10. Socialism – Business Environment



In this chapter, we shall study socialism which was developed by Karl Marx as an alternative to capitalism, its salient features, and its merits and demerits. After reading this chapter, you will be able to understand what is socialism and appreciate the fact that this system, too, shows certain defects when put to practice and is in no way superior to capitalism.


A socialistic economy is one where conscious and deliberate choice of economic priorities is made by some public authorities. Some features of a planned economy are:

  1. A central planning authority
  2. Pre-determined and well-defined objectives
  3. Fixation of targets
  4. Administration of controls
  5. Growing role of the public sector
  6. State is the final arbiter of all issues
  7. Public ownership of property
  8. State is the only entrepreneur
  9. Resources distributed as per priorities decided by the State
  10. Prices determined by the State

Socialism which has been advocated as an alternative to capitalism by Marxists as it addresses the evils of free-enterprise society had caught the imagination of the youth and social thinkers by the beginning of twentieth century. Karl Marx and Engels are the proponents of scientific socialism. The principle of equitable distribution of income and wealth is attractive to the youth who are said to be idealistic. Most of its followers were youth of the society. A Swedish King was supposed to have remarked to his minister while talking of socialism that “If one is not a socialist before the age of 25, it shows he has no heart, but if he continues to be a socialist even after 25, he has no head”.

Socialism has been defined in innumerous different ways depending upon the sensitivity of the analyst and his commitment to the principle of equitable distribution of income and equalities of opportunities. Broadly speaking, socialism aims in varying degrees at a form of classless society, to be achieved principally by transferring private property to social ownership and replacing the profit-motivated private enterprise system of free markets by centralized State planning. Although socialist programmes usually entail redistribution of income from the rich to the poor, they also emphasize equality of opportunity.”1 It can also be defined as the “Political doctrine that dictates that the means of production (machines, materials and output) should be owned by the society or by the State. The USSR practised socialism between 1917 and 1990.”2


A socialist economy has certain features that distinguish it from a capitalist or free market economy. The following are the most important features of a socialist economy:

  1. Public ownership of property: In a socialist economy, all the means of production including landed property are vested in the hands of the State. There is a total absence of private property in such economies. As a result, private individuals can neither own the means of production nor can they make use of it for private gains. Marxists believe that land being a free gift of nature and not the result of any exertion by individuals should be vested with the State. To them, labour is the only means of production which is the result of one's own effort. Labour the commodity is indistinguishable from labour the person. The value of any commodity is equal to the value of labour that is congealed in it. Invariably, capitalists who use labour in their organizations do not reward them according to the amount of work they have put in their work place. Instead, workers are underpaid by them and they are thrown out of their jobs by the use of labour-saving devices to create an army of unemployed people. This is done with a view to exploiting their labour by creating a situation wherein too many people contest for too few jobs and thus would be willing to accept lower wages as not taking in the jobs at lower wages will mean loss of income. This is because labour being a perishable commodity is lost forever, once one does not work for the day. Capitalists acquire and add on capital through such exploitation and use it to their advantage by acquiring smaller competitors. To Marxists, therefore, capital is not the legitimate factor of production that could be owned by individuals, but to be owned by the State. Since entrepreneurs are also trained labour, the entrepreneurial activity should also be undertaken by government. It follows logically that in socialism, State is the only entrepreneur who provides its own capital and organization to any business or industry owned exclusively by it. When socialism was initiated in feudal societies, the first step governments took was to take over private lands and make them state property. In Russia, for instance, soon after socialism was enthroned as an economic system in 1917–1918, the then Government nationalized all landed properties much against the opposition of peasants.3 Likewise, “Since the early years of Communism, the Chinese Government, in one form or another has owned all the land in China. The 1949 revolution, led by Mao Zedong, ended in a system of property ownership that reached back for centuries.”4

    Some of the salient features of a socialist economy are given in Fig. 10.1.

  2. A central planning authority: Economic development in socialist economies is carried out through centralized planning. In such economies, the State establishes a central planning authority (generally called Planning Commission) to carry out plans of five year or seven year durations; the Planning Commission plans, supervises, executes and evaluates the process of planning. The planning commissions work out predetermined and well-defined objectives, fix targets and administer controls to realize the overall objectives of the plans, which generally are: (a) faster economic growth, (b) reduction in inequalities of income, (c) stability of prices, (d) realization of full employment of all able bodied persons, and (e) achieving equilibrium in the balance of payments. Sometimes, objectives of planning may also include some short-term time-specific objectives such as flood control, rehabilitation of earthquake or Tsunami affected people and so on. Soviet Russia was the first country to adopt five year plans in 1930s. In India, the government established a planning commission in 1950 and adopted the First Five Year Plan in 1951. So far, we have had ten five year plans with varying degrees of results. A detailed analysis of the planning process is given in subsequent chapters.
  3. Growing role of the public sector: Socialism by its very definition and content is public sector oriented economic system; private sector has no place in it as private ownership of factors of production is anti-socialist. The State as the owner of all the means of production organizes, administers and controls public sector industries claiming profits, if any to itself. Occasionally, private individual workers may be assigned some pieces of land to work on them in their spare time as was done in Soviet Russia in the late 1970s and 1980s. But by and large, the government is committed to the growing role of the public sector in national economies governed by socialist philosophy.



