Tuesday, December 15, 2015

When communism means free markets and capitalism means central planning

Image (left to right): Josip Broz Tito (President of Communist Yugoslavia), United States President Nixon, Pelagija Broz (Tito's wife), and Pat Nixon (Nixon's wife) en route to a 1971 Presidential dinner hosted by Nixon in Tito's honor. (source)

This post is meant to address one of the most common misconceptions about what, exactly, are communism and capitalism. It is nearly universally assumed (even by those whose job it is to write about social policy) that communism means a centrally planned economy and capitalism means a free market economy, but this is totally false. Communism and capitalism can exist--and have existed--in a free market or centrally planned economy. Indeed--as we will see below--the Yugoslavian Communists believed that communism should exist in a libertarian free market paradise, where government "withered away" to nothing and everyone was supposed to get their social welfare services (like health care) from their employer. If you couldn't get health insurance from an employer, you were on your own--there was no government program to provide medical care as a last resort, because the government had "whithered away" entirely. To these libertarian communists, the government was not even supposed to build roads and other infrastructure. The Yugoslavian Communists believed that this was the most faithful plan to bring about Karl Marx's vision of a communist worker's paradise, and for several decades following World War II, this type of free market communism existed in Yugoslavia.

It's equally preposterous that capitalism is synonymous with free markets; capitalism and central planning have gone together well throughout history, as we shall see below.

Communism and capitalism have nothing to do with the structure of markets and everything to do with ownership. To see what this means, let's take a very simplified example, then we'll apply it to real world examples like former Yugoslavia.

In capitalism, the owners of capital have the right to any profits generated from the use of their capital. Let's say that Mr. Widget is the only owner of Widget Co., a company that makes doo-dads. Doo-dads are produced using a large machine that requires several workers to operate, as well as some hands-on work at the end using specialized tools. Widget Co.'s capital is the doo-dad machine, the building that houses their production, and the tools used at the end of the process. Widget Co.'s labor are the workers who operate the machine and use the tools to create doo-dads. Mr. Widget is not a part of Widget Co.'s labor, since he doesn't work the machine or the tools.

For the sake of discussion, let's push this example further. Let's assume that Mr. Widget doesn't even manage Widget Co. Let's assume that he has hired Jerry Rig to manage production and to market/sell the completed doo-dads; all Mr. Widget does all day is play golf.

Actually, since this is a hypothetical anyway, let's push this example further still. Not only does Mr. Widget play golf all day, but he inherited the widget machine and Widget Co. from his father. He didn't invent the widget machine; he didn't build the widget machine; he didn't start Widget Co. He simply owns the company and its capital.

At the end of each year, Mr. Widget sits down with his accountant and they go over sales revenues and production costs. Widget Co. has paid all of its costs during the year: the wages of its workers and their manager Mr. Rig, electricity costs to run the widget machine, the cost to rent the production facility, repairs or replacements for broken or damaged capital, taxes owed to the government, etc. This is tallied into the total cost for the year. Then, they tally up all the income derived from all the doo-dads Mr. Rig was able to sell during the year--this is Widget Co.'s revenue. The excess revenue--or profit--is whatever is leftover when costs are subtracted from revenues.

In a capitalist system, Mr. Widget is entitled to all of the profits of the company. Even though all he did during the year was play golf, and didn't invent or build the widget machine, or even start Widget Co., Mr. Widget is still entitled to all of Widget Co.'s profits as sole owner. The workers and their manager Mr. Rig are employed at will by Mr. Widget. Mr. Widget pays them whatever hourly wage the market will bear, but they have no entitlement to Widget Co.'s profits--nor does anyone else who isn't an owner. Because we assumed Mr. Widget is the sole owner of Widget Co., he is entitled to all the profits of Widget Co.

