consistency and viability of capitalist...a catalogue record of the book is available from the...

Consistency and Viability of CapitalistEconomic Systems

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Consistency and Viability of CapitalistEconomic Systems

John Marangos

consistency and viability of capitalist economic systemsCopyright © John Marangos, 2013.

Softcover reprint of the hardcover 1st edition 2013 978-0-230-110 0-6 1 All rights reserved.

First published in 2013 byPALGRAVE MACMILLAN®

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ISBN 978-1-349-29303-2 ISBN 978-1-137-08087-5 (eBook)

DOI 10.1057/9781137080875

Library of Congress Cataloging-in-Publication Data

Marangos, John, 1962–Consistency and viability of capitalist economic systems / by John Marangos.

pages cm

1. Capitalism—Developed countries—History—20th century.2. Developed countries—Economic policy—20th century. 3. Economichistory—20th century. 4. Economic history—19th century. I. Title.HB501.M3153 2013330.12′2—dc23 2012046503

A catalogue record of the book is available from the British Library.

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First edition: May 2013

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This book is dedicated to my wife Eleni and daughter Ariana forall their love and support. Without both of you I could not have made

it here or there.

Contents

List of Figures ix

List of Tables xi

Preface xiii

Abbreviations xv

1 Introduction 12 Consistency and Viability of Economic Systems 93 Consistency and Viability of Market Capitalism 494 Great Britain: From Atlee’s Postwar Consensus and Welfare State

to Thatcher’s Free Market Economy 775 Postwar Japan: From the Economic Miracle to the Bubble

Economy 1196 The European Union as an Economic System: From the European

Coal and Steel Community to the Euro 1717 Sweden: From “Third Way” to Joining the European Union 223

Index 271

List of Figures

2.1 Consistency and viability of economic systems 142.2 Property relations and economic systems 176.1 Unemployment rate in Europe, the United States, and Japan,

2000–2012 1986.2 Unemployment rate for the EU in 2011 2207.1 Fiscal deficit for 1970–1993 as percent of GDP in Sweden 254

List of Tables

2.1 Consistency within the economic structure 232.2 General principles of consistency of economic systems 423.1 Consistency and viability of market capitalism 634.1 Industries taken into public ownership in Great Britain,

1945–1951 824.2 The stop–go cycle in the United Kingdom, 1955–1997 954.3 Growth of real GDP in percent, 1950–1979 974.4 Main economic indicators for six OECD countries, 1950–1973 984.5 Privatization in Britain, 1981–1990 1034.6 Main economic indicators in Britain, 1986–1992 1155.1 Europe versus Japan in the late 1980s 1455.2 Japan’s growth rate, unemployment, and inflation: 2000–2011 1676.1 Membership of the European Union 1736.2 Medium-term gains from the completion of the internal market

in 1992, as a percentage of GDP 1776.3 Allocation of seats in the European parliament per country 1866.4 Eurozone membership 2026.5 Estimates of net benefits of EMU membership 2096.6 Labor productivity per person employed, EU-27 = 100,

2002–2010 2187.1 Key ratios, consumer cooperative movement, and KF group 2497.2 Wage drift and unemployment 257

Preface

Dear Reader,

It is my great pleasure that you are holding the text and hopefully with the intentto read. The development of this book series (Consistency and Viability of Cap-italist Economic Systems, Consistency and Viability of Socialist Economic Systems,Consistency and Viability of Islamic Economic Systems and the Transition Process)has been a long, time-consuming process. This book series is based on my mas-ter’s thesis of 1991 at the Department of Economics, Monash University, with thetitle The Search for a Consistent and Viable Economic System in the Soviet Unionand supervised by Associate Professor Ian Ward. Since then I have been teach-ing Comparative Economic Systems by extending the analytical framework ofconsistency and viability to other economic systems. Consequently, the bookseries is the result of the ample experience that I gained and the feedback thatI received from my students in Australia, the United States, and Greece. Nev-ertheless, I have been standing on the shoulders of giants and their influenceis noticeable throughout the text. I have to point out that for this book seriesI have gained much stimulus from the following works: Angresano, J., (1996),Comparative Economics, Pearson, Second Edition; Gardner, H. S., (1998), Com-parative Economic Systems, Second Edition, The Dryden Press; Gregory, R. andR. Stuart, (2004), Comparing Economic Systems in the Twenty-First Century,Houghton Mifflin; Kennett, D., (2004), A New View of Comparative Economics,South-Western; Rosser, J. B. and M. V. Rosser, (2004), Comparative Economicsin a Transforming World Economy, MIT Press. Every effort has been made torecognize the contribution of these authors throughout the text. I apologizebeforehand if I have missed pointing out their contributions. I am grateful tothe following colleagues and friends who read the manuscript and offered theiradvice and comments: Sean Alley, Donna Boudreau, Paula Cole, Lynn Duggan,John Hall, Barbara Hopkins, Pam Jackson, Valerie Kepner, Nancy Murray, EdO’Boyle, Maeve Powlick, Tonia Warnecke, Karl Widerquist, and Tim Wunder.Special thanks to Jim Mignato for his tireless effort. Also, a great thank you to my

