741 December 8,1989 COMMUNISM, CAPI"SM, AND E CONOMIC DEYEXDPMENE IMPLlCAmONS FOR US, EXONOMIC ASSISTANCE INTRODUCTION Dramatic changes unthinkable just a few years ago are shaking socialist nations. Having learned hard lessons about the inefficiency of their economic systems, the peoples of communis t -run nations are now. pressinglfor greater individual liberty and free enterprise. Free market reforms that contradict the basic tenets of Marxist-Leninist economic theory are being enacted in the Soviet Union, Poland, Hungary, and China. Free elections a re demanded by the citizens of many of these nations as well.

Although heartening, this tide of change does not mean that the evils im posed by socialism are dead. Not only is violent repression possible, as has been the case in China, but some communist l eaders might try to preserve socialism by introducing limited elements of the market system. In this way they might think, social problems that they attribute, mistakenly, to the free market, such as slums and uneven distribution of wealth, can be avoided . And then there are critics in the United States and other developed countries who, while conceding that a market system will help economic-growth in poorer countries, nevertheless believe that it will fail to meet what they call basic human needs, such a s better health and lower levels of infant mortality.

Both the communist leaders and the Western social critics are wrong. This is clear from examining the evidence of the past four decades Relevant Factors. Socialism and capitalism each have had their chance.

The results: democratic, free-market countries have higher living standards better health and education, and faster growing economies than do socialist countries. Following World War 11, Germany, China, and Korea were split into socialist and non-soc ialist parts, producing three pairs of countries with the same culture, language, history, birth rates, and standards of living when they were divided.Thus, the major relevant factors determining their syb sequent histories were their respective economic a nd political systems by-side comparisons highlight the deficiencies of the socialist model. In each of these country pairs, since 1950, the free market countries -West Ger many, the Republic of China onTaiwan, and South Korea have ex perienced far more ra p id income growth, provided more education for a larger percentage of their citizens, have longer life expectancies and lower in fant mortality rates, and fare better in other "quality of life" measurements than their socialist counterparts East Germany, t h e People's Republic of China, and North Korea. In some cases the differences are astonishing. In 1986, the last year for which complete figures are available, Taiwan had an average income that was ten times higher than mainlandChina;.:over.ten times as hi gh a percentage of students in higher education, and around half the infant mortality rate.

Contrary to the conventional wisdom that population control is a necessary condition of development, in each of these pairs of countries, the faster-grow ing free-m arket countries have had more rapid population growth and sub stantially higher population density over the last four decades.

These findings should be of interest to members of Congress as they con sider Amer ica's 5 billion foreign economic assistance program. Many mem bers insist that this aid should be used primarily to promote such social goals as reducing poverty, infant mortality, malnutrition, and illiteracy rates in I developing countries. There is lit t le debate over setting such laudable goals the question is how best to achieve them.The data show that in comparison with communist states, the democratic, free market countries have been most successful both in promoting economic growth and combating the s e social problems. Therefore, U.S. policy makers should direct foreign assistance to promoting market-oriented economic reforms in less developed countries as the best way to assure the highest living standards for the greatest number of people Astonishin g Differences. The results of these probably unprecedented side 1 One possible influence on the growth rates of these pairs of countries since World War I1 is foreign aid flows. Yet, the impact of foreign aid on development is highly doubtful. For instance , according to a study of economic development in 17 countries between 1%2 and 1982, Keith Marsden, former economist with the World Bank, found "Economic performance was not significantly linked to fmancial flows from abroad.

Foreign lending to African gov ernments was generally much higher in relation to gross national product than for East Asian counterparts." Keith Marsden Why Asia Boomed and Africa Busted The Wull Sfmet Journal June 3,1985, op ed page 2 SOCIALISM: THE FAILED ECONOMIC EXPERIMENT In the e a rly and middle 20th century, socialists criticized the free market for creating poverty for the majority of people. A planned economy without private ownership, they claimed, would produce prosperity for all. From the 1920s on, such classical free market economists as Ludwig von Mises and Friedrich Hayek had described the theoretical flaws of socialist economics.