    Figure 10.1 The Features of a Socialist Economy


  4. The economic equality of people: Socialism is founded on the principle that resources belong to the entire society and they should be distributed equitably among all members of the society. There should be also equality of opportunities so that there can be no basis for some people to enjoy greater income and wealth than others; given the fact opportunities remain the same for all. However, it should be noted that there is no basis to believe that socialism postulates economic equality of all persons. Socialism does not guarantee economic equality in its true sense. It only emphasizes that there should be no glaring inequalities in income distribution. It is not the aim of socialism to achieve perfect economic equality which can only be an ideal. Socialism advocates that the State should initiate all steps to reduce economic inequalities of income and wealth. Moreover, since industrial and business enterprises are owned and run by the State there is no possibility of private individuals amassing wealth far beyond what is sanctioned by public authorities. Certain amount of inequality in society is understandable given the fact that people are born and endowed differently. Besides, a certain degree of inequality in incomes is necessary reflecting incentives provided to people who work harder and better. Unless more productive and efficient workers are rewarded better, no one will try to be efficient in his/her work. Employees will not use their skill, ability, expertise and experience to the maximum extent unless they are adequately rewarded. Likewise, workers who absent themselves unauthorizedly or those who shirk their work too often or play truant need to be disciplined with penalty. A system should have both reward for good work and penalty for violations to inspire confidence in others. In fact, in Soviet Russia, productive workers in coal mines and factories were rewarded more based on certain productivity norms in the 60s and 70s. Therefore, socialism aims at minimum practicable inequality rather than achieving perfect equality of incomes. Socialism does not permit inheritance that leads to unearned incomes. Likewise, factors of production such as land and capital that yield unearned incomes are brought under the direct control of the State. However, when individuals save and hand it over to the government for use for public purposes, interest is permissible. In the words of Douglas Jay, “The basic aim of socialism is not literal or absolute equality but the minimum equality that is workable if human beings are actively to use their talents, not equal share but fair shares, not perfect equality but social justice.”5
  5. The equality of opportunity: One of the basic objectives of socialism is to provide equality of opportunity to people. Every individual irrespective of their economic status or where they come from enjoys equal opportunity under socialism to rise in life. Individuals may come from rich or poor families, but they are given equal opportunity in education or training, according to their aptitudes and attitudes so that they can get trained in the profession of their own choice. Unlike under capitalism where the children of poor families cannot afford costly professional education or cannot have recourse to basic minimum means to equip themselves mentally or physically for life, under socialism the State initiates such steps as to ensure that every child irrespective of its family background gets the maximum opportunity to nurture and develop its inborn and latent talents. Government provides free education and health services up to the secondary level. Even at the university level, talented students are encouraged to perform well academically through a scheme of stipends and scholarships. Thus under socialism, individuals are encouraged at every possible level to develop their capabilities and make use of every opportunity available to them.
  6. Social welfare and security: Under socialism, unlike in capitalism, there is a consideration of social welfare rather than private profit that guides and motivates productive activity. In a capitalist society, entrepreneurs undertake production and distribution of only such commodities and services that are expected to yield maximum profits for themselves. This results in the production of more visible, profitable luxury goods that mainly promote the standard of living of the rich, middle and the upper middle classes. The rich and the affluent in such societies indulge in luxurious and conspicuous consumption while the poor are denied even the wage goods that will assure them a decent living. But under socialism, the State directs industries to produce goods and services of the type and quantities that are essential to promote social welfare of the entire community. The motive of economic activity under socialism is welfare of the society rather than profit for individuals. What is performed by market mechanisms under capitalism is done by a central planning authority under socialism which directs and guides all economic activity. “Under socialism, such an authority keeps social welfare uppermost in its consideration. Under socialism, the State devotes its attention to ameliorating the lot of the common man by providing him and his family with adequate medical aid, full and free education and means of recreation and entertainment. Freedom from want is guaranteed and fear, born of insecurity, is to be banned.”6

    Socialism like the welfare-state-concept under capitalism assures its people social welfare and social security. Under socialism, the government takes the responsibility of catering to the basic needs of all people irrespective of their economic and social status. Socialism guarantees a life of freedom from wants and fears to all persons living under its charge.

