Inequality, economic models and the Russian Revolution

This contribution from Vladimir Popov is a concept note for a new project, 'Inequality, Economic Models and Russian October 1917 Revolution in Historical Perspective'

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Topics: NEW ECONOMIC MODELS | |
Protest at the European Commission, February 2016 (Credit: Joel Schalit/Flickr)
Protest at the European Commission, February 2016 (Credit: Joel Schalit/Flickr) (via: bit.ly)

Utopian socialists believed that socialism is inevitable because it is a more rational system for organising production and life, a system more in line with the ‘good’ nature of human beings.

Marxism rejected this reasoning, replacing it with what is known as historical materialism: social systems, it argued, emerge, develop, and die not because they correspond more or less to the ‘natural’ aspirations of the people, but because they become more or less competitive in the process of historical evolution – a version of social Darwinism applied not to individuals, but to communities and countries.

In particular, Marxism stated that capitalism develops productive forces up to the point when they can no longer be managed efficiently in societies with markets and private property; at this point social ownership of the means of production and a centrally planned economy (CPE) become a more efficient way of managing productive forces, whose social nature has outgrown the narrow private property limits.

This prediction did not come true. During the 20th Century, socialism came into being not in most advanced capitalist countries, but in the periphery and semi-periphery (the USSR, Eastern Europe, China, North Korea, Cuba). It was only in North Korea and Cuba that it survived into the 21st Century.

This project seeks to examine why capitalism was competitive over 500 years, why it failed in the 20th Century and was replaced by socialism in a large part of the world, and why the socialist societies did not succeed and eventually made a transition back to capitalism.

The key hypothesis is that the increase in income inequalities between 1500 and 1800 allowed a raising of savings and investment rates and spurred economic growth. However, the costs of numerous negative consequences of high income inequalities, like greater social tensions, high crime rates, and poor institutional capacity of the state, become larger than the benefits of the high savings-investment rates that had made capitalism competitive for 500 years. This leads to the emergence of ‘new socialism’ that will not necessarily mean a total elimination of markets and private property but is likely to limit both substantially for the sake of achieving lower income inequality.

Stylised facts

The destruction of communal, collectivist institutions that was first carried out in Western countries from the 16th to the 19th Centuries was accompanied by an increase in income inequality.

The available data (Milanovic, Lidert, and Williamson, 2007) suggests that in England, Holland, and Spain in the 18th Century, the Gini coefficient of income distribution was at a level of 50 and even 60 percent (table 1)[1] – an extremely high level according to today’s standards and, most probably, according to the standards of the distant past (about 40 percent in Rome in the first Century and in Byzantium in the 11th Century – table 1).

In Denmark – a country with very good statistical records on individual incomes – the share of total income of the top 10%, in the period 1870-1920, was always over 40% (reaching 54% in 1917), whereas the Gini coefficient for this period was always higher than 40%, exceeding 70% in 1917 (Atkinson, Søgaard, 2013).

Table. 1. Gini coefficients around particular years in Western countries, %

Years141000129015501700175018002000
Rome39
Byzantine41
Holland56635730.9
England36.755.652.259.337.4
Old Castille/Spain52.534.7
Kingdom of Naples/Italy28.135.9
France5533

 

Source: Milanovic, Lindert, Williamson, 2007; Modalsli, 2013; data for 2000 are sometimes from the WDI. 

It was only in the 20th Century that the trend towards an increase in income and wealth inequalities was temporarily interrupted, most likely due to the checks and balances that the socialist countries with very low inequalities (25-30% Gini coefficients) provided for the capitalist system.

Fig. 1. Income shares of top 0.1, 1, 5 and 10% in 17 developed countries, unweighted average

Inequality, economic models and the Russian Revolution 1

Note:   Unweighted average for Australia, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, Netherlands, New Zealand Norway, Portugal, Spain, Sweden, Switzerland, UK, United States.

Source: Alvaredo, Facundo, Anthony B. Atkinson, Thomas Piketty and Emmanuel Saez, The World Top Incomes Database, http://g-mond.parisschoolofeconomics.eu/topincomes, April 25, 2012.