In a communist system, this type of ownership--in so many words, ownership of companies by shareholders--would be limited by law or outright illegal. In a communist system, companies can only be owned by certain people: for example, the workers of the company, partner companies (companies that supply the materials used in production or who purchase and use the products themselves), customers, publicly by a holding company like Temasek Holdings, etc. Or, Mr. Widget could have some claim to profits if he were the builder or inventor of the widget machine, for example.

In sum, passive ownership of companies by shareholders is allowed in capitalism, but not in communism. That is the only difference. In later posts, we'll explore why this is a desireable outcome. But for now, I want to stick to the central idea of this post--what exactly is meant by the words "capitalism" and "communism."

Free market vs centrally planned economies
Having established clear definitions for capitalism and communism, we turn to the concepts of free market and centrally planned economies. As we establish basic definitions of free market economies and centrally planned economies, it will become obvious that capitalism and communism can easily fit into either system.

In free markets, firms have autonomy--that is, they make their overall business strategies as well as day-to-day decisions on their own. They may have government-imposed laws and regulations they need to abide by, but by and large, firms are autonomous and free to operate as they see fit; very few decisions need approval by a central authority.

By contrast, in a centrally planned economy, the government may establish production quotas, wages employees must be paid (whether floor or ceiling), the price of individual goods or materials, the design of the products each company must produce, etc. Firms are not autonomous, in that they are more limited in the decisions they are able to make; they are constrained by the dictates of the central planner. Fundamentally, the government has economic goals it is trying to reach, and a central authority employs some or all of these strategies to direct each economic actor toward reaching those macro-level goals. Generally, companies cannot make most decisions without prior approval from a central planner.

Now, with our (very theoretical) definitions, let's examine see some real world permutations of capitalism and communism with free market and centrally planned economies.

Free market capitalist
This section is not very long because the United States and the rest of the developed West is free market capitalist, and we're all presumably very familiar with it. Obviously, the owners of capital (the shareholders) are entitled to all of a company's profits--capitalism--and firms are free to act autonomously--free market. The developed West is a free market, capitalist economy.

However, it's important to note some diversity in free market capitalism, which can take radically different forms. The Arab Gulf states are also free market capitalist:
Contrary to popular misconceptions, the enormous pools of capital in the Gulf are not simply held by state institutions or Sovereign Wealth Funds (SWFs). The Financial Times reported in mid 2013 that the levels of wealth held by GCC banks, private companies, and the wealthiest individuals and families reached $3 trillion, a figure that does not include wealth held by SWFs...One remarkable indication of this is the Gulf’s proportion of millionaire households. According to a recent report by the Boston Consulting Group, countries from the GCC occupy five out of the top eleven spots for the proportion of millionaire households at a global level, with tiny Qatar ranked number one in the world (14.3% of households).
Ownership of capital by shareholders is permitted in the Arab Gulf states, and so they are capitalist. Yet these countries are also absolutist monarchies where slavery (h/t) is basically legal. Two hallmarks of capitalism in the developed West is a representative democracy and abolition of slavery, but the Arab Gulf states make it clear that these aren't preconditions of capitalism. Free market capitalism can be adapted to suit an absolutist monarchy as well as a representative democracy; it can fit comfortably with labor law that is so permissive that consenting adults can (and do) enter into contracts that amount to slavery. Clearly, there is no one way to design a free market capitalist economy.

Centrally planned capitalism
During World War I and World War II, the United States economy was centrally planned:
In both World War I and World War II, and to a lesser extent during the Korean War, the United States imposed a comprehensive system of wage and price controls, and created federal agencies charged with controlling and maximizing war production.
Indeed, the reconversion from a wartime command economy to a market-oriented postwar economy, a transition accomplished with astonishing speed and little apparent difficulty, constitutes one of the most remarkable events in U.S. economic history.
In World War II, there were strict rations on many items: tires, cars, bicycles, gasoline, fuel oil, kerosene, solid fuels, stoves, rubber footwear, shoes, sugar, coffee, processed foods, meats, canned fish, cheese, canned milk, fats, and typewriters. Here is a fascinating exhibit of civilian ration vouchers used during World War II, and government propaganda justifying rationing. Obviously, a hallmark of a free market system is not one where each person is assigned by a central planner the number of consumer goods and raw materials they are allowed to buy.