They predicted that centrally planned economies would suffer from low productivity, goods and services shortages, and, eventually, declining livi ng standards. They also argued that economic freedom, individual rights, and democracy all ultimately would require one another Political and Economic Liberty. Recent theoretical statistical studies bear out these predictions. Social scientist Raymond Gas t il of FreedomeHouse, a New York-based human rights monitoring organization, has graded each na tion of the world in terms of political, civil, and economic liberty. Economic liberty comprises two sub-measures -the extent of government intervention in the marketplace and the level of personal economic liberty?

University of Texas economist Gerald W. Scully, in a study published last year, finds a strong relationship between each of these three variables and the rate of economic growth from 1960 to 1980 amon g 115 nations? He finds that nations characterized by Freedom House as politically open, individual rights, and free market had an average annual per capita growth rate of 2.73 percent, whereas those characterized as politically closed, state rights, and command [economy] had an average annual growth rate of 0.91 percent.

Other recent studies confirm this conclusion. A study by University of Chicago economist Gary S. Becker found that political democracy is posi tively related to economic growth!

Similarly, an analysis by the U.S. Agency for International Development in vestigated the impact on economic growth of policies that promote corn eti tion and individual opportunity in 42 countries between 1980 and 1987.

Countries with secure property rights, low marginal tax rates, sound monetary policies, and limited government regulations had growth rates about three percentage points faster than nations that fared poorly on this index B I 2 Raymond Gastil, Liberty and Economic Progress, Journal of Economic Gr o wth, November 1988, pp. 3-10 3 Gerald Scully, The Institutional Framework and Economic Development, Journal of Political Economy June 1988, pp. 652-662 4 Gary S. Becker, An Environment for Economic Growth, The Wall Sbeet Journal, January 19,1989, p. AS 5 D evelopment and the National Intemt: US. Economic Assistance into the 21st Century, Report by Alan Woods, Administrator, Agency for International Development, February 1989, p. 52 3 LIMITATIONS OF SOCIALISM: ANECDOTAL EVIDENCE Anecdotal evidence supports t he case for the free market over socialism.

One need only travel by bus across the Soviet Unions Karelian peninsula which was wholly within Finland until World War II. The part still within Fin land has remarkably better roads and more modem shops and faci lities than the part that isnow the Soviet Union. Or drive from West Berlin to East Ber lin. Or take the train from Hong Kongs New Territories across the border to China. The differences in favor of a free-enterprise private-property society are unmistaka ble for all who are not totally masked by ideological blinders.

Patterns of immigration are another unmistakable indicator of the market systems superiority. Millions have voted with their feet, fleeing from com munist countries to free countries, despite formidable barriers. Virtually no traffic goes in the other direction.

Results of Reforms. The results of recent economic reforms in China un derscore the contrast between socialism and the free market. Under the col lective production system that prevail ed before 1979, there was little personal incentive for farmers to work hard and take risks. Food production plum meted during the Great Leap Forward from 1958 to 19

60. Production fell so drastically that 20 million to 30 million Chinese died of starvati on, certain ly the worst food production performance of any country in modem times and perhaps the worst ever! During Chinas agricultural reforms between 1979 and 1981, the 700 million people in the agricultural sector shifted from collective farms to ind ividual enterprise. Between 1980 and 1985, Chinese agricultural production skyrocketed by 74.3 percent?

Justas remarkable, rural incomes in China have doubled in a decade.

