ECON 4337 Comparative Economic Systems

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ECON 4337 Comparative Economic Systems

• Lecture 2 Part II
• January 27, 2009

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Role of State Intervention in Capitalism

• Neoclassical position
• In the absence of monopoly, forms of imperfect
  information and externalities, the economic role
  of state should be strictly limited.

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Role of State Intervention in Capitalism

• Limits to the Efficiency of Market Capitalism
• In general, laissez-faire market capitalism will
  not be
• completely efficient and this is called the
  problem of
• market failure
• What causes market failures?

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Role of State Intervention in Capitalism

• Limits to the Efficiency of Market Capitalism
• What causes market failures?
• Monopoly power
• Violates competitive markets assumption
• A monopolist will produce less and charge a
  higher price than would the competitive industry
• ? Deadweight loss
• Why inefficiency?

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Role of State Intervention in Capitalism

• Limits to the Efficiency of Market Capitalism
• What causes market failures?
• Monopoly power
• Natural monopoly (e.g. electricity, water)
• Monopolistic competition
• many firms in an industry producing a different
  (and thus unique) version of the same good or
  service
• Oligopoly
• small number of firms in an industry

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Role of State Intervention in Capitalism

• Limits to the Efficiency of Market Capitalism
• What causes market failures?
• Monopoly power
• How to control monopolies?
• Combine subsidization with producer taxation
  while producing a social tax dividend for society
• Direct regulation (dictate the efficient level of
  output)
• Let monopolies alone (Friedman)
• Enforce antitrust and anticartel legislation,
  remove legal barriers to competition

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Role of State Intervention in Capitalism

• Limits to the Efficiency of Market Capitalism
• What causes market failures?
• Monopoly power
• U.S. has a relatively more competitive and less
  concentrated economy
• U.S. economy can support more firms in most
  industries than can many smaller economies

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Role of State Intervention in Capitalism

• Limits to the Efficiency of Market Capitalism
• What causes market failures?
• Externalities
• Violates complete markets assumption
• Costs or benefits that are borne by or accrue to
  an agent other than the agent generating them
• Negative externalities (e.g. pollution)?overproduc
  ed
• Positive externalities (e.g. innovations)?underpro
  duced

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Role of State Intervention in Capitalism

• Limits to the Efficiency of Market Capitalism
• What causes market failures?
• Externalities
• How do we solve the problem?
• Tax negative externalities and subsidize positive
  externalities (Pigou)
• Command and control quantitative or technological
  restrictions
• Clearly define and enforce property rights, then
  externalities will be automatically internalized
  if negotiation costs are negligible (Coase)
• Form artificial markets

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Role of State Intervention in Capitalism

• Limits to the Efficiency of Market Capitalism
• What causes market failures?
• Public goods (Collective consumption goods)
• Violates complete markets assumption
• Public goods cannot be provided by private
  markets in optimal quantities and public
  production causes inefficiencies

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Role of State Intervention in Capitalism

• Limits to the Efficiency of Market Capitalism
• What causes market failures?
• Public goods (Collective consumption goods)
• Two characteristics
• Non-excludability of consumption
• Causes a free-rider problem
• Non-depletability of consumption

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Role of State Intervention in Capitalism

• Limits to the Efficiency of Market Capitalism
• What causes market failures?
• Public goods (Collective consumption goods)
• How do we solve the problem?
• Taxation?
• Government provision?
• Privatization?

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Role of State Intervention in Capitalism

• Limits to the Efficiency of Market Capitalism
• What causes market failures?
• Public goods (Collective consumption goods)
• How efficient is government provision?
• Certain factors prevent public choices in a
  democratic (majority rule) society being made in
  an efficient manner (James Buchanan, Gordon
  Tullock, Kenneth Arrow)

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Role of State Intervention in Capitalism

• Limits to the Efficiency of Market Capitalism
• What causes market failures?
• Public goods (Collective consumption goods)
• How efficient is government provision?
• Problems with majority voting
• Vote trading
• Effect of special interest groups
• Rationally ignorant voters
• Public choice can be irrational (Condorcets
  Paradox)

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Role of State Intervention in Capitalism

• Limits to the Efficiency of Market Capitalism
• What causes market failures?
• Imperfect information
• Violates full information assumption
• Asymmetric information
• When one party in a transaction knows more than
  the other (e.g. Akerlofs Lemons Problem)
• Adverse selection problem
• Moral hazard problem

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Role of State Intervention in Capitalism

• Limits to the Efficiency of Market Capitalism
• What causes market failures?
• Imperfect information
• How do we solve the problem?
• Government can increase the amount of relevant
  info generally available
• Hayek argues
• Market capitalists respond to price signals to
  move the economy along optimally, even though
  individual actors possess only limited knowledge
  a central planner can never achieve that

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Role of State Intervention in Capitalism

• Role of Capitalist State in Income
  Redistribution
• To what extent should the capitalist state
  redistribute income?
• Fairness Returns to factors are equal to their
  marginal productivities ? Is this fair?
• Cons and pros of redistribution
• Increased productivity, more investment
• Altruism and free rider problem
• John Rawls view

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Role of Unions in Capitalism