xiv ● Preface

ex-CSU students Shaina Sorrell and Brianna Tomlinson, and to my current Uni-versity of Crete students Emmanouil Androulakis and Michael Psarakis for theirassistance. I am also grateful to the Special Account for Research of the Universityof Crete Project KA3543 for funding my presentation at the 2012 ASSA meetingat Chicago with the title: “The Economic System from Social Science Perspec-tive: Consistency and Viability”. I would be interested to hear your comments,so please do not hesitate to contact me on [email protected].

Thank you and may your reading be stimulating and thought-provoking.

John MarangosRethymno, Crete,November 2012.

Abbreviations

ACP Africa, Caribbean, and PacificCAP Common Agricultural PolicyCCP Common Commercial PolicyCEO Chief Executive OfficerCET Common External TariffCFSP Common Foreign and Security PolicyDPJ Democratic Party of JapanECB European Central BankECSC European Coal and Steel CommunityECU European Currency UnitEDC European Defense CommunityEEA European Economic AreaEEC European Economic CommunityEFTA European Free Trade AreaEMI European Monetary InstituteEMCF European Monetary Cooperation FundEMS European Monetary SystemEMU Economic Monetary UnionEPA Economic Planning AgencyEPC European Political CommunityERM Exchange Rate MechanismESPRIT European Strategic Programme for Research in Information

TechnologyESCB European System of Central BanksEU European UnionEuratom European Atomic Energy CommunityGATT General Agreement on Tariffs and TradeGDP Gross Domestic ProductGNI Gross National IncomeGNP Gross National ProductHDI Human Development IndexIPO Initial Public OfferingKF Kooperativa Forbundet, Swedish Cooperative Union

xvi ● Abbreviations

LDP Liberal Democratic PartyLO Swedish Trade Union Confederation, LandsorganisationenMETI Ministry of Economy, Trade, and IndustryMITI Ministry of International Trade and IndustryMOF Ministry of FinanceMPs Members of ParliamentNATO North Atlantic Treaty OrganizationNCB National Coal BoardNCBs National Central BanksNEDC National Economic Development CouncilNHS National Health ServiceNNPT Nuclear Non-Proliferation TreatyNUM National Union of MineworkersOECD Organization for Economic Cooperation and DevelopmentOEEC Organization for European Economic CooperationRGDP Real Gross Domestic ProductSAF Swedish Employers AssociationSDP Social Democratic PartySEA Single European ActSGP Stability and Growth PactTMD Theater Missile DefenseVAT Value Added TaxWTO World Trade Organization

CHAPTER 1

Introduction

If we are to understand, and form an opinion about, the restructuring processin any economy, it is essential to view the economic system in a broad socialscience context that incorporates economic and political relationships, as well

as ideology, the external environment, and the process of reforms. To understandchanges in an economic system, it is essential to analyze all the relationshipsthat influence economic choices; therefore, we must examine the structure ofthe political authorities and the state, the prevailing ideology, and the externalenvironment and the process of reform. The purpose of the analytical frameworkdeveloped in this text is to remedy this neglect of the political and ideologicalelements, the external environment, and the process of reform, which has beenexplicit or implicit in the study of economic systems. By placing these structuresendogenously in an analytical framework, we can incorporate all the elementsthat influence economic choices, decisions, and outcomes.