Negative consequences of high inequalities

Income inequality goes together with weak institutional capacity, as measured by the murder rate (Popov, 2014). Subjective measures of institutional capacity – various indices, such as ICRG (international country risk guide), government effectiveness, rule of law, corruption perception indices, the doing business index, etc., are negatively correlated with income inequalities. Islam and Montenegro (2002) claimed that income inequalities do not influence institutional capacity, but they were able to arrive at this result only by introducing dummy variables for Latin America (LA) and Sub-Saharan Africa (SSA) – the two most unequal regions in the world.

In a more recent and more accurate study (Alonso, Garcimatrin, 2013), making all efforts to control for endogeneity, income inequalities have a strong and significant impact on virtually all institutional indices even after introducing regional dummies for LA and SSA.

Together with per capita GDP and government tax revenues they explain 60% to 80% of variations in the quality of institutions as measured by four out of the six indices of the World Bank (government effectiveness, control over corruption, rule of law, regulatory quality, but not political stability or transparency and accountability), Transparency International’s Corruption Perception Index, the Global Competitiveness Index (Institutions component) of the World Economic Forum, Objective Governance Indicators and Doing Business Indicators (Alonso, Garcimatrin, 2013).

Both older and more recent research shows that inequalities are associated with an array of negative social consequences – from increases in crime and mortality to the decline in educational attainments and proliferation of psychological disorders and obesity (Wilkinson, Pickett, 2010). Besides, inequalities undermine social mobility and lead to the conservation of social stratification: the higher the inequalities, the higher the probability that one’s incomes will closely resemble that of their parents (the Great Gatsby curve). Hence the social and very often the political structure of the society becomes less flexible as well.

“…Great economic inequality has always been correlated with the extreme concentration of political power, and that power has always been used to widen the income gaps through rent-seeking and rent-keeping, forces that demonstrably retard economic growth” (Milanovic, Lindert, and Williamson, 2007).

As Joseph Stiglitz explains, “Widely unequal societies do not function efficiently, and their economies are neither stable nor sustainable in the long run…When the wealthiest use their political power to benefit excessively the corporations they control, much-needed revenues are diverted into the pockets of a few instead of benefiting society at large… That higher inequality is associated with lower growth – controlling for all other relevant factors – has been verified by looking at a range of countries and looking over longer periods of time,” (Stiglitz, 2012, p. 83, 117).

Latin American countries, writes Stiglitz, may show the future of other states that are just stepping out on the road leading to growing inequalities. “The experience of Latin American countries, the region of the world with the highest level of inequality, foreshadows what lies ahead. Many of the countries were mired in civil conflict for decades, suffered high levels of criminality and social instability. Social cohesion simply did not exist” (Stiglitz, 2012, p. 84).

Analysis

The hypothesis is that countries at a high level of development experience more costs than benefits from high income inequalities – they are more likely than others to end up in a vicious circle: bad equilibrium with poor quality of institutions, low growth, low social mobility, and high social tensions. It may take a revolution to break this vicious circle and to exit the bad equilibrium.

All previous anti-capitalist revolutions in the 19th and early 20th Centuries were strongly associated with, if not directly caused by, growing income inequalities (1830 and 1848 in Europe, the Paris commune of 1871 in France, 1905 and 1917 in Russia, 1918 in Hungary and Germany). These revolutions happened not because capitalism became economically inefficient and could not appropriately manage productive forces whose social nature had ‘outgrown’ private property, as Marxists believed. And these revolutions did not occur in the most advanced countries, like the US and Britain. The real reason for these revolutions were social tensions caused by mounting income and wealth inequalities that have grown most significantly in continental Europe.