  7. Classless society: The basic aim of socialism is to create a classless society wherein there would be no distinction between the rich and the poor, the “haves” and “have-nots”. In such a society, every individual is expected to enjoy equality of opportunity irrespective of caste, creed, community and religion. Socialism believes in a secular State. Socialism does not vouch for the class conflict. It does not allow the existence of divisions of society as classes of labour or owners of capital. Under socialism, restrictions are put in place on the control and the ownership of private wealth. Every individual is rewarded according to their work and perceived ability. Thus, socialism strikes at the very root of class conflict and avows to promote in its own way a classless society.
  8. The state is the final arbiter of all issues: In a socialist system, the State is the final arbiter of all issues emanating from any conflict of interest or violation of any written or unwritten contract. In a capitalist society, any violation of contract is arbited by courts of law or any administrative machinery created for the purpose. Where there is a conflict of interest between an individual and individual or an individual and the State, the court of law, which is an arm of the government, decides who is legally right and determines the onus of responsibility. Under socialism, the State is the final and supreme authority. Where there is a conflict of interest between the individual and the State, it is the interest of the State which predominates and that of the individual becomes subservient to that of the State. In all cases, it is the interest of the State that is paramount.

Socialism as an economic system was developed in response to the evils found in the working of capitalism. Under capitalism, workers are exploited; capitalists flourish at the expense of workers and consumers, people are traumatized under vicissitudes of recession and depression and problems such as inflation, unemployment, inequalities of income and so on. Socialism, committed as it is to equity and growth, was created to address all these issues found abundantly under capitalism.

  1. Social justice: Social justice is one of the basic objectives of socialism. Under this system, all the inhabitants are assured of social justice. The State attempts to reduce the inequalities of income to the barest minimum and attempts to distribute national income more evenly and equitably. The system attempts to ensure a fair share for all its entire population. It does not permit anyone to accumulate or to amass wealth or to have any source of unearned income. Man is not allowed to exploit another man. Equal opportunities are provided to everyone to develop his/her latent talents through appropriate education and training, expenses on which are borne by the State.
  2. Rapid development: Planned economic development helps socialist economies to achieve faster and quicker development. Planning also helps socialist governments to avoid wastage of resources and duplication of efforts. Planners use advanced statistical methods and input-output models to achieve maximum operational efficiency and optimum economic gains for its people. Planning prevents exploitation of the nation's resources for the privilege of the few. For instance, in the initial phase of the Soviet regime, the government was able to achieve not only faster development but also growth with equity to ensure basic amenities, and biological necessities of all its citizens such as food, shelter and clothes were available for all. In fact, Pandit Jawaharlal Nehru, the first Prime Minister of Independent India, was so thoroughly impressed with the Soviet model of development that he wanted to replicate it in India, though he could not fully succeed in his efforts.
  3. Rational outlook and scientific temperament: Socialists believe that people should have rational outlook and scientific temperament. To them, religion is the opium of the people. It intoxicates them with false notions of faith and religion and instils in them superstitious ideas. Since religions cannot explain many mysteries that go under the name of faith, they believe it creates in them an irrational outlook. Therefore, socialists want to develop in their followers scientific temperament which is based on a questioning mind and beliefs based on demonstrable facts and evidences. This kind of attitude was behind faster development of science and technology in the Soviet type of economies. It was for this reason that religious worship was banned in Soviet Russia when socialists were ruling the country.
  4. Avoids pitfalls of capitalism: Scientific socialism which was created as an antidote to the pitfalls of capitalism helps in the avoidance of major capitalist problems such as inflation, unemployment and inequalities of income. Unlike capitalist economies wherein business decisions are made and executed by millions of individual entrepreneurs juxtaposed by innumerable decisions of countless consumers leading to unavoidable anarchy of production and consumption, socialists decide issues on the basis of the collective wisdom exercised by thousands of experts and professionals through a centralized planning mechanism. Problems such as inflation, unemployment and inequalities of income are kept under strict control by the watchful eye of the State. Besides, since the State is the sole producer and distributor of goods and services and the deciding authority for fixing prices, it can keep prices under control, provide employment to the unemployed or can offer alternate deployment of human resources and ensure that inequalities of income do not become rampant.
  5. Better allocation of resources: Socialism through planned economic development and system of prioritization ensures that the productive resources of the nation are more optimally allocated among the various competing productive uses, ministries and development agencies. This is not possible under capitalism where due to inequalities of income and emergence of monopolies rational and optimal allocation of productive resources is not possible. Moreover, unlike in capitalism where individual entrepreneurs do not consider social causes to be their purpose and objective while deciding about allocation of scarce resources, a central planning authority under socialism ensures that the allocation of resources among the various competing uses is done with the sole aim of securing social welfare and social security. A central planning authority is in a much better position to assess the basic needs of the people, their sensitivity and the intensity of their desires so that it can devote the resources to satisfy them and meet their needs in the best possible manner.
  6. Improvement in productive efficiency: It is claimed by Socialists that there is a definite improvement in the productive efficiency of organizations under socialism vis-à-vis capitalism. This is because of the fact that under socialism (a) The State organizes production through public sector industries with the objective to increase social welfare rather than for the exclusive benefit of individuals constituting an organization under capitalism. This spurs the efforts of State-owned organizations to obtain greater social benefits from their production; (b) In a socialist economy public authorities invest heavily in improved techniques of production and scientific research which are then made easily and freely available to all public sector organizations that require them. This is not so under capitalism where production techniques and benefits of scientific research are exclusively held by the firms who invested in them and obtained patent rights. Therefore, benefits arising out of these scientific efforts are not freely available to competing firms and thus to people at large; (c) In socialist societies, governments make no effort to reduce output or to create artificial scarcity. This is unlike capitalism where monopoly firms try to reduce their output artificially so that they can charge premium on the prices of their much-demanded products with a view to increasing their profits; (d) Under socialism, governments try to improve production techniques mainly with a view to avoiding wastage, but in capitalism firms waste enormous amount of money in competitive advertisements and in wasteful competition against one another; and (e) Moreover, in capitalism there is a wide variety and choice of goods and services mainly with a view to developing brand names and charge exorbitant rates to the consumers. All these lead to wasteful expenditure of scarce resources under capitalism which can be studiously avoided under socialism.