Viewing economic analysis and policy from a broad social science perspectiveis crucial, since the economic structure of a society does not exist in a vacuum.Societies cannot exist only based on economic relationships. Engels in a letterto J. Block on September 21–22, 1870, reaffirms this argument: “according tothe materialist conception of history, the ultimate determining element in his-tory is the production and reproduction of real life. Neither Marx nor I haveasserted more than this. Therefore if somebody twists this into saying that theeconomic factor is the only determining one, he is transforming that proportioninto a meaningless, abstract, absurd phase” (Marx and Engels 1977, 75). Hence,equally as important as economic factors are the political institutions, ideology,the external environment, and the process of reform. This is because there is anintimate connection between these elements, and societies are cohesive by theequiproportionate development of these structures and elements.

2 ● Consistency and Viability of Capitalist Economic Systems

Hence, the success of an economic system depends not only on specifyingthe necessary economic conditions, but also on whether certain conditions weresatisfied with respect to the non-economic elements. Differences in historicalbackground, national culture, economic and political structures, and interna-tional aspirations can affect growth patterns (Ofer 1987, 1768). For this reason,the analysis adopted in this text is in the tradition of “political economy.”This framework takes into consideration economic relationships—the interac-tion between political institutions, social consciousness, and ideas. The changingof an economic system is a holistic, historical, dynamic, and comparative processand, as such, a political economy methodology would seem appropriate: “Polit-ical economy is necessarily procedural, human, institutional and environmentalin its scope” (O’Hara 1999, 128). Political economy stresses that making eco-nomic sense and understanding economic relationships is not feasible withoutexplicit awareness of power, institutions, and values. In particular, political econ-omy maintains that politics and economics are not reducible to one another.However, a political economy approach eventuates in disagreement and in alter-native economic systems. Different views on “social reality” and “what is a goodsociety?” and different speeds of implementing reform give rise to alternativeeconomic systems.

This book will develop an analytical framework that requires that all the ele-ments of the economic system (economic structure, political structure, ideology,external environment, and the process of reform) must be interconnected andthus evaluated in terms of achieving “consistency.” By viewing the economic sys-tem in its totality, the terms of analysis are not narrow, economic “independent”variables, but rather the analysis encompasses the complete economic-politico-ideological spectrum. Nevertheless, this analytical framework does not dismissdeveloping economic systems based on different priorities and sequencing of theelements of the reform program.

Exposition of the economic system in economic literature appears to oversim-plify the complexities involved. In most cases, economists writing on economicsystems have reduced it to an isolated variable of the economic sphere. Theeconomic system has been “pigeon-holed” into thematic subcategories such aspricing policy, government expenditure, investment policy, and unemployment,thus ignoring the interrelated nature of economic policies, institutions, andbehavior. These economists provide a solution to any economic problem bysometimes explicitly, but mostly implicitly, assuming specific behavioral assump-tions and/or economic relationships. These assumptions result in presenting anddefending a predetermined position as the only feasible one. Thus, economistsmodeling in this way offer a view of the economic system that is highly subjec-tive and based on value judgments; comparing economic systems while ignoringthese aspects is meaningless.

Every society is governed by the need for equiproportionate developmentof the economic, political, and ideological structures joined with the external

Introduction ● 3

environment and the process of reform. An economy consists of a group of peo-ple who are located within a specific geographical area, have a common historicaland political entity, and are producing and consuming goods and services. A fun-damental dilemma in any economic system is the scarcity of resources relativeto wants. Decisions need to be made on how a given volume of resources ismade accessible to production, what production technique is used, and how theincome derived from production is distributed among various production factors(capital, labor, and land). Human wants, if not unlimited, are at least indefinitelyexpansible. However, the goods and services that can satisfy these wants are notindefinitely expansible, and neither are the factors of production that can producethe desired goods and services. These productive factors also usually have alterna-tive uses in the production of any number of different goods and services. Everyeconomic system must allocate limited productive resources that have alternativeuses, to the satisfaction of increasing and unlimited wants.

In any system, large amounts of capital will not be available for use in pro-duction unless there is a process of saving and capital formation. This processis fundamentally the same in all economies. It cannot operate unless the avail-able productive resources are more than adequate to provide at least a subsistenceliving for the people. Once the subsistence level is within reach, the capital pro-duction process involves the spending part of the income of an economy forcapital goods rather than consumer goods. In other words, saving and capital for-mation require the allocation of a part of productive resources of the economyto producing capital goods rather than consumer goods. The cost of obtainingcapital goods is the same in all economic systems: the best value alternative fore-gone produced of the quantities of consumer goods and services by the factors ofproduction (opportunity cost).

