"Whither Socialism?" is not—as the title might suggest—another refutation of the now-disintegrating real socialism of the 1970s and 1980s by contrasting it with the pure model of competitive capitalism widely used as reference point in much of the literature on system transformation. Rather, the book's focus is "market socialism," by which the author means neither the incoherent blend of central planning and market coordination tried by some Central European countries in the 1980s, nor a utopian "third way." Instead, Stiglitz focuses on the market socialism model of Lange, Lerner, and Taylor, prevalent in the 1930s, which was based on the assumption that if public enterprise managers enjoy enough independence in their business decisions, they behave rationally (equalize marginal revenue to marginal cost)—that is, that the efficiency of the free market system can be reproduced without private property.
Why should one devote a whole book to a model that never extended beyond academic debate, and which has produced little new theoretical insights for decades? Stiglitz' surprising answer is that the model of market socialism and that of competitive market capitalism suffer from the same simplified assumptions. In the author's words, "market socialism took the neo-classical model seriously, that was its fatal flaw." Through a discussion of the common and differing qualities of these two "pure" models, the author explores the defects of "real market economies" (capitalist or transition), drawing a sharp line between feasibility and utopia. Thus, the transition issues come into focus only gradually, in the chapter on privatization, well into the second half of the book.
Stiglitz is widely known as one of the pioneers of the new information economics; according to the bibliography he is the author or coauthor of 129 publications in this area. Information economics challenges key assumptions of the competitive capitalism model and focuses on information inefficiencies, such as imperfect competition (oligopolistic practices); incomplete markets for goods, labor, capital, and land—in particular, forward markets; and incomplete and costly information, as well as limits and costs of processing available information. Other constraints, such as increasing returns (including research and development, learning- by-doing), further weaken the basis for competitive capitalism. Stiglitz concludes that both capitalist and market socialism models are operationally irrelevant.
Let us summarize the author's position on four closely related issues: competition, privatization, capital markets, and the role of the state.
Competition. Change of ownership will improve performance automatically and swiftly only by assuming perfect competition. But in modern economies, due to informational and other constraints, imperfect—mainly oligo-polistic—competition prevails. Thus, subjecting firms to real competition is more important than changing ownership. Competition serves crucial functions: it generates information about the success or failure of firms, which in turn enables management to develop rational incentive structures; and it promotes innovation.
Privatization is viewed as having fallen under the spell of the "property myth ...[which] holds that all one has to do is correctly assign property rights, and economic efficiency is assured. This myth is a dangerous one because it has misled many of the countries in transition to focus on property rights issues, on privatization, rather than a broader set of issues. Resolving property rights is certainly not sufficient, and may not even be necessary," the author remarks. Voucher privatization, that is, free distribution of assets, amounts to a "negative lump-sum tax." This loss of government rents requires raising tax revenues, which has distorting consequences. Although the theoretical argument for fast and complete privatization is questionable, practical economic arguments may yet support such a strategy, especially if the government is losing control over state-owned enterprises.
Privatization can provide other practical benefits, such as a consequent change of incentives, a hardening of budget constraints, and a demonstration of political commitment to systemic change. Efficient corporate governance—the main argument for swift privatization—is highly unlikely, whatever privatization model is used, and there is no plausible answer to the intriguing question of who would monitor the monitors—in other words, who would control the business decisions of the managers if share ownership were dispersed. Therefore, banks should be given a prominent role as owners. Indeed, banks have the information derived from, and power exerted through, granting or withholding financing. (Stiglitz urges the transition economies to adopt the continental European and Asian model of banking.) Mutual or peer monitoring by a coalition of the major "stakeholders" (including state holding companies) could provide more competent corporate governance than any alternative, in contrast to the fashionable focus on shareholder value.
In the capital markets, information shortcomings have particularly grave consequences. The social return of information generated on the security markets is negligible; nor is is such information useful for developing rational patterns of savings and investment—even in highly industrialized economies. Reshuffling existing state ownership—the primary function of the stock market—is essentially a zero-sum game, predominantly driven by rent-seeking and by perceptions, rather than information on fundamentals, with at best minor effects on aggregate efficiency, the author claims. Stock markets, therefore, are primarily "the rich man's horse track, or the middle-class' gambling casino," with little effect on raising funds and allocating resources. Even mature equity markets may distort enterprise behavior; a good example is the linking managers' rewards to short-term stock price fluctuation. Therefore, it is a myth that a good stock market is all one needs, Stiglitz points out.
Role of the State. The scope for massive coordination failures resulting from information deficiencies in competition, privatization, and capital markets leads to the rejection of the "folk theorem" that "anything the government can do, the private sector can do better." Stiglitz believes that on the contrary, there is no intellectual foundation for the separation of efficiency and equity concerns. Government intervention can improve welfare beyond correcting the traditional market failures, such as externalities, public goods, and monopolies. Economic history offers innumerable examples of both market and government failures, but no "controlled experiments" exist that could settle the question in favor of one or the other institutional arrangement. However, empirical evidence suggests that transition economies with a weak government can be better off with private arrangements. The role of government, therefore, cannot be defined on the basis of the insupportable normative axiom that government should be as small as possible. A pragmatic approach would be more proper, choosing between the public or the private alternative, depending on which would perform better under the existing informational and institutional constraints.
Only in the last few pages of the book does Stiglitz offer a veiled answer to the title's question. In a philosophical rather than economic conclusion, the author tries to explain the incessant appeal of Marxism over more than a century. He predicts that although the "great socialist experiment" has run its course, its perseverance suggests that the "dream of a better world, ... a central theme in the development of Western civilization since the Reformation," is likely to persist in one form or another. He suggests, further, that even forgetting its theoretical shortcomings, the narrow neoclassical model which holds that individuals' self-interest is the only motivating force for economic and social relations will not convince those who have decided to quest for a more humane and egalitarian society. The author makes no secret of his conviction, pointing out, "the question is whether the insights of modern economic theory and the utopian ideals of the nineteenth century can be brought closer together?"
Joseph E. Stiglitz is Loan Kennedy Professor of Economics at Stanford University.
Martin Schrenk is consultant, World Bank.
Stiglitz, Joseph E. 1995. "Whither Socialism?" MIT Press. Cambridge, MA 338 p.
