists contend that shared ownership of resources and central planning provide a more equal distribution of goods and services, and a more equitable society.

BREAKING DOWN 'Socialism'

Common ownership under socialism may take shape through technocratic, oligarchic, totalitarian, democratic or even voluntary rule. Prominent historical examples of socialist countries include the former Soviet Union and Nazi Germany. Contemporary examples include Cuba, Venezuela and China.

Due to its practical challenges and poor track record, socialism is sometimes referred to as a utopian or “post-scarcity” system, although modern adherents believe it could work if only properly implemented. They argue socialism creates equality and provides security – a worker’s value comes from the amount of time he or she works, not in the value of what he or she produces — while capitalism exploits workers for the benefit of the wealthy.

Socialist ideals include production for use, rather than for profit; an equitable distribution of wealth and material resources among all people; no more competitive buying and selling in the market; and free access to goods and services. Or, as an old socialist slogan describes it, “from each according to ability, to each according to need.”

Origins and Development of Socialism

Socialism developed in opposition to the excesses and abuses of liberal individualism and capitalism. Under early capitalist economies during the late 18th and 19th centuries, western European countries experienced industrial production and compound economic growth at a rapid pace. Some individuals and families rose to riches quickly, while others sank into poverty, creating income inequality and other social concerns.

The most famous early socialist thinkers were Robert Owen, Henri de Saint-Simon, Karl Marx and Vladimir Lenin. It was primarily Lenin who expounded on the ideas of earlier socialists and helped bring socialist planning to the national level after the 1917 Bolshevik Revolution in Russia.

Following the failure of socialist central planning in the Soviet Union and Maoist China during the 20th century, many modern socialists adjusted to a highly regulatory and redistributive system, sometimes referred to as market socialism or democratic socialism.

Socialism vs. Capitalism

Capitalist economies (also known as free-market or market economies) and socialist economies differ by their logical underpinnings, stated or implied objectives, and structures of ownership and production. Socialists and free-market economists tend to agree on fundamental economics – the supply and demand framework, for instance – while disagreeing about its proper adaptation. Several philosophical questions also lie at the heart of the debate between socialism and capitalism: What is the role of government? What constitutes a human right? What roles should equality and justice play in a society?

Functionally, socialism and free-market capitalism can be divided on property rights and control of production. In a capitalist economy, private individuals and enterprises own the means of production and the right to profit from them; private property rights are taken very seriously and apply to nearly everything. In a socialist economy, the government owns and controls the means of production; personal property is sometimes allowed, but only in the form of consumer goods.

In a socialist economy, public officials control producers, consumers, savers, borrowers and investors by taking over and regulating trade, the flow of capital and other resources. In a free-market economy, trade is conducted on a voluntary, or nonregulated, basis.

Market economies rely on the separate actions of self-determining individuals to determine production, distribution and consumption. Decisions about what, when and how to produce are made privately and coordinated through a spontaneously developed price system, and prices are determined by the laws of supply and demand. Proponents say that freely floating market prices direct resources towards their most efficient ends. Profits are encouraged and drive future production.

Socialist economies rely on either the government or worker cooperatives to drive production and distribution. Consumption is regulated, but it is still partially left up to individuals. The state determines how main resources are used and taxes wealth for redistributive efforts. Socialist economic thinkers consider many private economic activities to be irrational, such as arbitrage or leverage, because they do not create immediate consumption or “use.”

Bones of Contention

There are many points of contention between these two systems. Socialists consider capitalism and the free market to be unfair and possibly unsustainable. For example, most socialists contend that market capitalism is incapable of providing enough subsistence to the lower classes. They contend that greedy owners suppress wages and seek to retain profits for themselves.

Proponents of market capitalism counter that it is impossible for socialist economies to allocate scarce resources efficiently without real market prices. They claim that the resultant shortages, surpluses and political corruption will lead to more poverty, not less. Overall, they say, that socialism is impractical and inefficient, suffering in particular from two major challenges.

The first challenge, widely called the “incentive problem,” says no one wants to be a sanitation worker or wash skyscraper windows. That is, socialist planners cannot incentivize laborers to accept dangerous or uncomfortable jobs without violating the equality of outcomes.