Yet the United States was still capitalist, because the owners of capital--the companies' shareholders--were still entitled to the profits generated by the production and sale of goods. Producers were not free to act autonomously--they had to produce as the federal government directed them to--but they still owned their capital. The United States government did not nationalize the machines that built armaments, for example--these remained privately owned by the companies' existing shareholders, even if those shareholders no longer had the freedom to direct how their capital was used. And because they retained ownership, the shareholders retained their entitlement to the profits generated through their companies' wartime production. After wages, electricity bills, maintenance costs, etc, were paid, the shareholders got to keep the all the profit. (Here is a 1946 article lamenting extensive war profiteering by shareholders during both World Wars)

Clearly, the American economic system during both World Wars was centrally planned capitalism.

Again, there is no one way to design a centrally planned capitalist economy. For other examples, the East Asian Miracle countries (or Asian Tiger economies) except for China were ^centrally planned, capitalist economies during their Miracle years.

Capitalist mercantilism
Mercantilism is an exploitative economic system designed to help conquering countries extract as much wealth as possible from their colonies. The entire purpose of colonization was to extract wealth, and European colonizers had different strategies for doing so. The Spanish did so by enslaving the natives and forcing them to work in plantations and mines, then sending the riches back to Spain. But other European countries--most famously, Great Britain--developed a new type of capitalist system to extract wealth from their colonies, called mercantilism.

The strategy behind mercantilism is for the colonizer to force the colonies to export their raw materials only to the colonizer at low prices, then force the colony to purchase manufactured goods only from the colonizer at high prices. The key here is that markets are not free, nor are they centrally planned. Each economic actor--from peasant farmers to huge corporations, whether in the colony or colonizing country--is free to act autonomously. Unlike the United States during the World Wars, mercantilism does not feature a central planner establishing quotas or price controls. However, despite the autonomy of economic actors and lack of central planner, mercantilist markets are not free. Military power means that only certain transactions are allowed. Raw materials producers in the colony can only sell their goods to companies chartered with the colonizing country. A cotton producer in colonial Virginia, for example, couldn't sell his cotton to a French or Spanish company. Exports could only go to companies in England. Nor could a Virginia cotton producer sell his cotton to an American textile manufacturer--because the British outlawed manufacturing in their colonies, and used military power to enforce this ban. And colonies could only purchase manufactured goods from the colonizing country; British military might kept Dutch and Italian manufactured goods out of colonial India, for example.

So, companies chartered in the colonizing country have an extraordinary deal: the raw materials they need are produced in the colonies, and the colonies can only sell those raw materials to companies in the colonizing country--meaning that chartered companies have a very strong bargaining position. And because the colonies can only purchase manufactured goods produced in the colonizing country, the chartered companies stand to make a large profit by selling manufactured goods at high prices in the colony. To give an idea of how successful this system is at exploiting colonies, at one point, the British East India Company accounted for half of all world trade. Obviously, mercantilism created tremendous profits for the East India Company and other chartered companies.

Those enormous profits accrued to the company's shareholders; chartered companies were not government owned or operated in any way. Their only ownership was their shareholders, who controlled a company's operations and all claims to profits. Clearly, mercantilism as exercised by European colonizers was capitalist because a company's shareholders were entitled to all of a company's profits.

Thus, we have an example of an economy that is capitalist (because passive ownership entitles shareholders to all of a company's profit), yet markets are neither free (because military might ensures that only companies from the colonizing country can do business there) nor planned (because all economic actors, whether Indian yeoman farmers or the British East India company, were free to act autonomously, independent of a central planner). Many lands unfortunate enough to be colonized by Europeans had a capitalist, mercantilist economy forced upon them.

Clearly, the mercantilist economies of European colonies make it indisputable that economies do not come in only two flavors--centrally planned and free market--since mercantilism is obviously neither centrally planned nor free.

