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The contributions of Market Capitalism to economic prosperity

by / 0 Comments / 372 View / April 29, 2015

Since WWII, the world has seen the collapse of communism and the expansion of international trade. Since the time of Adam Smith economists have believed that both markets and trade are important contributors to economic growth and ultimately human flourishing. In fact, there is a large body of empirical evidence which supports these theoretical presumptions…

Evidence from countries in transition…

The transition of ex-Soviet countries from socialist central-planning to market capitalism represents a good example of the long-term economic benefits of capitalism. Consider a meta-analysis of 60 studies published in the peer-reviewed journal Economics in Transition which examined the economic performance of formerly centrally planned socialist economies after undergoing economic liberalization (pro-market reforms) found that the empirical literature indicates that liberalization reduced economic growth in the short run, but had strong positive effects on economic growth in the long-run. In particular, the authors note that “the positive effects of reforms outweigh the costs after about a year and then continue to contribute to economic growth.”

It’s also worth noting that while many individuals consider market capitalism to be environmentally destructive, these same people often never point out that centrally planned socialist economies have done more damage to the environment that capitalism ever did. In fact, the transition from socialism to capitalism actually improved the environment in post-socialist countries. As noted by Harvard economist Andrei Shleifer

“Communism left behind a blighted environment, and not just around Chernobyl. East Germany discharged more than seven times as much sulfur oxide per capita as West Germany, and more than three times as much as the US. Things have improved. On average, the 11 postcommunist EU members have slashed emissions of nitrogen oxides, sulphur oxides and carbon monoxide each by more than 50 percent since 1990. Twelve post-Soviet republics cut the release of harmful pollutants into the air from stationary sources by 66 percent on average between 1991 and 2012. This happened even as postcommunist economies grew.”

The transition to a market economy was one of the major reasons for these positive changes. One paper found that there was “strong evidence that the majority of the transition reforms, such as increased openness and enterprise restructuring and privatization, have influenced the allocation of resources towards cleaner manufacturing sectors.”

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The collapse of the totalitarian Soviet state also resulted in the transition to democracy. Many on the left, primarily ‘democratic socialists’, believe that markets and democracy are incompatible. However, the evidence from post-socialist (transition) countries shows this is not the case. In a paper using survey data for 28 transition countries economists at the European Bank for Reconstruction and Development found that “democracy enhances the support for market development” and that “building democratic institutions can play as an ingredient in favor of market liberalization.” Similarly, another highly cited paper on this matter found that democracy “had a positive effect on [economic] growth during transition [from socialism to capitalism], albeit indirectly, through facilitating economic liberalization.”

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As an aside, when I once pointed this out to a professor of mine, who happens to be a Marxist and democratic socialist, he seemed to dismiss these findings by pointing out that when he visited Russia, ‘Capitalism’ was considered a dirty word as it is rather unpopular there. Thus, in the Russian case, democracy does not lead to economic liberalization. It’s certainly true that Russians aren’t a fan of the market economy; however, as the above graph based on survey data shows, Russians don’t support democracy either (less than 35% support democracy). In fact, they have the lowest levels of support for democracy in the entire sample of countries studied.

China is another example of the failures of central planning and the success of the market. During the late 1950’s and early 1960’s, the Communist Party of China lead by Chairman Mao attempted to rapidly transform the country from an agriculture based economy to an industrialized one via mechanisms such as the mandatory collectivization of agriculture and industry. Indeed, during this time, private farming was prohibited. Unfortunately for the communists, the Great Leap Forward measures did not lead to an industrialized economy, but instead to a great famine which lead to 18 to 32 million deaths. Economic historians have noted that…

The Great Leap Forward disaster, characterized by a collapse in grain production and a widespread famine in China between 1959 and 1961, is found attributable to a systemic failure in central planning. Wishfully expecting a great leap in agricultural productivity from collectivization, the Chinese government accelerated its aggressive industrialization timetable. Grain output fell sharply as the government diverted agricultural resources to industry and imposed an excessive grain procurement burden on peasants, leaving them with insufficient calories to sustain labor productivity. Our analysis shows that 61 percent of the decline in output is attributable to the policies of resource diversion and excessive procurement.

However, during the late 1970’s and early 1980’s, China decollectivized it’s agricultural system by dividing the communes into private plots and subsequently began pro-market economic reforms in the late 20th century which resulted in rapid economic growth and poverty reduction. Following reform “agricultural output increased by 8.2% a year, compared with 2.7% in the pre-reform period, despite a decrease in the area of land used.” Research from Oxford University’s Economics Department finds that China’s economic growth was driven by trade liberalization, rapid privatization, and sectoral changes. As a result of these reforms, China’s GDP per capita grew 4.1 percentage points faster than it otherwise would have.

China currently has a population of over 1.3 billion and it managed to bring down the share of its people living in poverty from 53% at the onset of economic reforms in 1981 to 8% twenty years later. This suggests that over 400 million people have risen out of abject poverty in China alone since it began economic liberalization. Indeed, one analysis of China’s pro-market reforms finds that reform lead to “universal increases in living standards that have elevated hundreds of millions from absolute poverty.”

Evidence from non-transition economies…

The economic benefits of capitalism go beyond the experiences of transition economies. Many studies have examined the relationship between economic liberalization (measured using indices of economic freedom) and economic growth using data from a large number of countries. A survey of these studies came to the conclusion that “there are strong indications that liberalization stimulates economic growth.” Similarly, a meta-analysis of 40 of these studies came to the conclusion that:

[Our] meta-analysis shows clearly that there is a positive and statistically significant association between economic freedom and economic growth. Importantly, this association is very robust. That is, regardless of the sample of countries, the measure of economic freedom and the level of aggregation, there is a solid finding of a direct positive association between economic freedom and economic growth. This association is both statistically significant and of economic importance.

In regards to the relationship between economic freedom and poverty, research shows that “both the level and change in economic freedom have contributed to reductions in the poverty rate over recent decades.”

The evidence on privatization…

A recent paper published in the peer-reviewed  Journal of Banking and Finance surveyed the empirical evidence on privatization and firm performance and efficiency. The review came to the conclusion that, “the evidence suggests that better institutions along with government relinquishment of ownership allow market-led forces to coalesce to boost efficiency, investments, and economic growth.” An earlier survey of the evidence comes to the following conclusion:

The extant evidence from privatizations in many developed and developing shows that privatization usually results in an increased productivity and positive effects on the society. The effect of privatization depends however on economic institutions in place, in particular on rule-of-law, competition, hard budget constraints, quality of governance and regulation…

This research provides solid evidence that privatization “generally” works, both for the firms that are privatized and for privatizing economies as a whole. While privatization usually results both in increased productivity and reduced employment in privatized firms, fears of negative overall effects at the economy level are not justified. An important caveat here is that the benefits of privatizations depend on market institutions being in place. The countries that manage to ensure property rights protection and the rule-of law, impose hard budget constraints, increase competition, and improve corporate governance reap the largest benefits. If appropriate institutions are not in place, privatization often fails to improve performance at the firm level and for the economy as a whole.

Overall the evidence seems to suggest that market capitalism significantly contributes to economic prosperity.

 

 

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