• In the U.S. history
• AFL (American Federation of Labor) (1881)
• Wagner Act (1935)
• established the modern U.S. system of collective
  bargaining
• CIO (Congress of Industrial Organizations)
• Taft-Hartley Act (1947)
• put restrictions on union activities
• AFL-CIO united (1955)
• number of workers in unions peaked
• Not much influential today

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Role of Unions in Capitalism

• In Western Europe
• Unions are
• Larger
• More accepted
• More influential
• More centrally organized
• Main political-economic base for Western European
  
• social democracy

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Role of Unions in Capitalism

• Percentages of the labor force belonging to
  unions

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Role of Unions in Capitalism

• Effects of unionization
• If unionized workers are paid more, then this
  might weaken unions since it leads to
  unemployment (e.g. Belgium)
• If unions cooperate with management, then high
  unionization might take place, productivity might
  increase and low unemployment is achieved. (e.g.
  Sweden)

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Critics of the Neoclassical Model

• Macroeconomic Instability of Market Capitalism
• Two main problems
• Unemployment
• Fluctuations in GDP (business cycles)
• Unemployment rate ?

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Critics of the Neoclassical Model

• Macroeconomic Instability of Market Capitalism
• Why is there unemployment?
• View of the Classical school
• Free markets are self-stabilizing
• Intervention is bad since it generates inflation

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Critics of the Neoclassical Model

• Macroeconomic Instability of Market Capitalism
• Why is there unemployment?
• View of the Keynesian school
• John Maynard Keynes General Theory of
  Employment, Interest and Money (1936)
• Nominal rigidities due to contracts (wages not
  fully flexible)
• Fiscal or monetary policy by government is
  suggested to stimulate the economy and to
  stabilize and smooth-out business cycles

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Critics of the Neoclassical Model

• Macroeconomic Instability of Market Capitalism
• Keynesian Revolution
• No fast auto adjustment mechanism as claimed by
  classicals
• No assurance of full employment
• Very popular after the WW II. such that budgets
  could be in deficit to stimulate the economy
• Business cycles were declared dead by the mid-60s
  
• ? Keynesian revolution

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Critics of the Neoclassical Model

• Macroeconomic Instability of Market Capitalism
• Tools of macroeconomic policy
• Fiscal policy tools Government spending and
  taxes
• Treasury makes tax proposals executive agencies
  propose spending packages
• ? Increase government spending or decrease taxes
  to increase aggregate demand

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Critics of the Neoclassical Model

• Macroeconomic Instability of Market Capitalism
• Tools of macroeconomic policy
• Monetary policy tools Money supply and interest
  rates
• Controlled by the Fed in the U.S. (The Federal
  Reserve Bank The U.S. central bank)
• ? Increase money supply or lower interest rates
  to increase aggregate demand

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Critics of the Neoclassical Model

• Macroeconomic Instability of Market Capitalism
• Monetarism Milton Friedman
• To control inflation control the growth of money
  supply so that it increases steadily at a rate
  equal to that of the rate of real GDP growth
• Currently, focus is on managing interest rates
  with the goal of targeting inflation

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Critics of the Neoclassical Model

• Macroeconomic Instability of Market Capitalism
• Monetarism Milton Friedman
• Money as the principal determinant of economic
  activity
• Money demand is a stable function of income
• M.VP.Y
• Return to laissez faire rejection of
  discretionary monetary and fiscal policies

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Critics of the Neoclassical Model

• Other Perspectives on Capitalism
• John Kenneth Galbraith (1908-2006)
• . . . the myth that production is the
  central problem of our lives." This concept of
  social efficiency, says Galbraith, originated in
  the days of Adam Smith in an era of scarcity. The
  classic economists have repeated it the public
  has echoed them. Now it is obsolete the
  present-day economy not only turns out all the
  goods needed but spends much of its energy
  whetting the consumers' appetites for things they
  do not need. The consequence of this lack of
  "social balance" is that production, largely in
  private hands, has far outdistanced services,
  which Galbraith seems to think are the
  responsibility of government. Thus there are
  plenty of vacuum cleaners but few street
  cleaners, a plethora of automobiles but no place
  to park. "The more goods people procure, the more
  trash must be carried away . . . the greater the
  wealth the thicker the dirt." (Time Magazine -
  June 2, 1958)

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Critics of the Neoclassical Model

• Other Perspectives on Capitalism
• John Kenneth Galbraith (1908-2006)
• The New Industrial State, The Affluent
  Society, Economics and the Public Purpose
• Against invisible hand hypothesis
• Modern capitalist economies as dual economies
• Enterprises with market power
• Competitive enterprises
• Remedy Public must regain the control of the
  state from corporations (role of economists)

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Critics of the Neoclassical Model

• Other Perspectives on Capitalism
• Joseph Schumpeter (1883-1950)
• Pessimistic admirer of capitalism
• Capitalism is destined to be replaced by
  socialism
• Entrepreneur as the dynamic force destined to get
  increasingly bureaucratized
• Small firms and public support diminish
• Dynamic character is lost

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Performance of Capitalist Economic Systems

• Economic growth Unclear potentially lower
  capital formation
• Income distribution Unequal unless state
  intervenes
• Efficiency Good
• Macro stability Potentially poor
• Economic security Potentially low
• Degree of Economic and Political Freedom High