The troubling trend since the 1980s is the new rise in income and wealth inequalities in the West and in many developing countries (Jomo, Popov, 2013; Popov, 2014). According to Piketty (2014), the period of 1914-73 was an exception in capitalist development due to two world wars and the Great Depression, which resulted in the destruction of capital, and strong social policies during the New Deal in the US and in Europe after World War Two. This is definitely part of the story, but not the whole story. The strong social policies and declining inequalities of the post-war period are due not only to threatening events like wars and depressions but also to the existence of a viable alternative to capitalism in the form of world socialism.

In a similar vein, today there is a more immediate reason for the possible continuation of an increase in inequalities – the elimination of checks and balances that world socialism and workers’ movements posed to world capitalism before. By the end of the 1970s, it became clear that world socialism was not catching up with the West, and that it was no longer an appealing alternative to capitalism. The wave of neo-conservatism, Thatcher in Britain and Reagan in the US, together with harsh policies towards organised labour, was the capitalist response to the new social configuration.

Government spending, including social spending, stopped growing, many welfare programs were curtailed, unemployment rose to 50-year highs, trade unions had to retreat from many important strikes (coal miners in the UK, air traffic controllers in the US) and their membership declined. Top income tax rates that were always higher than 50% in the US, UK, Germany, and France in 1940-80 (and sometimes as high as 90%+), dropped to below 50% by 2010. To no one’s surprise, income inequalities started to rise in most countries (fig. 1).

The fall of the Berlin Wall, the collapse of the USSR, and the conversion of Eastern Europe and former Soviet republics to capitalism added an additional push to the growing income inequalities trend. The Chinese transition to ‘socialism with Chinese characteristics’ proved to be a transition to capitalism – private enterprises were rapidly emerging from scratch. Creeping privatisation had been going on since 1995, so by the end of the 20th Century, 75% of output was already produced by non-state enterprises. Income inequalities increased greatly in China and the Chinese model started to lose its appeal as a more just alternative to the capitalist society.

It may be hypothesised that the continuation of these trends could result in two outcomes.

First, there may be social upheavals in some countries, where social tensions, due to growing inequalities, will become unbearable and produce a social revolution. Thus, the world returns once again to a familiar historical track.

Second, countries which carry out successful policies for limiting inequalities may become more competitive, driving other countries ‘out of business’. By limiting inequalities, these societies will be drifting in the direction of socialism. While remaining market economies, they will likely limit, substantially, the functioning of market mechanisms through direct regulations and high progressive taxation to reduce bubbles and windfall profits. Besides, the crucial method of lowering inequalities is public and collective property, so it may be expected that state enterprises, non-profit institutions, labour-managed enterprises and co-ops, operating not for profits, but for the public good, will become more common.

This would be a new grassroots socialism growing from below and becoming more competitive than capitalist societies. The latter would have all the shortcomings of a high inequality environment, from poor institutional capacity to greater social tensions, and no more advantages in the form of a high savings rate that enables faster growth. If this hypothesis is correct, in the world of relatively high per capita income (over $25,000, for the sake of argument) socialist low-inequality countries and communities will have the same saving rate as capitalist societies with high inequalities. This is only a hypothesis though, based on the projection of current trends into the future.

The logic of the argument

Robert Heilbroner, the author of The Worldly Philosophers, the most famous economic history book ever, wrote that the political economy tradition is different from economics that emerged later. Classical economists were interested in the dynamics of the capitalist system, trying to explain how capitalism emerges, develops, reaches maturity, and dies, whereas economics is preoccupied with equilibrium and optimum in the basically static and allegedly eternal market system (Heilbroner, 1999).

This project follows the political economy tradition and asks the question of why, in the future, capitalism will die and be replaced by a more advanced form of social organisation. Why did capitalism survive despite coming to a brink of collapse (e.g., the Great Depression of the 1930s or the Great Recession of 2008-2009) but socialism did not? Heilbroner ascribed it to capitalism’s ability to innovate – it survived crises by evolving into a new form. If Heilbroner is correct, then what makes capitalism dynamic and socialism static?