Centrally planned communism
I'm not going to spill much ink on centrally planned communism, since the Soviet Union is a very familiar example. The Soviet Union was communist because ownership of capital by shareholders was forbidden; instead, the government owned all capital. And, the government directed all economic activity as a central planner. Thus, the Soviet Union was a centrally planned, communist economy.

It isn't my interest in this post to argue that centrally planned communism can work well in some situations. And it's never my interest to defend a repressive single-party government, so I'll end this short section by simply concluding that the Soviet Union was an example of centrally planned communism.

(ok, here's one link on Cuba)

Free market communism
Following World War I, Yugoslavia's system of government was an absolute monarchy. Yugoslavia was brutally introduced to World War II in 1942, when the Germans, Italians, Bulgarians, and Hungarians simultaneously invaded, forcing surrender in less than ten days and beginning a barbaric occupation in which over a million Yugoslavs died. The Yugoslav Partisans, led by Josip Broz Tito, were the most effective resistance movement in the entire globe-spanning conflict. The Partisans were so effective that the Nazis were forced to commit as many soldiers to fighting in Yugoslavia as they committed to defending Italy against invasion by the Americans and British.*

The Partisans were organized and led by the Yugoslav Communist Party, which rallied around the goal of a harmonious, multiethnic communist state and a defeat of fascism. Unlike other resistance groups, the Partisans eschewed ethnocentricism; Catholics, Eastern Orthodox Christians, Jews, and Muslims from all Yugoslav ethnic groups fought shoulder to shoulder--something rather incredible given Yugoslavia's violent shattering along ethnic and religious lines in the 1980's and 90's following Tito's death.

After the war, the Communist Party of Yugoslavia controlled Yugoslavia. Unlike the Soviets, Tito and the Yugoslav Communists did not believe in state control of the economy. Yugoslavia's rejection of central planning so enraged Josef Stalin that he severed Soviet ties to Yugoslavia. Yugoslavia lived in fear of a Soviet invasion until 1955, shortly after Stalin's death.

The Yugoslavian Communists created what we might call free market communism. Ownership of companies by shareholders was forbidden, and thus the Yugoslavian economy was communist. Yet the economy was also free market, as each company was autonomous and free from the control of a central planner:
Tito recognized the Soviet model of government ownership of the means of production as little more than a fiction. He thus pushed for sweeping decentralization and economic liberalization. Under Tito, then, the worker’s self-management system was meant, in its purest conception, to provide the opposite of a Soviet-type dominance over the worker; the “new” Yugoslav worker, by contrast, was intended to have democratic control and a democratic voice in the daily activity of work. In retrospect, five decades later, this visionary social management seems extraordinary.

In a prescient image of management texts and innovative articles on new management thinking (found most often in the Harvard Business Review) at the millennium’s end (14), self-management sought innovation in a system that resembled an inverted pyramid in which workers from the lower echelons controlled and mandated the decisions made by higher management. Yugoslav self-management was, in theory at least, akin to democracy—tied to the tenet that basic decisions would be made by the workers who would have to carry out such decisions or be most affected by them (15). Worker’s councils, composed of as many as 50 individuals in large factories, represented the “will” of the worker. Further, since the state itself was intended to wither away, political leadership attempted to shift responsibilities to the worker’s commune—or opština (općina)—which was meant, in turn, to raise its own funds, sets its own budgets, and provide workers with necessary social services (16).

