18 April 2016

Do workers need capitalists? New lessons from Yugoslavia’s socialist experiment


From Bernie Sanders in the US to Jeremy Corbyn in the UK, socialist tendencies have been on the rise ever since the global financial crisis. Along with it, so have been defences of the free market system. Whilst nothing is more persuasive than actual historical experience, debates have tended to instead take place in the theoretical sphere and, even when past experience has been drawn upon, it’s been limited to the obvious countries, to Russia, North Korea and Cuba.

Eastern Europe offers a whole wealth of experience on the Russian side of the iron curtain, and it’s an experience that is still to be properly tapped by economic researchers. New research is now helping to shed light on our understanding of the region, including that presented on Yugoslavia this month at the annual conference of the Economic History Society, held this year at the University of Cambridge. In summary, it tells us one thing: we need to be very weary of repeating past mistakes, particularly in regard to the idea that workers can operate successfully by eschewing their capitalist managers.

Socialism was the greatest political and economic experiment of the twentieth century and of all the countries in Eastern Europe, Yugoslavia is, perhaps, the most fascinating from which to learn.

Yugoslavia was the fastest growing socialist economy in the post World War Two era. In fact, as noted by Balassa and Bertrand in 1970 , it was one of the fastest growing countries in the world – despite, some might say paradoxically, being socialist. Whilst the country might at first seem to present itself as a poster boy for those on the left, the Yugoslavian socialist engine eventually ran out of steam, leading Leonard Kukic, a young researcher from the London School of Economics, speaking at the Conference and the author of the new research, to ask: what went wrong?

Two key possibilities present themselves: technology and labour. In other words, a failure of what economists call total factor productivity (TFP) growth, which could revolve around the supposed limited technological potential of non-market economies, or labour constraints – workers whose incentive structures under socialism were not conducive to economic growth. Whilst both could have potentially played a role, the trick is to measure the relative contribution, to see whether socialism in action hampers the economy more through technology or through distorted labour incentives.

Using a relatively new business cycle accounting technology, and based on a standard Ramsay-Cass-Koopmans growth model, Kukic models the Yugoslavian economy from 1952 to 1989 allowing for four “wedges”. These wedges reflect the potential deviation of the socialist economy from free-market efficiency principles in the realms of labour, capital, TFP (technology) and demand. By estimating these wedges, he attempts to identify the causes of Yugoslavia’s initial success in the post War period (in the 1950s and 1960s) – and of it’s eventual growth slowdown in the 1970s and 1980s.

Kukic finds that total factor productivity growth actually became more and more important for economic growth in Yugoslavia during its golden age in the 1950s and 1960s. This includes through the efficiency enhancing effects of structural change (shifting labour out of low value-added sectors such as agriculture) and the entry of the country to GATT in 1966, which helped open Yugoslavia to global markets. By the 1980s, however, TFP was starting to stagnate.

Interestingly, however, Kukic finds that stagnating total factor productivity wasn’t the most important factor behind Yugoslavia’s growth slowdown. Instead, labour distortions should take more of the blame.

Kukic dates the labour driven slowdown to 1965, when Yugoslavia introduced reforms that shifted control of production towards the work councils of labour-managed firms. Control was taken from the hands of the state and placed directly in the hands of the workers. What, you might wonder, could possibly go wrong?

Amongst other things, these work councils were now free to decide on the distribution of income between wages and investment. In one sense, this policy change was a success: income per worker increased and wages became a bigger share of the economic pie. However, labour-managed firms seem to have reaped such rewards by hurting other members of the labour force, restricting the employment of new workers so as to limit the worker-based labour market competition that could scupper the wage demands of the “insiders”.

Naturally, unemployment soared, from under 5% in the 1960s to close to 15% by the end of the 1980s. Whilst in a free-market economy there would have been an incentive for new businesses to enter and compete with incumbents, employing some of the unemployed labour along the way, the entry of firms was severely restricted under the socialist regime. Business people were viewed with suspicion.

The result: the insiders, whether already employed workers or already established firms, gained at the cost of the outsiders (new workers, including the youth, and potential but never established new firms).

All in all, then, it seems that the problems socialist economies face revolve more around labour than they do technology. Of course, given Russia’s success in the space race, something which shocked America at the time, we shouldn’t be that surprised. However, what the findings do provide is an important warning to those on the left who look to the good old days of worker power and worker management with rose-tinted spectacles. Not only can the economy suffer when it lacks “capitalists”, but so can workers that fall outside of the privileged (already established) groups.

It’s sometimes a matter of better the devil you know than the devil you don’t.

Victoria Bateman is Director of Studies, Fellow & College Lecturer in Economics at Gonville & Caius College, Cambridge and Fellow of the Legatum Institute, London. She is author of the book Markets and Growth in Early Modern Europe, published in 2012 by Pickering and Chatto.