The following are the demerits of socialism:

  1. Extensive centralization and bureaucratization: This is one of the major drawbacks of socialism. Socialistic economy by its very nature is run by bureaucrats who are known for poor efficiency. All over the world, bureaucracy is considered to be inefficient in administration and more so in the management of business. The civil servant does not have the same stake and self-interest in the organization they help to run in the same way the employees of a private company where their performance is watched and thei tenure is insecure and dependent on how well they produce results, as the civil servant gets promoted by way of seniority, is paid higher emoluments as a matter of routine, there is no extra reason or motivation for them to work harder and more efficiently. They are more concerned to let things go on somehow without any major breakdown of the system in which they are involved. Moreover, they are loath to take risk and bear any uncertainty which are important characteristics of private enterprise. Generally, the public sector show neither initiative nor resourcefulness and their business policy also lacks in enterprise and initiative. Moreover, decisions are never taken by them on time and are procrastinated as much as possible. Bureaucracy also leads to bossism, loss of individual liberty, lack of autonomy and freedom.
  2. Equality of opportunity and equitable distribution in socialism is a myth: Socialism is based on the lofty principle of equitable distribution of income and wealth. It is also the raisen deitre and sine qua non for the replacement of capitalism by socialism as a viable and acceptable economic model. However, wherever it has been put into practice, it has been found that socialism has failed to achieve this noble objective. In Soviet Russia, between 1917 and 1991, notwithstanding several initiatives undertaken by the Government, it was not possible for it to eradicate inequalities in income distribution. In fact, sometimes the measures initiated by the Government to increase productivity in mines by paying higher incentives to workers itself created inequalities in wages. Besides, scientists and professionals had to be paid higher compensations. Hazardous occupations had to be compensated more than others.7 Recently, for instance, it was reported in the media that natural calamities and efforts at rehabilitation exposed a widening wealth gap in China. It was found that a devastating earthquake inflicted greatest destruction in rural areas, smaller towns and cities peopled by erstwhile farm labourers. Buildings in such places were badly constructed with poor building safety practices which resulted in some citizens being “more vulnerable than others when disaster struck.”8 Factors such as self-interest, government policies and differences in opportunities add to the innate inequalities that exist in human beings in terms of intelligence, enterprise, work habits, physical and mental stamina and add their own to the widening inequalities among individuals in every society.
  3. Tramples personal liberty and freedom: Socialism by its very nature denies individuals personal liberty and freedom. A socialist economy is generally a regimented economy. People are neither given freedom nor choice. It is argued that when people have no freedom of enterprise there will be no corresponding free choice of occupations. Workers who are given certain types of jobs to perform have no choice to change them without the consent of the authorities concerned. Every worker is assigned a job under a scheme and if they leave it without the approval of the concerned authority, they are considered a deserter and punished. Personal freedom which is considered as the most important asset of a democratic society is conspicuous by its absence in socialist society. It is said that the kind of freedom and choice enjoyed by people in a free society to choose the job they want or the profession they seek to follow is denied in a socialist order. A worker under socialism is a mere cog in the wheel of production, the very same criticism that is levelled against capitalist society where capitalists take workers as a mere cog or a vendible commodity.
  4. Kills private initiative and enterprise: Socialism is believed to be a system which kills private initiative and enterprise and offers no incentive to the hardworking, enterprising, imaginative and inventive people. Moreover, the removal of incentives to hard work and stimulus to self improvement (which is the by-product of self interest and personal gain under capitalism) in a socialist society will not prompt people to give their best in their work place. Inventive ability, enterprising spirit and the ability to get things done whatever be the cost are all important for fast track growth both for personal and corporate development. These seem to have no place in a regimented society such as socialism.
