Chapter 5 – Guiding Development: Markets versus Controls, page 1 of 6• capitalist market economies vs. socialist planned economies:• the extreme distinction between market and planned economies is often used• the textbook discusses the “march to markets” to refer to both the transition fromsocialism in centrally planned countries and the increasing liberalization in LDCs• the difference in efficiency between a market and planned system depends largely onhow each deals with 1) information and 2) incentives• incentives:• it is argued that the profit motive is the most reliable way to increase output, cut costs,innovate, and meet unmet wants• in socialist economies, public-mindedness was an insufficient incentive, so promotionsand raises were offered to managers who met the goals of government planning;although these might have helped managers achieve quantitative goals, they did notencourage them to cut costs, innovate, and meet unmet needs• advantages and disadvantages of market economies and planned economies:Market Economy Planned EconomyAdvantages Disadvantages Advantages Disadvantages1. better provision ofincentives1. the market satisfiesdemand but mightnot meet needs1. successful at rapidindustrialization andstructural change1. enterprises tendedto be oriented towardincreasing quantity ofoutput but not quality2. better uses localinformation andconveys globalinformation morecheaply (in prices)2. public goods notautomaticallysupplied2. tended to have lessincome and wealthinequality and higherlevels of literacy andbasic health care2. economies as awhole were nottechnologicallydynamic3. market power –monopolies, cartels,etc.3. despite high savingrate, growth wasslowed by lowproductivity of capital(high s, also high v)4. possible negativemacroeconomicoutcomes4. output mixlopsided – producergoods vs. consumergoods and agriculture5. structural changesmight be difficult5. political repression• advantages of a market economy:1) incentives:• the profit-motive has been the best way to motivate; although peoplecan be motivated to work for moral commitments, etc., this has notworked on a large scale for a national economy; changing people’spsychology through propaganda did not work over a sustained timeperiod• mimicking market incentives for managers helped meet physicalquantity goals, but did not help reduce cost, create better products, etc.;Chapter 5 – Guiding Development: Markets versus Controls, page 2 of 6this is similar to the problem with paying workers on a piece-rate basis(workers neglect quality, maintenance of equipment, etc.)2) information:• in a market economy, local decision makers use their informationwithout having to convey it up a decision hierarchy; the globalinformation they need is transmitted to them through the price system;prices are an automatic byproduct of exchanges in markets• information does not travel to a central bureau in a market economy• disadvantages of a market economy – these can sometimes remedied by governmentintervention:1) the market satisfies demand but might not meet needs:• the market will provide a good if people are willing to pay and have thepurchasing power• however, needs might not be backed by purchasing power• thus, this explains why luxuries might be produced instead ofnecessities (food, etc.)• the government could intervene and redistribute purchasing power2) public goods:• a public good has the characteristics of nonexcludability andnonrivalness• nonexcludability - it is costly or impossible to prevent someone whodid not pay from consuming• nonrivalness – one person’s consumption does not affect anotherperson’s consumption; for example: an apple (rival) versus a lecture(nonrival))• the government could intervene by supplying public goods becauseprivate firms will not3) market power – monopolies, cartels, etc.:• monopolies, cartels, etc. will produce inefficient quantities because theytry to maximize profit• the government could also intervene4) possible negative macroeconomic outcomes:• negative macroeconomic outcomes include price instability,unemployment, and underemployment of factories during low points ofthe business cycle• the government could correct price instability but it requires people tohave faith that government intervention will solve the problem5) structural change might be difficult:• planners, theorists, etc. have worried that a poor country will stay pooras long as it produces labor-intensive products (such as primaryproducts)• a poor country will want to change the structure of its economy so thatit will be more capable of producing manufactured goods and be moreself-reliant, on the theory that only industrialized countries can raise theirstandard of living• however, structural change might not happen through the marketbecause the market might encourage continuance of the economy’sChapter 5 – Guiding Development: Markets versus Controls, page 3 of 6structure; for example, if labor is cheap and capital is scarce in aneconomy, then manufactured goods cannot be produced cheaply;according to the theory of comparative advantage, this economy shouldnot produce manufactured goods (it will already be producing the goodsit is suited for)• thus, China and the Soviet Union tried to push their economies towardindustrialization; other nonsocialist countries tried protectionism (such asimport substitution industrialization)• advantages of a planned economy:1) successful at rapid industrialization and structural change:• the rate of structural change was high in the 1930s in the Soviet Unionand in the 1950s and 1960s in China2) tended to have less income and wealth inequality and higher levels ofliteracy and basic health care:• for example, China and India before liberalization measures in the1980s had similar per capita incomes; however, primary education levels,literacy, and life expectancy were higher and infant mortality was lowerin China because of government expenditures• planned economies were not perfectly egalitarian, even in theory; theMarxist theory (followed by the USSR) supported unequal distribution ofincome for unequal work but was associated with greater equality if onlybecause financial capital and land were not privately owned• regional differences were not eliminated after economies becameplanned, but some income inequalities were reduced• disadvantages of a planned economy:1) enterprises tended to