Far more serious is the calculation problem, a concept originating from economist Ludwig von Mises’ 1920 article “Economic Calculation in the Socialist Commonwealth.” Socialists, wrote Mises, are unable to perform any real economic calculation without a pricing mechanism. Without accurate factor costs, no true accounting may take place. Without futures markets, capital can never reorganize efficiently over time.

Can a Country be Both?

While socialism and capitalism seem diametrically opposed, most capitalist economies today have some socialist aspects. Elements of a market economy and a socialist economy can be combined into a mixed economy. And in fact, most modern countries operate with a mixed economic system; government and private individuals both influence production and distribution.

Economist and social theorist Hans Herman Hoppe wrote that there are only two archetypes in economic affairs – socialism and capitalism – and that every real system is a combination of these archetypes. But because of the archetypes' differences, there is an inherent challenge in the philosophy of a mixed economy, and it becomes a never-ending balancing act between predictable obedience to the state and the unpredictable consequences of individual behavior.

How Mixed Economies Develop

Mixed economies are still relatively young, and theories around them have only recently codified. "The Wealth of Nations," Adam Smith's pioneering economic treatise, argued that markets were spontaneous and that the state could not direct them, or the economy. Later economists including John-Baptiste Say, F.A. Hayek, Milton Friedman and Joseph Schumpeter would expand on this idea. However, in 1985, political economy theorists Wolfgang Streeck and Philippe Schmitter introduced the term "economic governance" to describe markets that are not spontaneous, but have to be created and maintained by institutions. The state, to pursue its objectives, needs to create a market that follows its rules.

Historically, mixed economies have followed two types of trajectories. The first type assumes that private individuals have the right to own property, produce and trade. State intervention has developed gradually, usually in the name of protecting consumers, supporting industries crucial to the public good (in fields like energy or communications) providing welfare or other aspects of the social safety net. Most western democracies, such as the United States, follow this model.

The second trajectory involves states that evolved from pure collectivist or totalitarian regimes. Individuals' interests are considered a distant second to state interests, but elements of capitalism are adopted to promote economic growth. China and Russia are examples of the second model.

Transitioning from Socialism

A nation needs to transfer the means of production to transition from socialism to free markets. The process of transferring functions and assets from central authorities to private individuals is known as privatization.

Privatization occurs whenever ownership rights transfer from a coercive public authority to a private actor, whether it is a company or an individual. Different forms of privatization include contracting out to private firms, awarding franchises and the outright sale of government assets, or divestiture.

In some cases, privatization is not really privatization. Case in point: private prisons. Rather than completely ceding a service to competitive markets and the influence of supply and demand, private prisons in the United States are actually just a contracted-out government monopoly. The scope of functions that form the prison is largely controlled by government laws and executed by government policy. It is important to remember that not all transfers of government control result in a free market.

Privatizing a Socialist Economy

Some nation-wide privatization efforts have been relatively mild, while others have been dramatic. The most striking examples include the former satellite nations of the Soviet Bloc after the collapse of the U.S.S.R. and the modernization of the post-Mao Chinese government.

The privatization process involves several different kinds of reforms, not all of them completely economic. Enterprises need to be deregulated and prices need to be allowed to flow based on microeconomic considerations; tariffs and import/export barriers need to be removed; state-owned enterprises need to be sold; investment restrictions must be relaxed; and the state authorities must relinquish their individual interests in the means of production. The logistical problems associated with these actions have not been fully resolved, and several differing theories and practices have been offered throughout history.

Should these transfers be gradual or immediate? What are the impacts of shocking an economy built around central control? Can firms be effectively depoliticized? As the struggles in Eastern Europe in the 1990s show, it can be very difficult for a population to adjust from complete state control to suddenly having political and economic freedoms.

In Romania, for example, the National Agency for Privatization was charged with the goal of privatizing commercial activity in a controlled manner. Private ownership funds, or POFs, were created in 1991. The state ownership fund, or SOF, was given the responsibility of selling 10% of the state's shares each year to the POFs, allowing prices and markets to adjust to a new economic process. But initial efforts failed as progress was slow and politicization compromised many transitions. Further control was given to more government agencies and, over the course of the next decade, bureaucracy took over what should have been a private market.

These failures are indicative of the primary problem with gradual transitions: when political actors control the process, economic decisions continue to be made based on noneconomic justifications. A quick transition may result in the greatest initial shock and the most initial displacement, but it results in the fastest reallocation of resources toward the most valued, market-based ends.

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