The failure of Chinas agricultural system under collectivization is not an isolated event. Swedish economist Sven Rydenfelt, in his 1983 bookA Pattern for Failure, analyses the experience of fifteen socialist countries and finds a pervasive pattern of economic failure. 8 6 Nick Eberstadt, The Poverty of Communism (New Brunswick, New Jer s ey Transaction Books, 1988 7 Alvin Rabushka, The New Chinc Comparative Economic Development in Mainland China, Taiwan, and Hong Kong (San Francisco: Pacific Institute for Public Policy Research, 1987) p. 206 8 Sven Rydenfelt,A Partem for Failurn (NewYork: Harcourt Brace Jovanovich, 1983 See also Eberstadt, op cit 4 SOCIALISM VERSUS FREE MARKETS -A CROSS-COUNTRY COMPARISON A more systematic examination of the respective results of socialism and the free market is found by comparing three pairs of countries - East and West Germany, mainland China and Taiwan, and North and South Korea each pair with similar social-cultural backgrounds and economic starting points immediately prior to their separation after World War JI. A com parison of other selected pairs of n eighboring communist and non-com munist countries with similar economic backgrounds Austria and Czechos lovakia, Burma and Malaysia, and Yugoslavia and Greece expands the study, and comparisons between the two prototype free marke and socialist systems, t h e U.S. and the Soviet Union, round out the picture The most comprehensive measure of national economic well-being is per capita income, which is the amount of Gross National Product (GNP) per person. The standard mode of measurement is to value a nations p roducts at its own prices, and then utilize exchange rates to put countries on the same footing. Figure 1 -drawn fromTable 1 in the appendix, which contains data from 1960 to the present -shows the recent results for the paired countries using this method . In each case, the communist country has a lower income than the free country.Taiwans per capita income is three or four times as high as mainland Chinas, South Koreas about twice that of North Koreas and West Germanys is at least twenty percent higher th a n East Germanys.lo Causing Shortages. Table 2 and Figure 2 show the results for the three sets of formerly unified countries using the purchasing power parity (PPP method, which values countries products in terms of actual local prices and costs of 1iving . The results are essentially the same as inTable 1, though the numerical differences are not quite so dramatic.These figures do not reflect the fact that leaders in the command economies often underprice basic goods and services, thus causing severe shorta g es and queues. If products are pur chased on the black markets in these countries, their prices are much higher d 9 For some of the socialist countries, reliable data are unavailable.This absence of data may.in itself indicate backwardness in development. A sophisticated data-gathering and publication system is a hallmark of an advanced country. Furthermore, some of the data from the socialist nations represent the official records supplied by the central-government; in these closed societies there is litt l e opportunity to verify the accuracy of the data. In measuring growth rates, for instance, government officials may pad the data to improve their countrys recorded performance. Hence, the differences in the achievements of the socialist and free market co u ntries can be underestimated 10 The comparison of West and East Germany needs some amplification. The real differences surely are greater than indicated by these statistics. Recent events in Berlin have shown that East Germanys currency is hugely overvalu e d. Furthermore, differences in product quality are obscured by these comparisons, but are important. Autos are an important example. The East German autos are clearly inferior to those in West Germany: they are smaller, less powerful, and lack modern acce s sories. Moreover, an eight-year-old used car may cost qs much as a new car in East Germany because of burdensome licensing requirements in obtaining a new car. The Wall Sheer Journal, Despite CloserTies,TheTwo Germanys Grow Further Apart, September 4 1987 , pp. 1,lO 5 and therefore purchasing power is much lower. There are very few good measures of the prices in black markets.

Another indicator of long-run economic development in a society is the proportion of the labor force employed in agriculture.The fewer needed to feed the population, the larger the number that can be employed in providing those goods and services that ful f ill other human wants. Figure 3 shows the recent proportions for the three pairs of countries. It is apparent that the countries with freer markets including freer labor markets and freer agricul ture need fewer people to feed the rest. Table 3 shows the h istory of this process since 1960.The conclusion that free market systems yield better results than centrally planned economies is reinforced by the other four country pairs DOES ECONOMIC GROWTH IMPROVE THE QUALITY OF LIFE Defenders of socialism often ack n owledge that a command economy may not offer the best method for accelerating economic growth, but compensates for this by creating greater economic equity. Some contend, for instance, that capitalist countries, despite their superior economic performance , fail to equalize income distribution, provide jobs to all workers, and offer all citizens health care and education. Socialist countries presumably fare better under these criteria.

Yet evidence suggests that economic growth is the key ingredient to solv ing most social and economic problems. A study last year by the U.S. Agency for International Development reveals that the poor are almost certainly better off in less developed countries with high GNP growth than in slow growing Third World countries. It also found that income distribution is more equal in less developed countries with growing economies than in those with stagnant economies. Severe poverty is most prevalent in developing countries with slow or negative growth rates.

Equality Under Capital ism. And a survey of over twenty studies on income distribution by economistsThomas R. Dye of Florida State University and Harmon Zeigler of the University of Washington concludes that We have good theoretical reasons and substantial evidence challenging t he idea that socialist systems provide greater equality than market systems. Equality is primarily a result of economic development, not type of political or economic system. Capitalist systems are more successful in stimulating economic development than c ommunist systems. 12 11 Development and the National Internst, p. 32 12 Thomas R. Dye and Harmon Zeigler, Socialism and Equality in Cross National Perspective, Political Science and Politics, Winter 1988, pp. 45-56 6 Economic development also goes hand in hand with improvements in health and education. For example, a 1980 study by Stanford University economist Victor Fuchs found that one-third of the increase in life expectan cy in a nation can be traced to per capita income growth alone.

