Is socialism good for the economy?
In his latest book Capitalism Alone Branko Milanovic makes a provocative claim, namely that for poor countries, socialist systems provide more economic gains than market economies. And when I say socialist systems, I don’t mean the term socialist as used by conservatives in the United States, because what they call socialism is essentially the social democratic status quo in Western Europe as practiced in Scandinavia, Germany, and France. And we know that this system works because the standard of living in these countries is as high if not higher than in the United States when measured as GDP per capita. And if we measure the quality of life with metrics other than GDP per capita but instead the Human Development Index, then Germany and the Scandinavian countries are ahead of the United States.
What Milanovic means with socialist systems are the former Warsaw Pact countries in Central and Eastern Europe, for example. He shows that poorer countries had stronger economic growth than richer countries under a socialist system. Below is my reproduction of his chart. It shows the average annual growth in GDP per capita for a set of Western and former socialist countries in Europe in comparison to the standard of living in 1950. The chart looks a bit different than the one in Milanovic’s book, but the results are qualitatively the same. Growth in socialist countries was stronger if they were poorer in the beginning. And for the poorest socialist countries, economic growth between 1950 and 1989 even outpaced economic growth in Western economies.
Real economic growth from 1950 to 1989
Source: Maddison Project.
This result surprised me but it seems to be true since another academic paper by Wendy Carlin and her colleagues shows similar results for a global set of countries. What seems to happen here is that for very poor countries, a lack of infrastructure (e.g. a working electricity grid) and a lack of legal foundations for economic activities (e.g. a social safety net) hinder economic growth. The advantage of socialist systems is that they can more easily establish such structures and thus bring the poorest countries on a higher level of development fast. Outside of a planned socialist system, such countries often lack the capital or are so mired in corruption that the fundamental investments to build infrastructure, etc. never happen in the first place.
However, once the foundations of economic activity are in place and the standard of living has reached a certain minimum level, socialist systems are unable to foster growth for all the well-known reasons (central planning leads to misallocation of resources and stifles innovation). Thus, market economies do significantly better than planned economies in the case of middle income and high-income countries.
Once socialism was abolished after the fall of the Soviet Union, these middle-income countries that were held back by socialism could catch up to market economies and showed higher economic growth than comparable market economies. In short, socialism is bad for the economy, unless you are so poor that you need a dictatorship to get you started.
Real economic growth from 1989 to 2016
Source: Maddison Project.