To understand how an economic system works, it is necessary to be awareof the institutional arrangements. Societies continue to exhibit fundamentaldifferences in their institutional structures, notwithstanding the growing tradeand capital flows and increasing economic interdependence that apparently gen-erate significant pressures toward convergence in economic systems (Matthijs2011, 6). An institutional arrangement is a practice, convention, or custom thatis part of life and is a persistent element of the culture within an economy.Notably, an economy functions according to certain rules, customs, and lawsthat underpin the institutional framework within which the people live. Themost interesting aspect of comparative economic systems is the comparison of theinstitutional frameworks that exist within differing economies. Economic institu-tions arise in reaction to certain economic and social phenomena that economieshave to face. Some economic institutions become justified based on custom,while others are formally recognized and enforced through legislation. Institu-tions matter because they maintain order. Whenever there are rules of behavior,there must be a means of enforcing these rules. Thus, institutions consist notonly of the rules themselves, but also of the means of their enforcement. When


classifying different economic systems, we need to consider the endless variety ofinstitutional frameworks.

Thus, there is a need within the institutional context of the economic systemto identify a few key variables and specify a finite number of relationships to con-struct an analytical framework. This analytical framework is useful for classifyingand comparing economies, as well as determining the process of change. The goalof the analytical framework developed in this text is to understand the relation-ship between economic, political, and ideological structures in conjunction withthe external environment and the process of reform within an economic system.This analytical framework embodies the view that non-economic factors partlyinfluence the behavior of individuals. Consequently, an institutional approach inconjunction with an evolutionary methodology is the foundation of the analyticalframework used in this text to examine elements of an economy, as well as changeand reform of economic systems. Put simply, the text adopts an institutional andevolutionary approach to economic systems.

Theoretically, we can combine the aforementioned different elements inmany different ways; nevertheless, only certain combinations prove function-ally workable, thus giving rise to certain economic systems. A hypothesis hasbeen developed that the survival of every society depends on whether it isable to develop interrelationships, mechanisms, and institutions that facilitatethe achievement of its citizens’ goals. Thus, consistency requires the develop-ment of an economic system that facilitates the achievement of the economicgoals of its members. This book develops the hypothesis that whilst the eco-nomic, political, and ideological structures, the external environment, and theprocess of reform are interconnected, they must be consistent with each otherto maintain functionality. The establishment of a consistent economic systemhas several conditions. The first condition is consistency within the economicstructure between property, organizational relations, and motivational relations.The second condition is consistency between the economic and political struc-tures. The third condition is consistency between the prevailing ideology andthe economic-politico structures. Fourth, there must be consistency betweenthe economic-politico-ideological structures and the external environment; andfinally there must be a consistent process of implementing reforms. Consistency,however, is not enough. An economic system may be consistent in the short runbut not in the long run.

Economic systems are not static. Even a quick look at history, especially thehistory of merely the last three decades, reveals that change in the structure ofeconomic systems is relatively frequent. A social science perspective that embod-ies an institutional and evolutionary approach produces the view of economicsystems exemplified by ongoing processes of dynamic transformation. The goalsof the society and its members change with the passage of time; the society mustinitiate changes appropriate to the new goals. Consequently, economies are fluidover time, not static, because institutions are subject to modification. Why do

Introduction ● 5

economic systems change? Because changes take place in social reality, in whatexists. Hence, a consistent economic system must be flexible and be able to adaptto changes in social reality, change under changing economic conditions, thusmaking possible its survival over time. In other words, the economic system inthis case achieves viability. Viability requires the establishment of a consistent eco-nomic system that is able to facilitate reforms toward satisfying the new needs ofsociety. This includes the ability to sustain an adequate rate of increase in materialproduction and making those exercising power accountable to the people. Thus,the economic system, in its broad social science context based on an institutionaland evolutionary approach, must be both consistent and viable.

Through these two concepts, we are able to view the economic system in itstotality. Our attention then is not at narrow economic relationships but rather atthe complete economic-politico-ideological and international spectrum. A con-sequence of viewing the economic system in this way is that it becomes apparentthat changes within the economic structure has to initiate changes in other struc-tures; this is necessary in order to maintain consistency. However, the ultimateaim of the reforms should be not only the achievement of consistency but alsoviability: the establishment of an economic system that has the capacity to changeunder changing conditions.