Similarly, litera cy is directly related to raising income 1evels.The female literacy rate is 21 percent in nations with per-person income of $200 per year or less, 60 percent in nations with income of $800, and 88 percent in countries with $2,000 per capita income.14 Thes e data affirm the common-sense notion that by accelerating economic development, free market policies lead to broad improvements in the quality of life in a nation 13 QUALITY OF LIFE IN SOCIALIST VERSUS FREE-MARKET COUNTRIES The contrasting performance of s ocialist and free market countries provides additional evidence to refute the often-heard proposition that socialism is the system which best meets the basic human welfare needs of citizens. Almost without exception in these country profiles, life expecta n cy is longer, health care superior, education more universal, and material goods more affordable and available in the free enterprise countries than the socialist nations Health One of the best measures of the living standards of a country is the life ex pectancy of its residents. This statistic captures improvements in health care income levels, nutrition, and other key factors. Furthermore, the goods and services provided in an economy only have value if one is alive to enjoy them.

Table 4 shows the numb er of years that a person can expect to live, based on current mortality experience. The free-enterprise countries do better in each pair, even though each country pair started out with much the same life expectancy after World War II.

The same is true of the results for infant mortality, shown inTable 6 and Figure 4.

These results are particularly striking because public health has been one of the more successful activities of the socialized countries. Moreover, im provements in health care, such as the introduction of a new drug or vaccine 13 Victor Fuchs A Comment on Preston's Findings in Richard Easterh, ed Population and Economic Growth in Developing Counhies (Chicago: University of Chicago Press, 1980 14 Melanie S. Tammen, The Global Poverty Reducti o n Act: Ignoring the Key Ingredient Heritage Foundation Erecutiw Memorandum No. 213, September 9,1988. are easily and rapidly exportable; this allows oorer countries to "narrow the gap" with wealthier countries rather quickly Widening Gap. Yet, the gap bet w een free market and socialist countries on health measures is widening. Several decades ago the differences between the countries in each pair were smaller than at present. But throughout East em Europe, life expectancy has actually fallen in recent years . In a 1986 study on Soviet population trends, Hoover Institution economist Mikhail S Bernst m found a "steep decline in life expectancy within the last twenty years.

By the mid-l980s the advances of the late 1950s and 1960s have complete ly vanished The U SSR male life expectancy seems to have fallen b low the mid 1950s level of 63 years to a remarkably low level of 60.8 years slowdown, and in some cases reversal, in progress is not yet well-understood but it certainly stems from a number of characteristic s of socialized economies.

Education The proportion of potential students who are obtaining a higher education is a precursor to development in the future. The data are sparse, especially for the communist countries. Yet in all cases but one, the free ente rprise countries generally provide greater higher educational opportunities than the command economies (seeTable 5 with the one exception of the Germanies.

In fact, in 1960 West Germany was well behind East Germany in percentage of students in higher educ ation; now they are virtually equal These figures, furthermore, do not reflect the quality of education. The communist countries actively seek to place their students in Western schools to have access to cutting edge research and discoveries not available in the communist world Material Well Being U.S. Agency for International Development observes that B 18 919 This 18 A report on Development and the National Interest issued this year by the Being able to afford more than just the necessities of life such a s food and shelter is the beginning of broad-based development. More purchasing power 15 Development and the National Interest, op. cit pp. n-31 16 Mikhail S. Bernstam, Trends in the Soviet Population in Henry S. Rowen and Charles Wolf, Jr The Future of t h e Soviet Empim (New York Institute for Contemporary Studies, 1986 pp. 186-199 17 These life expectancy figures do not match the "official" statistics from the Soviet Union discrepancy is due most likely to inflated numbers released by the Soviet governmen t 18 Bernstam concludes his study by emphasizing that "declining Soviet life expectancy is not a health problem.