  5. Lacks consumer sovereignty: One of the chief merits of capitalism is consumer's sovereignty. The wide choice and immense satisfaction that a consumer gets in exercising such choices are significant tools to promote the overall welfare of the society. Maximization of human satisfaction is the result of such exercise of choice. A society that does not permit such a choice cannot promote its overall welfare. The growth in incomes and wealth though does not reflect itself in corresponding and proportionate increase in the welfare of the society, it does have a significant impact on human and social welfare. A society that does not permit the increase in social welfare through an increase in the choice of the consumer does not augur well for happiness of people living in such societies. Moreover, it has been reported that governments in Soviet type of countries were more concerned about increasing their visibility in the comity of nations rather than fulfilling the basic needs of its people. It was reported that Soviet Union spent more than 75 per cent of its resources on the manufacture of arms and ammunitions, satellites, intercontinental ballistic missiles and the like rather than catering to the basic and biological needs of its populace. Since Russia had lost almost all the wars that it fought against Western capitalist democracies, the Soviet Union concentrated heavily on production of war weapons so that they would not loose another war if it was ever started. As a result of these considerations of the government, ordinary Russians were denied adequate amount of consumer goods compared to their compatriots in the West and as such they enjoyed a poor standard of living.
  6. Slow and lethargic: Socialism is known to be a very slow and lethargic system which does not respond quickly and adequately to emerging economic or social problems. Too much centralization, bureaucratization and red tapes had made the entire socialist system an unresponsive mammoth leviathan. The people under Soviet regime were languishing for years for want of goods and services, freedom of choice and enterprise and yet the Soviets were unable to respond adequately and correctly to these inadequacies. If the Soviet system collapsed like a pack of cards even after more than seven decades of experimentation with socialism, it was because people found it wanting in terms of fulfilling their socio-economic and political aspirations. It is, therefore, said the socialism is too slow and lethargic to be of any use to a modern forward looking society.

Case 10.1 Why Did Socialism Fail in the USSR?

If USA is the citadel of capitalism, the Soviet Union was once the fortress of socialism. Socialism—established in Soviet Union in October 1917 by the Bolsheviks led by Lenin, Stalin and Trotsky after a violent revolution against the stupidly oppressive Czars—saw its heyday during the 1930s and 1940s, and started collapsing at the end of 1980s. Why did socialism that was touted as a viable alternative to capitalism collapse?

The Marxists declare that capitalism inevitably results in progressive impoverishment of the masses, wherein the rich get richer, and the poor get poorer. This is especially true of “mature” capitalism, of what they call “imperialistic monopoly and finance capitalism.” They claim that all capitalist schemes, such as labour unionism or social security designed to ward off the evil effects of the free-enterprise system, are but feeble attempts to salvage the exploitative system. The only way to prevent any catastrophe to civilization is to substitute socialism for capitalism. Socialism aims at an impressive improvement in the standard of living of the masses that the capitalist “exploiters” have reduced to utmost poverty. However, an impassioned analysis of both the systems reveals that the socialists have painted a totally distorted picture of the working of capitalism. Capitalism is essentially a mass production system for the satisfaction of the needs of the masses. “All that big business turns out serves, directly or indirectly but inevitably, the average citizen. There is no other means for business to prosper and to grow into bigness than to render its products and services accessible to the many.”1 The shops that cater to the affluent and offer luxury goods remain small because of the small clientele or at least medium sized. As a result of meeting the demand of the masses, capitalism has shown an unprecedented improvement in their standard of living.