The application of the analytical framework developed in this text is usefulto examine the interrelationships between the economic, political, and ideolog-ical structures, the external environment, and the process of reform of specificeconomic systems. In view of the fact that capitalism has arisen as the victoriouseconomic system in the ideological war between economic systems, an analysis ofcapitalism can reveal important interrelationships necessary for a consistent andviable economic system. Whether the shift from socialism to capitalism will bea permanent state of the world, an irreversible and linear evolution in economicsystems, or merely a short-lived development, cannot be determined a priori.Nor can one assume that a favorable performance of capitalism will continueforever. Nevertheless, the fact that the struggle between capitalism and social-ism is over for the time being does not mean that economic systems no longermatter. How a society organizes its economic-politico-ideological institutions inconjunction with the external environment and the process of reform continuesto matter. In much the same way as individuals learn from the accomplishmentsand the mistakes of others, economic systems can learn from the successes andfailures of other systems.

In such a context, there has been a transformation in the way that we viewthe subject matter of comparative economic systems. In the past, the con-tents of comparative economic systems texts emphasized the differences betweencapitalist and socialist societies. However, the subject itself is undergoing trans-formation. As the world economies have changed, comparative economic systemsas a discipline has transformed as well. The ultimate goal, nowadays, of the studyof comparative economic systems is to learn what is successful within differing


arrangements and settings. Thus, the study of comparative economics has neverbeen more important. Achieving a deep understanding of this transformation ofthe subject matter, I will argue, depends on adopting a social science perspectiveto economic systems. The social science approach embodies an institutional andevolutionary approach and thus allows the student of economics to understandhow these historical transformations of economic systems take place.

The study of comparative economic systems addresses the effect of the wholesystem on economic performance. In recent years, the institutional settings havechanged, as have economic systems themselves, providing important new per-spectives on the nature and impact of differing economic systems in a globalsetting. Economists have a new interest in these issues. The objective of thisbook is to study comparative economic systems through a summary of selectedrepresentative “real” economies, describing each economy’s elements from asocial science perspective, which embodies an institutional and evolutionaryapproach. In general, our focus is on the various types of market capitalismand the necessary institutional arrangements that foster consistency and viability.There are many varieties of market capitalism, and as various economic problemscontinue to trouble the world economy. The significance of these differencesincreases the global search for an efficient and humane economic system. Yetin all systems, the ultimate objective must be to achieve a consistent and viableeconomic system.

In order to understand and assess reforms in any other economic system, itis necessary to put them in a historical context. There is a need to understandhow the interrelationships that developed give rise to the economic system andwhat outcomes in the process were accomplished. Using the concepts of consis-tency and viability as analytical tools, we are able to trace the development ofeconomic systems. In fact, the changing and evolving systems demonstrate theneed for a new and incisive way of looking at economic systems. This need callsfor a social science perspective that embodies an institutional and evolutionaryapproach such as our analytical framework based on consistency and viability.

The objective is to introduce in a methodical way the student to real economicsystems experienced in the world and the problems of transitioning from one sys-tem to another, in particular, the transition from centrally administered socialismto capitalism. The goal is to demonstrate the relevance of issues important incontemporary economic thought: institutions, corruption, principal–agent prob-lem, regulation, market and government failure, culture, external conditions andsocial policy. From an institutional and evolutionary perspective, the tools ofconsistency and viability arise to provide an analytical framework that explic-itly identifies an economy’s economic, political, ideological, international, andreform characteristics through history. “In order to understand the differences ininstitutional infrastructure between the advanced industrial countries, a more his-torical institutionalist perspective that takes into account the role of competingideas during periods of crises would help fill that gap” (Matthijs 2011, 6). This

Introduction ● 7

framework also allows us to see how all of these elements interact to establishand modify the economy’s institutions. The consistency and viability frameworkis the most distinctive method of analysis of economic systems studied in thisbook. The framework is quite useful as an analytical device with which to under-stand and explain the path of development of all economic systems. It emphasizesthat economies are fluid, and institutions are constantly subject to modification.

The analytical framework developed through the concepts of consistency andviability makes possible the examination of economic systems from a new andenlightening perspective. Through this institutional evolutionary approach, weare able to understand more accurately the collapse of centrally administeredsocialism, the success of capitalist economic systems, the struggle of Islamiceconomies as alternatives to capitalism, and the unsuccessful attempts of reformsin a broad social context. We enrich our understanding of what reformers andpolicy makers were and are trying to achieve and we are able to justify the ini-tiation of change not only in the economic structure but also in the politicalstructure, the ideology, and the external environment. Overall, the purpose ofthe consistency and viability framework is to provide a novel and realistic per-spective in the study of comparative economic systems. It should be attractive tothose seeking an innovative approach to study economies and societies, especiallyto anyone willing to recognize the contribution of relevant economic, political,ideological, international, and historical factors to the nature and evolution ofeconomic systems.