It is an economic problem of living and working conditions He suggests that some of the causes of the reduction in life expectancy include: red uced safety, increased industrial injuries, and lagging sanitary improvements in the cities. Bernstam, op. cit pp. 193-195 8 increases the ability of individuals to control their own future as well as improve the material quality of their life. It is an i n dication of how the range for individual choices increases. 19 Data show that the citizens of free enterprise countries fare much better than those of socialist countries using various measures of material well being. The number of telephones, for instanc e , is a good measure of the development of a countrys infrastructure, and more particularly its crucial communications infrastructure. Table 7 shows how the communist countries have lagged substantially behind the development of the market-oriented countri es.

Newsprint and autos are two good indicators of the level of consumption in a country.Tables 8 and 9 show that the communist countries lag far behind in both these categories of consumer wealth.

Working Longer for Basics. The shortage of consumer goods combined with the low income levels in socialist countries means that the citizens of these countries must work longer to obtain basic goods and services than the citizens of free market countries. In Czechoslovakia one of the wealthier socialist countri es -the average factory employee must work 2.5 times longer to purchase meat than the average worker in Austria, twice as 1.ong to pur chase shoes or a car, and five times as long to purchase a television set.

Similarly, an East German must work six times longer to earn enough money to buy a car than the average West German;. seven times longer *to buy a refrigerator, and five times longer to buy a suit. The WdZ Street Journal in 1987 reported that in East Germ a ny sought after items like color television sets can be staggeringly expensive. According to one East German the only color set recently available in his region was going for the equivalent of the average yearly income in his country.21 In sum, these data for the paired-country experiments in political and economic systems confirm that by any measure of well being, communism is a failure 20 POPULATION GROWTH AND DENSITY AS INFLUENCES ON DEVELOPMENT Since the early 1960s, the U.S. Agency for International D e velopment, the World Bank, and various United Nations agencies have focused on high levels of population growth, arguing that this is a key factor hindering economic development. A.W. Clausen, the World Bank President in 1985 19 Development and the Nation a l Inteest, op. cit p. 29 u) Austrian, CzechTowns So Near, Yet So Far Apart, The Washington Post, September 18,1988, p. A25 21 Despite Closer Ties, The Two Germany Grow Further Apart, The Wall Sttvet Journal, September 4,1987 pp. 1,lO 9 echoed the feeling o f many policy makers when he said that: The interna tional community has no alternative but to cooperate, with a sense of urgen cy, in an effort to slow population growth if development is to be achieved.22 Yet this focus on population has turned policy m a kers attention away from the central factor determining a countrys economic well-being -its economic and political system and led to a misdiagnosis of the causes of poverty, problems such as starvation, illiteracy, and pollution. This in turn has led to u nsound economic advice for developing nations.

Positive Effect. The paired-country data inTable 10 and Figure 6 shows that in each pair, the centrally planned country has a lower population density per square kilometer compared to the corresponding free en terprise country and thus less population pressure. Moreover, the population growth. in the free market countries generally has outpaced the socialist countries (see Table 11 and Figure 7 Contrary to the notion that population growth in hibits economic gr o wth, the free-market countries, each with faster expansion in population, experienced more rapid development on a per-person basis than their neighboring socialist nations. If anything, the data show that more people have a positive effect on development.

Hong Kong is a vivid example of this phenomenon. In the 1940s and 1950s it seemed impossible for Hong Kong to surmount its problems -huge masses of impoverished people without jobs, lack of exploitable natural resources more refugees pouring across the bo rder each day. Today, Hong Kong enjoys high living standards, low unemployment, modern high-rise apartments and office buildings and one of the worlds most modem transportation systems.

Hong Kong demonstrates that a very dense concentration of human being s does not prevent comfortable existence and exciting economic expansion, as long as the economic system gives individuals the freedom to exercise their talents and to take advantage of opportunities. And the experience of Sin gapore demonstrates that Hon g Kong is not unique CONCLUSION The superior performance since World War I1 of free-market countries compared to socialist nations has, after four decades experience, become.too pronounced for defenders of socialism to ignore or explain away as due to bad weather. The markedly higher living standard today in West Germany than in East Germany, South Korea than in North Korea, and Taiwan than in China has exposed the failures of socialism for all to see.