Thus, the factory was meant to be an autonomous and competitive organization. Self-management represented "an indirectly controlled market economy, with elements of Keynesianism [that is, based on the economic theories of John Maynard Keynes] as well as Marxism" (17). The worker’s council was the basic operations unit—deciding what and whom to pay, what wages to give, how best to reallocate profits after taxes and operating costs were made. Unlike a capitalist economy in which shareholders determine both the allocation of resources and decide on how best to use capi­tal, self-management provided a system whereby workers themselves were shareholders. The worker was not able to individually invest his or her earnings but would reap in the collective wealth of the organization. The worker’s only task was to make a profit for the organization.
This was experiment was initially quite successful:
From 1952 to 1965, Yugoslavia witnessed the golden age of its economy, rivaling Japan as the fastest growing worldwide economy(24). Labor-managed firms seemed to allow freedom of choice and direction for workers ; equally, self-management was an indicator both of a market economy taking root and the presence of economic democracy within Yugoslavia. From 1950-1985, only Taiwan (6,64 percent), Japan (6,26 percent) and China (5,10) produced Gross National Product (GNP) rates that exceeded Yugoslavia’s (4,46)(25).

In particular, the year 1960 saw Yugoslavia "riding a wave of unprecedented prosperity" (26). Agricultural yields, the rise in imports, demand in consumer goods along with extended lines of consumer credit were as high as ever.
Whereas the Soviet communists believed that the government should own everything, the Yugoslavian communists believed that the state should be eliminated entirely. Tito planned to have the Yugoslavian government--in his own words--"whither away" literally to nothing; he wanted to eliminate all state functions, including social welfare and infrastructure, which he believed were problems best solved by worker-controlled companies. Of course, this is downright libertarian: a total abolition of the state, including provision social welfare services, which were to be provided by one's employer. Yugoslavian communism was thus radically free market oriented, yet still communist because it forbade shareholder ownership of companies. Clearly, this is one area where the overly-simplistic left/right dichotomy obscures far more than it clarifies.

It is difficult to overemphasize how different Yugoslavian and Soviet communism were. All they had in common was the goal of eliminating the problems of capitalism by forbidding shareholder ownership of companies. Yet despite sharing this simple goal, they chose radically different paths. As stated above, their forms of communism were so different that the Yugoslavians actually feared the Soviets would invade due to their ideological differences on the structure of markets.

Yugoslavia was truly neutral in the cold war, both politically and economically. Like the West, they had a free market economy. But like the Soviet Union, ownership of companies by shareholders was forbidden. Yugoslavia was a communist, free market economy.

Free market communist, other
To show the potential diversity of free market communism, I'll mention two other examples here. First, the Guatemalan land reform of 1952, which I will discuss further in a forthcoming post, used a legal principle identical to eminent domain to purchase unused land from large landowners and distribute it to Guatemalan peasants (the Guatemalan President who signed this bill into law was himself a landowner and had some of his own land involved in the land reform). The vast majority of rural Guatemalans were landless and--without any other means of supporting themselves--were forced to toil on plantations owned by absentee landlords for sub-sustenance wages. Yet despite the misery of their workers, these plantations were enormously profitable. As a capitalist country, the owners of each plantation were entitled all of its profits. This was particularly problematic in Guatemala, as just 2% of the population owned 70% of all arable land. In other words, the people entitled to the enormous profits of Guatemala's farmland rarely--if ever--set foot on their plantations, let alone worked or managed them themselves. Further, only 12% of arable land was actually being farmed at the time of the land reform--a deliberate strategy of landowners to ensure there were always more rural job seekers than job openings, thus keeping rural wages low.

Thus, all that separated rural Guatemalans from destitution and a comfortable life was ownership: once they became landowners through land reform, they did the exact same work, but were now entitled to the profits. The Guatemalan land reform only involved land that was unused and paid 100% of the value of any land taken to its owner. The Guatemalan land reform is another example of free market communism, since ownership was shifted from shareholders to workers, but each farm or plantation was still autonomous.

Finally, in 1983, Rudolf Meidner of the Swedish Social Democratic Party proposed a policy called "wage-earner funds." Obviously, Sweden has been and remains a free market capitalist country, albeit with a large welfare state (though not the largest) relative to other capitalist countries. The Swedish Social Democrats very nearly transformed Sweden from capitalism to communism through the use of wage earner funds. The explicit goal of the policy was to gradually transfer ownership of Sweden's largest and most important companies from ownership by shareholders to ownership by workers.