In this introductory chapter, we explore the concept of an economic systemfrom a social science perspective, which embodies an institutional and evolu-tionary approach developing the concepts of consistency and viability. Next, wesurvey the various criteria that we use to classify economic systems within theconsistency and viability framework. Consequently, we turn our attention to thedevelopment of the analytical framework that we will apply to a selected set ofreal representative economies. Economic systems can be either real or theoretical.Economists supporting a specific economic system are often guilty of comparinga theoretical version of an economic system that they either approve or disap-prove of, with a description of the real problems of the other system. To avoidthis problem, we will only concentrate on “real” economic systems, economicsystems that exist or existed.

References and Further Reading

Marangos, J., (1999), “The Rise and Fall of the Stalinist Economic System: A SocialScience Perspective.” In: Shri Bhagwan Dahiya (ed.), The Current State of EconomicScience. Spellbound Publications, Rohtak, pp. 2685–2705.

Marangos, J., (2005), “A Political Economy Methodology in Modelling the Transitionprocess,” Global Business and Economics Review, 5(2), 197–225.


Marangos, J., (2011), “Social Change versus Transition: The Political Economyof Institutions and Transitional Economies,” Forum for Social Economics, 40(1),119–137.

Marx, K. and F. Engels, (1977), “Engels to J. Bloch.” In: K. Marx and F. Engels (eds.),Selected Letters. Foreign Language Press, Peking, pp. 75–78.

Matthijs, M., (2011), Ideas and Economic Crises in Britain from Attlee to Blair(1945–2005), Routledge, Abingdon.

O’Hara, P. A., (1999), “How Can Economics Be an Institutional-evolutionaryScience?,” Journal of Economic and Social Policy, 4(1), 127–143.

Ofer, G., (1987), “Soviet Economic Growth: 1928–1985,” Journal of EconomicLiterature, 25(4), 1767–1833.

CHAPTER 2

Consistency and Viability ofEconomic Systems

2.1 Introduction

Each human society establishes a specific set of interrelationships between itsinstitutions and its members. The ultimate survival of a society depends onwhether or not these interrelationships are consistent with each other. Not alleconomic systems, of course, possess identical sets of interrelationships. Differenthistories, cultures, ideologies, religions, and priorities give rise to unique inter-relationships, resulting in different institutional forms and variations in the waythese institutions interrelate and interact. Economic institutions are those ele-ments that reflect the way we organize our economic activities. They cover abroad range of economic, social, and political activities: property, organization,government, ideology, and formal and informal practices, just to mention a few.Economic history demonstrates that economic progress depends on having theright constellation of economic institutions. On the one hand, economic historyreveals a plethora of examples of societies that were able to survive in time andspace, making history because their structure brought people together in a pro-ductive fashion. On the other hand, there are examples of societies that did notsurvive in time or space due to a lack of consistency in the different spheres oflife. Thus, economic history suggests that “bad” economic institutions hindereconomic performance, whereas “good” institutions promote economic progress.Economic history also suggests that “good” institutions become “bad” with thelapse of time, thus societies must change the “bad” institutions into “good” insti-tutions, if they wish to achieve high economic performance and survive over time.Societies that are rich in economic resources may be poor by the unwise choiceof institutions, inhibiting progress in this way.


Institutions are normative patterns of social organization and behavior. Theyare normative in the sense that they define modes of action or social relationshipsthat society believes are expected of individuals. An institution is an organiza-tion, practice, convention, or custom that persists in the life and culture of asociety. Institutions have a tendency to create patterns of behavior and routinesthat are enduring due to tradition, custom, and/or legal enforcement. The pat-tern of behavior will invariably be affected by the values, beliefs, and motivesof the participants and by the norms, sanctions, and rewards. The patternsare regularized by common rules. Institutions that perform economic functionsincorporate methods, organizations, actions, and traditions that coordinate pro-duction, choice of technique, and distributional decisions, and determine therules governing ownership and control of productive resources.