It is not surprising then, that communism is under atta ck from within. The recent astonishing developments in China, the Soviet Union, and Eastern Europe not only signal a mounting dissatisfaction with socialism, but an in creased recognition among the peoples of these countries that political and 22 As quote d in The Wmhington Post, Population Explosion Forecast, July 16,1985, pp. AI, A1Q 10 economic freedom go hand in hand in generating meaningful improvements in material well being and human happiness Assuring Better Living Standards. U.S. policy makers in b oth Congress and the Administration are reevaluating Americas foreign aid program.

Some are focusing attention on meeting the basic human needs of the poorest of the poor in less developed countries U.S. policy makers are also considering ways to help East ern Europe as the Eastern and Western Europeans both ask whether socialism can be reformed or whether it must be abandoned entirely. Some Americans suggest that direct grants and assis tance, such as food handouts, population control programs, or funds fo r more hospitals are the answer toThird World poverty. Yet the data show that a free market system with private investment and economic opportunity and liberty for every individual not government transfers -are the best.way to.assure better health, educati o n, and living standards The battle over the best economic system for Eastern Europe seems to be over. Communists and opposition leaders alike say that socialism has failed and that a new, more market-oriented system is necessary. But in less developed cou ntries, the allure of socialism still lingers. Government controls and central economic planning still restrict the freedom of individuals to profit from their productive activities and to create for themselves a prosperous life.

Promoting Economic Freedom. As U.S. policy makers consider reforms for Americas foreign assistance program, they should heed the lessonsof economic records of China, Germany, Korea each divided into a free market and socialist part.

The free market has proved superior by every eco nomic measure. Market economies can best meet the basic human needs of their people. U.S. foreign aid thus should promote worldwide economic growth and.prosperity, to the limited extent that it can, first and foremost by promoting economic freedom.

Stephe n Moore Grover M. Hermann Fellow in Federal Budgetary Affairs and Julian L Simon Professor of Business Administration University of Maryland 11 APPENDIX Table 1 Per Capita Gross National Product in Current Dollars Source: World Bank, World Developrncnt Re p on, 1988 Figure 1 Per Capita Gross National Product 1986 14 I 12 T 10 h E a6 n d4 E 2 I 12 Table.2 Per Capita Gross Domestic Product Using the Purchasing Power Parity Method Source: U.S. Apncy for International Development, Computer File, 1988 d 13 Table 3 Percent of Workers in Agriculture Figure 3 Percent of Workers in Agriculture 1980 100 80 60 40 20 0 14 Table 4 Life Expectancy in years Table 5 Percent of 24 to 24-Year-Olds in Higher Education I 15 i Table 6 Infant Mortality Rate Deaths per 1,000 live b i rths Figure 4 Infant Mortality Deatha per 1,000 live'birthe 40 E. Ger. W. Ger. N. KomaS. Korea Taik 16 Table 7 Number of Telephones Per 100 Persons Source: US. StatkticalAhmc~ 1989 Figure 5 70 60 I 50 40 30 20 10 0 Telephones Per 100 Persons 1985 1 E. Ger . W. Ger. N. KoreaS. Korea China Tairran soraew u.8. statiatid Ahtam* 1989 Eerlhgeh~fB 17 Table 8 Pages of Newspaper Print Per 1,000 Persons Sourn: U.N. Yearbook, 1988 Table 9 Automobiles Per 100 Persons 18 Table 10 Population Density Density per 50 Kilome t ers (193 Square Miles 22 8 17 I I 154 245 423 535 I 12 26 I 175 Source: World Bank, World DNclopment RqnW, 1988 Figure 6 Population Density 1986 Density per 50 Kilometera (19.3 Square Miles) 800 500 I I 400 300 200 100 I 0 I I 7 1 E. Ger. W. Ger. N. Korea S . Korea China Taiwan source: world Bant lam He~!ltmge 19 Table 11 Annual Population Growth Rate 1960-1980 percent 0: 1 1.0 .2.8 2.2 1.9 2.7 1.1 1.2 I 0.6 I 0.3 I 2.3 I 2.6 I 1.0 I 0.7 I I I Source: World Bank, W& DNcloppnmr Rcporr, 1988 Figure 7 Annual Po pulation Growth Rate 1960-1980 P e r e n t C 3 2.5 2 1.5 1 0.5 0 0.5 I I I I I I I I I E. Ger. W. Ger. N.KomaS.Korea China Tairran 20