The policy worked like this: each year, large companies (those with over 50 employees) would be forced to disburse a small percentage of their profits in the form of new shares to wage earner funds, which were to be controlled by the company's workers. These new shares would be the same as any other shares in the company: owning 10% of the shares of a company, for example, entitled a shareholder to 10% of the company's profits and 10% of votes on the company's board of directors. Thus, slowly--over the course of several decades--all large companies would transition from shareholder control to worker control. No company would ever be fully worker owned as was the case in Yugoslavia--shareholders would never lose their initial stake, but their control over management and profits would be diluted by the new shares created for the wage earner funds. With ownership of more and more shares, a company's workers would have a slowly increasing influence over the company's management and entitlement to its profits, eventually controlling a majority of shares.

It's important here to note how little would have been changed about the Swedish economy. Companies would have continued functioning exactly as they had been, but with different owners. Sweden would have remained a free market economy, but with worker ownership of companies. Though wage earner funds were never instituted, this policy is clearly a valuable example of the diversity of free market communism; this policy could be introduced anywhere to gradually turn any kind of capitalist economy into communism.

In sum, the world has seen tremendous diversity of types of capitalism and communism. As noted above, the Yugoslavian communists and Soviet communists very nearly went to war over whether communism should be centrally planned or free market. Soviet-style communism may be the most well-known form of communism worldwide, but clearly, radically different forms of communism can exist--and have existed.

In capitalism, ownership of companies by shareholders is allowed; in communism, shareholder ownership of companies is limited (like in the wage earner funds) or outright banned (as in Yugoslavia or the Soviet Union). As the above examples demonstrate, these ownership rules can exist in any type of economy, and can further exist in any type of government, from direct democracy to representative democracy to fascism to absolute monarchy.

As I stated in the beginning of this post, it is not my goal here to explain why limiting or banning the ownership of companies by shareholders is a good idea, how this could be achieved, or what a post-capitalist world would look like. That is for later posts. Rather, my goal here is more limited: It's time to put to rest the misconception that capitalism equals free markets and communism equals a centrally planned economy. Capitalism or communism can exist in a free market economy, centrally planned economy, mercantilist economy, or any other type of economy not considered here. What determines communism vs capitalism is not the structure of the economy, but the type of ownership that is allowed.

Capitalism has many restrictions on ownership: you are not allowed to own people as slaves; you are not allowed to own capital that is harmful (the capital used for the production of street drugs, for example); ownership of written material is restricted by the principle of fair use when it interferes with the public good, education, literature, or scholarship; ownership of patents is restricted by the American federal government when it interferes with the public good or technological progress; restrictions on insider stock trading are fundamentally a limitation on ownership (if you own something, you have the right to sell it, but insider trading regulations forbid transactions that occur in an unfair way); etc. Clearly, establishing restrictions on ownership rights when needed to advance the public good has been and remains perfectly compatible with capitalism. Capitalism does not mean freedom of ownership; capitalism is full of limitations on ownership, and these limitations were usually introduced in order to advance the public good. As we saw above and will explore further in later posts, communism and capitalism are in many ways very similar--except that communism has a few more restrictions on ownership, with the goal of further advancing the public good.

*Winston Churchill told President Roosevelt in 1943:
It was a lamentable fact that virtually no supplies had been conveyed by sea to the 222,000 followers of Tito. ... These stalwarts were holding as many Germans in Yugoslavia as the combined Anglo-American forces were holding in Italy south of Rome. The Germans had been thrown into some confusion after the collapse of Italy and the Patriots had gained control of large stretches of the coast. We had not, however, seized the opportunity. The Germans had recovered and were driving the Partisans out bit by bit. The main reason for this was the artificial line of responsibility which ran through the Balkans...Considering that the Partisans had given us such a generous measure of assistance at almost no cost to ourselves, it was of high importance to ensure that their resistance was maintained and not allowed to flag.

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