Societies have adopted various mechanisms to structure the interrelationshipsbetween members of the society. Among the most important and relevant mech-anisms for today’s world are autonomy, authority, and tradition. An economybased on autonomy allows the members of the society to make their own deci-sions; it is a decentralized form of coordination as decisions are made primarilyat low levels of the society. Coordination is achieved through mechanisms thatfacilitate exchange, such as markets. Each member of the society makes deci-sions through an independent decision-making process and has the courage topursue his or her own convictions through the market exchange mechanism.Exchange is typically executed without violence, theft, or deception. As a result,both parties to an economic transaction benefit from it provided the transac-tion is bilaterally voluntary and informed. The market exchange prevents oneperson from interfering with another, allowing a high degree of autonomy. Theoutcome of adding up all individual choices, as consumer sovereignty dominatesallocative decision making, answers the questions posed by society: What prod-ucts will be produced? How will they be produced? Who will receive the endproduct?

In an economy based on authority, decision-making is centralized and mostdecisions are made at high levels of the society. Coordination is achieved throughmechanisms that facilitate commands, such as central administration. Membersof the society are coordinated by specific directives taking the form of commandsformulated by a superior agency, the central planning board, and disseminatedthrough a plan document. The responsibility of the central planning boardinvolves the generation, processing, and utilization of information by superioragencies. The outcome of the central planning board’s choices answers the ques-tions posed by the society: What products will be produced? How will they beproduced? Who will receive the end product? The members of the society areinduced to carry out the directives via appropriate incentives or threats designedby the planning board authorities. Central administration and an authoritarianform of coordination ensures that the decisions of the central planning boardwould be implemented, forbidding a large degree of autonomy.

Consistency and Viability of Economic Systems ● 11

A traditional economy is one in which coordination is maintained throughsimple perpetuation of the existing structure, the status quo. Tradition in itselfcannot effectively coordinate decisions, but can only perpetuate a set of deci-sions that has been coordinated in some way in the past. What products will beproduced? The products that were produced last year and the year before. Howwill they be produced? They will be produced the same way as in the past. Whowill receive the end product? As it has always been done: first those membersof society who are deemed in need, the elderly, children, and mothers; then theable-bodied members.

Economic history demonstrates that tradition can predominate as a mech-anism only in rather small, simple, and stationary economies; a dynamic andgrowing economy cannot be coordinated primarily by tradition. In modern tra-ditional economies allocation decisions are repeated based on what has been donein the past in association with a broader social context defined by a dominantreligion. The mechanism to structure the interrelationships between membersof these societies is a combination of tradition and religion. Economic deci-sion making, in this case, becomes embedded in the broader social contextof a religion, such as in Islamic economies that will be examined in a differ-ent book. Nevertheless, elements of tradition can be found in any functioningeconomy.

The role of ideology is to justify the claims of autonomy, control, or tra-ditional religious practices, and induce personality transformation toward theclaims. With these three basic mechanisms, autonomy, authority, and tradition-religion, people attempt to solve economic problems. Problems arise because theachievement of our goals depends on the decisions and actions of the other mem-bers of the society. This interdependence makes the achievement of our goals andother people’s goals uncertain. Through the pursuit of freedom and independence(autonomy), or through the pursuit of power and control (authority), or throughthe cultural continuity in social attitudes and customs (tradition-religion), peopletry to reduce the uncertainty of goal achievement.

The structure by which economic decisions are made within any society isreferred to as the economic system; in other words, the economic system is aset of institutions that assists in making and implementing economic choicesand solving economic problems. An economic system is a set of institutions fordecision-making and for the implementation of decisions concerning the produc-tion decision, the choice-of-technique decision, and the distributional decisionwithin a given society. Accordingly, the economic system consists of mecha-nisms, organizational arrangements, and decision-making rules that directly orindirectly affect economic behavior and outcomes. Thus, an economic system isan interactive set of institutions that constrain, facilitate, and coordinate the eco-nomic behavior of the members of a society. Within the institutional frameworkof an economic system, we attempt to influence economic performance by settingpolicies, which are implemented through the employment of policy instruments.


For example, the government may use fiscal policy, the changing tax rates andgovernment expenditure, and/or monetary policy, the manipulation of moneysupply, to stabilize the economy.