Apart from the comparative merits and demerits of both the systems and their impacts on the economies that practised them, there are several stand-alone reasons as to why socialism failed in Soviet Russia after almost seven decades of not so unsuccessful run in that country. The following are the reasons adduced not by hardcore socialism-baiters, but by many who were and still are sympathetic to the Marxian way of thinking:

  1. Loss of arms race to the West: The immediate cause of the Soviet collapse was economic, as the Soviet Union lost the arms race and international competition with the West. Added to this was the collapse of rouble as Soviet consumers turned to imports to satisfy their needs. They could not buy anything in the Soviet Union because all the goods they produced were swallowed up by military procurement. With no quality goods available for exports, there was no means of balancing imports. As the Soviet economist Latsis noted grimly “the gloomy background of the worsening market situation…has a depressing effect on people.” Their gloom deepened as a result of policy failures such as the explosion of the Chernobyl atomic power plant and the war in Afghanistan.2

  2. Lack of honest and reliable Information: Doctored information with the objective of indoctrinating the masses about the “ideals of socialism”, the secrecy and propaganda that is central to the culture of war the Soviet Union pursued was another factor that caused the system's ultimate collapse. As contradictions mounted, the Soviet people became more and more cynical about the propaganda of government-controlled media. It was common to hear the Russian people say that “you could find truth anywhere except in Pravda and the news anywhere except in Izvestia.”3 Secrecy and restricted movement pervaded in Soviet Russia, which hindered the work of all levels of the system, from institutes to ministries. They were inaccessible to one another due to the barriers to communication and by an attitude that one should keep to oneself. Economic parameters and related data were regularly suppressed or falsified to the point that when the final economic collapse was impending there were no published figures to indicate where things went wrong so as to take some corrective action to ward off the calamity. It was so strange, according to Latsis, that the government did not even admit until 1988 that it was running a budget deficit.

  3. Alienation of common people: If these adverse factors were not enough, there was a profound alienation of the Soviet people that had grown up over the years as the country remained in the grips of the culture of war. “Most people did not participate in governance.”4 Since the time of Labour camps, the alienation remained. It was too late by the time Gorbachev came to liberate Soviet society. Two more factors namely the economic collapse and the country's defeat in Afghanistan came on top of generation of alienation. Few seemed to worry when the government failed finally. The socialist countries could not overcome the alienation that they inherited from the previous feudalistic economies. Socialism requires that the worker has “real participation in the mechanisms of social control over the products of his/her labour; a feeling that the means of production and its products are his or hers as part of society.” … The over centralized and commandist economies of the socialist world helped to entrench a form of ‘socialist' alienation.”5 Under these circumstances, “socialist alienation” seemed to be as bad as or perhaps even worse than capitalist alienation.

  4. Deficit of democracy: To Joe Slovo, the most respected theoretician of the South African Communist Party, the major cause of Soviet collapse was the failure to develop socialist democracy. He says that “The thesis of the ‘Dictatorship of the Proletariat' … was used as the theoretical rationalization for unbridled authoritarianism” and there was a “steady erosion of people's power both at the level of government and mass social organizations.” In his famous 1989 article, Slovo argues that socialism failed to develop a real democracy, including for “all citizens the basic rights and freedoms of organization, speech, thought, press, movement, residence, conscience and religion; full trade union rights for all workers including the right to strike, and one person one vote in free and democratic elections.”6 These are all essential principles of a culture of peace and are unsuited with a culture of war. It was the culture of war that stood in the way of development of democracy. There was total absence of democratic participation by the masses of the people. The command-administrative model of soviet state constricted economic development. Slovo points out that “the concept of the single-party state is nowhere to be found in Marxist theory.” The so-called “consensus” effectively stifled dissent and promoted the artificial appearance of unanimity on everything. Basic differences were either suppressed or silenced by the self-imposed discipline of the so-called democratic centralism. Both for these historical reasons and the experience gained have shown that an institutionalized one-party state has a strong susceptibility for authoritarianism.