What will happen in the periphery, such as China and Vietnam? Will socialism survive in Cuba? Can the periphery skip the full development of capitalism before transitioning to socialism? Do the collapse of socialism in the USSR and its reversal in China and Vietnam mean they cannot transition to socialism? What would be the features of a new welfare state model or new socialist models? Will these outcomes be a natural peaceful progress or occur through violent conflicts/revolutions? How can the transition be managed or accelerated? Is there a tolerable level of inequality for societies to stay at an equilibrium? If so, what would it look like?

The logic of the argument, in a nutshell, is presented in the scheme below. The rise of capitalism began in the 16th Century after traditional societies started to dismantle community institutions (in Britain the enclosure policy intensified during the Tudor-period, 1485-1603). This led to the increase in income inequality, which pushed up savings rates, investment and productivity growth, but at the price of the impoverishment of the masses and growing social tensions.

Until the 20th Century though, capitalism was competitive because gains from productivity growth outweighed losses from rising inequalities and social polarisation. But growing social tensions finally resulted in the 1917 Russian revolution that gave birth to socialist society, which proved able to lower inequalities and mobilise domestic savings for catch up development. The existence of the USSR had a moderating effect on world capitalism – it started to acquire a human face by expanding social programs and lowering inequalities, especially after World War Two and the emergence of the world socialist system.

The centrally planned economy, however, had inherent deficiencies in allocating resources and replacing ageing fixed capital stock, so the Soviet economy started to slow down in the 1960s, 30 years after the ‘big push’ (Popov, 2014). It finally led to the loss of economic and social dynamism, to the collapse of socialism in the USSR and Eastern Europe, and to the gradual transformation of socialism into capitalism in China and Vietnam.

Left to themselves, without government regulations and checks and balances, competitive markets tend to increase inequality endlessly and this is exactly what began happening after 1980 in most capitalist countries. Chances are that this growing polarisation will result in a democratic transition to a new mode of social organisation which will be more competitive than capitalism due to its ability to maintain high savings and investment rates without high inequalities.

Scheme. Transitions to and from capitalism

Inequality, economic models and the Russian Revolution 2

 

References

Alonso, Jose Antonio, Carlos Garcimatrin (2013). The Determinants of Institutional Quality. More on the Debate . – Journal of International Development, 25, 206–226 (2013).

Atkinson, A.B., J.E.Søgaard (2013). The long-run history of income inequality in Denmark: Top incomes from 1870 to 2010. EPRU Working Paper Series 2013-01. Economic Policy Research Unit Department of Economics University of Copenhagen.

Heilbroner, R. (1999). Worldly Philosophers. The Lives, Times And Ideas Of The Great Economic Thinkers, Seventh Edition, 1999, Simon and Schuster, New York.

Islam, Roumneen, Claudio E. Montenegro (2002). What Determines the Quality of Institutions? Policy Research Working Paper 2764. World Bank, January 2002.

Jomo, K.S., V. Popov (2013). Whither Income Inequalities? – MPRA Paper No. 52154, December 2013.

Milanovic, Branko, Peter H. Lindert, Jeffrey G. Williamson (2007). Measuring Ancient Inequality, World Bank Policy Research working paper  no. WPS 4412. (Published as: Pre-Industrial Inequality. The Economic Journal, 2010,  121 (March), 255–272.

Modalsli, Jørgen (2013). Inequality and growth in the very long run: Inferring inequality from data on social groups. Discussion Papers No. 734. Statistics Norway Research Department, February 2013.

Piketty, Thomas (2014). Capital in the Twenty-First Century. Harvard University Press, 2014.

Popov, V. (2014). Mixed Fortunes:  An Economic  History of China, Russia and the West. Oxford University Press, April 2014.

Stiglitz,  Joseph E. (2012). The price of inequality: how today’s divided society endangers our future / New York : W.W. Norton & Co., 2012.

Wilkinson, Richard, Kate Pickett. (2010). The Spirit Level. Why Greater Equality makes Societies Stronger. Bloomsbury Press, New York, 2010.

[1] In England and Wales, the Gini coefficient increased from 46 percent in 1688 to 53 percent in the 1860s (Saito, 2009).