A number of institutional arrangements characterize each economic sys-tem. These arrangements reflect a set of basic beliefs that define how a societyshould be organized, what goods and services should be produced, how goodsand services should be produced, and how these goods and services shouldbe distributed. Hence, the economic system of a society is determined by itsinstitutions. Different institutional arrangements give rise to differing economicsystems, which influence resource allocation. If the economic system did notaffect economic performance, as economists we would have little interest inthe system and its institutions. Thus, the economic system is a set of institu-tional arrangements used to allocate scarce resources. The limits of productiveresources—land, labor, and capital—dictate the scarcity of resources. As a resultof scarcity, we must find in a systematic way a solution. If consistent arrange-ments are absent the economic system will collapse. Remember, we will studyonly modern “real” economic systems and not “hypothetical” theoretical eco-nomic systems. The three alternative mechanisms of autonomy, authority, andtradition-religion give rise to the following alternative modern economic systems,respectively: market capitalism as practiced in the United States and WesternEurope, centrally administered socialism as experienced in the Soviet Unionand Eastern Europe, and market socialism as practiced in Yugoslavia and thereligion-based theocratic Islamic economies.

The study of how such economic systems differ between economies andhow differences in systems determine economic outcomes comprises the fieldof comparative economic systems. It studies economic systems and their impacton the allocation of resources. By economic outcomes, we mean measurableconsequences such as gross domestic product (GDP), income per capita, the dis-tribution of income and wealth, employment and unemployment, inflation, andimportant social factors such as life expectancy, quality of life, freedom, etc. Theseoutcomes are the result of the mechanism chosen to structure the economic sys-tem in interaction with the available resources, politics, history, culture, ideology,external environment, and priorities.

An institutional and evolutionary approach to comparative economics sys-tems embodies the view that economies are characterized by ongoing processesof dynamic transformation. That is, economies are fluid over time, not static, asinstitutions are subject to modification. Institutions maintain order. New techno-logical conditions may modify the institutions under which order is maintained,necessitating efforts to establish new institutions. Changes in the environmentcreate new institutions, so that institutions are part of the evolving processthat characterizes an economy. The analysis focuses broadly on the principalinstitutions of the economic, political, and ideological structures, the externalenvironment, and reforms as they influence economic activity both at particularpoints in time and over time.

Consistency and Viability of Economic Systems ● 13

An economic system can vary in any of the aforementioned dimensions, par-ticularly in its structure, operation, and more importantly the adaptability tochange through time. Societies need from time to time to restructure the inter-nal relationships of their members. The economic system needs to be flexibleand adapt to changes. Changes in the way societies are structured are necessarybecause the goals that members pursue cannot be taken as fixed. People changethe content and the relative priority of their goals and values over time, so the sys-tem too needs to introduce such new mechanisms that would help them achievetheir new goals. War, famine, or natural disasters may also result in a radicalchange of goals and behavior, thus provoking internal changes. A particularlyinfluential factor is competition with other societies. This puts pressure on eachsociety to maintain a high standard of living; otherwise it will be seen to befalling behind, particularly in a world of growing international awareness. Thiscompetition encourages people to move to such other societies by legal or ille-gal means that are conducive to achieving their goals . Thus, the survival of asociety depends on its ability to introduce necessary reforms. The outdated rela-tionships give way to the new either through a process of evolution or throughcommand. However, the ultimate aim of reforms should be the equiproportion-ate development of each aspect of life: economic aspect, political aspect, andideological aspect; the external environment; and the process of reform so as toachieve consistency. Otherwise the reform in its totality will be doomed to fail-ure. The historical development of societies is the result of an endless struggle forconsistency.

To understand and assess economic systems or reforms, we need to askwhether the economic system is consistent or the reforms attempted achieve con-sistency. The economic system or the reforms must achieve a consistent set ofrelations among all spheres of life; otherwise, the economic system will not sur-vive for long. Five elements of the economic system (economic structure, politicalstructure, ideological structure, external environment, and reforms) have beenchosen for this book because economic systems differ along these dimensions.They have also been chosen because they affect economic outcomes. This meansthat the economic system or reforms would aim at

(a) Establishing consistency within the economic structure: establishing con-sistency among property relations, organizational relations, and motiva-tional relations.

(b) Establishing consistency between the political and economic structure.(c) Establishing an ideology consistent with the economic and political

structures.(d) Establishing consistency with the external environment and(e) Establishing a consistent process of implementing reforms.

While consistency is a necessary condition for the development of a viable system,it is not sufficient. The consistent economic system has to avoid massive waste,

consistency and viability of capitalist...a catalogue record of the book is available from the...

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