    Chaturanan Mishra, another staunch Indian Communist, held that the dictatorship of the proletariat as a theory failed. Soviet socialism had a deficit of democracy. The 1936 Constitution was democratic but it was not implemented. Democratic centralism became only centralism. The Soviet government forcibly founded collective and state farms, which proved to be an utter failure. “Incentive for all is a must in socialism. One basic cause for the fall of the Soviet Union was that the leadership did not know what to do about inventions and did not use them for the civilian economy as distinct from the military complex.”7

  5. An economic system sans incentives: Socialism does not work because it is not consistent with fundamental principles of human behaviour. The failure of socialism in countries around the world can be traced to one critical defect: it is a system that ignores incentives. A centrally planned economy without market prices or profits, where property is owned by the state, is a system without an effective incentive mechanism to direct economic activity. By failing to emphasize incentives, socialism is a theory inconsistent with human nature and is therefore doomed to fail. Socialism is based on the theory that incentives don't matter! In a world of scarcity, it is essential for an economic system to be based on a clear incentive structure to promote economic efficiency. The economic atrophy that occurs under socialism is a direct consequence of its neglect of economic incentives. No bounty of natural resources can ever compensate a country for its lack of an efficient system of incentives. Russia, for example, is one of the world's wealthiest countries in terms of natural resources; it has some of the world's largest reserves of oil, natural gas, diamonds, and gold; its valuable farm land, lakes, rivers, and streams stretch across a land area that encompasses 11 time zones, yet Russia remains poor. Natural resources are helpful but the ultimate resources of any country are the unlimited resources of its people—human resources.

    Look at how incentives are of the utmost importance in a capitalist economy. Market prices, the profit-and-loss system of accounting, and private property rights provide an efficient, interrelated system of incentives to guide and direct economic behaviour. Capitalism is based on the theory that incentives matter! The price system in a market economy guides economic activity so flawlessly that most people don't appreciate its importance. Market prices transmit information about relative scarcity and then efficiently coordinate economic activity. The economic content of prices provides incentives that promote economic efficiency. For example, whenever the OPEC cartel restricted the supply of oil, prices rose dramatically. Consumers received a strong, clear message through the market forces about the scarcity of oil by the higher prices at the pump and were forced to change their behaviour dramatically. People reacted to the scarcity by driving less, carpooling more, taking public transportation and buying smaller cars. Producers reacted to the higher price by increasing their efforts at exploration for more oil and were also incentivized to develop alternative fuel and energy sources. Again, when US gas prices were controlled in 1970s, long queues were formed at service stations all over the country because the price for gasoline was kept artificially low by government fiat. The full impact of scarcity was not accurately conveyed. As Milton Friedman pointed out at the time, we could have eliminated the lines at the pump in one day by allowing the price to rise to clear the market. The collapse of socialism is due in part to the chaos and inefficiency that result from artificial prices. Administered prices are always either too high or too low, which then creates constant shortages and surpluses.

  6. Lack of competitive enterprise: Socialism collapsed also because of its failure to operate under a competitive, profit-and-loss system of accounting. A profit system is an effective monitoring mechanism which continually evaluates the economic performance of every business enterprise. The firms that are the most efficient and most successful at serving the public interest are rewarded with profits. Firms that operate inefficiently and fail to serve the public interest are penalized with losses. Competition forces companies to serve the public interest or suffer the consequences. Under central planning, there is no profit-and-loss system of accounting to accurately measure the success or failure of various programmes. Without profits, there is no way to discipline firms that fail to serve the public interest and no way to reward firms that do. There is no efficient way to determine which programmes should be expanded and which ones should be contracted or terminated. Without incentives, the results are a spiralling cycle of poverty and misery.

  7. Private property disallowed: Another fatal defect of socialism is its blatant disregard for the role of private property rights in creating incentives that foster economic growth and development. The failure of socialism around the world is a “tragedy of commons” on a global scale. The “tragedy of the commons” refers to the British experience of the sixteenth century when certain grazing lands were communally owned by villages and were made available for public use. The land was quickly overgrazed and eventually became worthless as villagers exploited the communally owned resource. While private property creates incentives for conservation and the responsible use of property, public property encourages irresponsibility and waste. If everyone owns an asset, people act as if no one owns it. And when no one owns it, no one really takes care of it. Public ownership encourages neglect and mismanagement. On the contrary, as stated by Arthur Young, a British economist of the eighteenth century, “The magic of private property turns sand into gold”. Much of the economic stagnation of socialism can be traced to the failure to establish and promote private property rights.

  8. Failure to kindle the human spirit: By their failure to foster, promote and nurture the potential of their people through incentive-enhancing institutions, centrally planned economies deprive the human spirit of full development. Socialism fails because it kills and destroys the human spirit. Capitalism will play a major role in the global revival of liberty and prosperity because it nurtures the human spirit, inspires human creativity and promotes the spirit of enterprise. By providing a powerful system of incentives that promotes thrift, hard work and efficiency, capitalism creates wealth. The main difference between capitalism and socialism is this: capitalism works.

