Future of socialism uncertain

If you have sat through a course on the principles of economics in a Western country, you may recall that capitalism is a better form of economic system than socialism. A main feature distinguishing capitalism from socialism is the private ownership of the factors of productions (tangible and intangible inputs used in the production of goods and services). It is often said that capitalism creates more economic growth, higher productivity and prosperity. You may also remember that socialist economic systems-such as those of China, Cuba, North Korea and Vietnam-ultimately lead to undesirable economic and social outcomes.

A frequently asked question I have encountered is whether capitalism improves social welfare (roughly speaking, the standard of living enjoyed by people within a country). In my younger days, I used to study economics, often in its purest form. (Rumor has it that I got out of doing theory before it got too hard, but that is debatable!) A memorable course was "International Trade Theory," which was designed to examine the economic effects of an "open"(typically found in market/capitalist economies) and "closed" (commonly pursued by socialist countries) economies.

We spent the first half of the course studying the theoretical models of international trade and the remainder of the semester reviewing the empirical evidence to "test the models" and see if they are unsupported by the data. The course instructor was a rock star in the field with nearly 50 peer-reviewed journal articles, several of which had helped lay the groundwork for modern international trade theories. One of the predictions derived from the mathematical models that he repeatedly emphasized is that capitalist/market economies can achieve higher Pareto optimality or higher efficiency. Closed economies-a situation in which social welfare can be improved without hurting anyone else-produce much lower total output and are plagued with inefficiencies. The traditional trade models are generally supported by real-world data. One of the stylized facts is that market economies produce higher growth rates of gross domestic product (a measure of the total amount of goods and services produced within a nation) and their citizens enjoy higher standard of living.

A potential problem with the standard economic models, as noted by some researchers, is that they have trouble explaining the unprecedented performances exhibited by a few economic "tigers" like China, where the central government, not consumers and businesses, make economic decisions. Could it be that the models are too abstract, failing to capture the subtleties that exist in the real world? Why do some socialist economies perform so well, based on many traditional financial indicators? Why does a country with a massive shadow banking system have so few loan losses even during the financial crisis of 2018? How could China attract substantial direct foreign investments in the last two decades, despite being a communist country-a more extreme form of socialism whereby private ownership of the means of production is absent?

As I am writing this article, my airplane is departing to Hong Kong from China. I am about to attend the Asian Financial Forum as part of my investigation into this issue. Traveling with me for the last 10 days in our group is a Yale-trained financial economist with about four decades of international experience who currently leads a research institute at a major university in the U.S. We have had many discussions during the trip about the current state of academic research in emerging economies, particularly China. Bob (name changed to protect his privacy) and many we have spoken to, including a few Nobel-winning economists, are worried about the reliability of the Chinese data used in economic and financial research. Specifically, the recent financial indicators are inconsistent with China's growth rates reported in the news and literature. I am a bit more optimistic than Bob and am happy to report that the "problem" does not appear to be very serious, at least in the academic circle, and that it stems from the way we classify the economic regimes, among others. I invite you to stay tuned for the next interesting episode when I further elaborate on these topics, after analyzing some proprietary data I have collected from the journey.

 

 

Upcoming Events