“The evidence of history overwhelmingly favours capitalism as the greatest wealth-producing economic system available. The strength of capitalism can be attributed to an incentive structure based upon the three Ps: (i) prices determined by market forces, (ii) a profit-and-loss system of accounting and (iii) private property rights. The failure of socialism can be traced to its neglect of these three incentive-enhancing components.”8 The information transmitted by higher oil prices provided the appropriate incentive structure to both buyers and sellers. Buyers increased their effort to conserve a now more precious resource and sellers increased their effort to find more of this now scarcer resource. The only alternative to a market price is a controlled or fixed price which always transmits misleading information about relative scarcity.9



1 Ludwig von Mises, “Chapter: 27: The Soviet System's Economic Failure” in Economic Freedom and Interventionism: An Anthology of Articles and Essays, selected and edited by Bettina Bien Greaves (Indianapolis: Liberty Fund, 2007), Available online at http://oll.libertyfund.org/title/1887/109668on2010-01-28.

2 Otto Latsis, “Progress of Econmic Reform in the USSR,” World Marxist Review, 12 November, 1989, available online at http://www.culture-of-peace.info/latsis/page1.html.

3 David Adams, “Economics and the Arms Race: A Two-edged Sword,” Political Affairs, September/October 1991:16-22, excerpts available online at: http://www.culture-of-peace.info/soviet-collapse/introduction.html.

4 Jessie Dijo in The Fall of Soviet Union, http://socialstudiesvc.blogspot.com/2008/04/fall-of-soviet-union.html;

5 Joe Slovo: Has Socialism Failed? January 1990, available online: http://www.sacp.org.za/main.php?include=docs/history/1990/failed.html;

6 Ibid.

7 Chaturanan Mishra, Need to Redefine Socialism After the Collapse of the Soviet Union (2007) available online: http://www.mainstreamweekly.net/article492.html;

8 Mark J. Perry, “Why Socialism Failed,” The Freeman, 199545: 6, available online at http://www.thefreemanonline.org/featured/why-socialism-failed/.

9 Ludwig von Mises, “Chapter: 27: The Soviet System's Economic Failure” in Economic Freedom and Interventionism: An Anthology of Articles and Essays, selected and edited by Bettina Bien Greaves (Indianapolis: Liberty Fund, 2007), Available online at http://oll.libertyfund.org/title/1887/109668 on 2010-01-28

  • A socialistic economy is one where conscious and deliberate choice of economic priorities is made by some public authorities. Some features of a planned economy are: a central planning authority, pre-determined and well-defined objectives, fixation of targets, administration of controls and growing role of the public sector.
  • Socialism is founded on the principle that resources belong to the entire society and they should be owned by all members of the society represented by the State. In such an economy, all the means of production including landed property are vested in the hands of the State. Economic development is carried out through centralized planning. It is a public sector oriented economic system.
  • One of the basic objectives of socialism is to provide equality of opportunity to people. Under socialism, there is a consideration of social welfare rather than private profit that guides and motivates productive activity. Socialism assures its people social welfare and social security.
  • The basic aim of socialism is to create a classless society wherein there would be no distinction between the rich and the poor, the “haves” and “have-nots”. In such a system, the State is the final arbiter of all issues emanating from any conflict of interest or violation of any written or unwritten contract.
  • Social justice is one of the basic objectives of socialism. Planned economic development helps socialist economies to achieve faster and quicker development. Socialists believe that people should have rational outlook and scientific temperament. Socialism helps in the avoidance of major capitalist problems such as inflation, unemployment and inequalities of income. Socialism ensures that the productive resources of the nation are more optimally allocated among the various competing productive uses, ministries and development agencies.
  • Too much centralization and bureaucratization is one of the major drawbacks of socialism. Socialism by its very nature denies individuals personal liberty and freedom. It kills private initiative and enterprise and offers no incentive to the hardworking, enterprising, imaginative and inventive people. There is also lack of consumer sovereignty. Socialism is known to be a very slow and lethargic system which does not respond quickly and adequately to emerging economic or social problems.
bureaucracy central planning authority choice of occupations
classless society equality of opportunity equality of people
faster development human satisfaction lethargic system
pitfalls of capitalism productive efficiency public ownership
public sector scientific socialism scientific temperament
social justice social welfare and security socialism
state is the final arbiter    
  1. Critically evaluate the features of socialism. Does it have a future?
  2. Compare the economic role of the State in a socialist economy with its role in a capitalist economy.
  3. Distinguish between capitalism and socialism. In what respects is socialism superior to capitalism?
  4. How does a capitalist economy differ from a socialist one? To what extent are the defects of both eliminated in a mixed economy?
  5. Examine critically the case for ‘socialism' as a system more conducive to the progress of society than capitalism.
  6. What are the incentives to production under a socialist economy? Can they be more effective than those under capitalism?

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