John E.

Roemer

An Anti-Hayekian Manifesto

Whither Socialism? poses as an attack on the possibility of market socialism.* But that pose is superficial. The central object of Stiglitzs attack is the conventional general equilibrium model of twentieth-century economic theory, fathered by the French economist Lon Walras in the late nineteenth century, and brought to term by Kenneth Arrow and Grard Debreu, with their proof of the existence of a Walrasian equilibrium in an abstract mathematical model of a private-ownership economy, in 1954. The Arrow Debreu model provides a rigorous foundation for three important views regarding capitalist economies (ones where ownership of resources and firms is private, and economic activity is market-directed): first, that it is possible for markets to engender a general economic equilibrium, a set of trades between economic actors in which every firm demands resources and labour and sells outputs in a profit-maximizing fashion, subject to its technological constraints, and every consumer purchases goods and supplies labour and other resources to firms in that way which maximizes her utility, subject to
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her budget constraintthat she purchase goods whose value, at market prices, does not exceed the value of the resources and labour she is willing to sell. This set of trades is an equilibrium in the sense that no demand (by a firm or consumer) goes unfulfilled and no supply (of a resource or commodity) goes unpurchased. The second claim, known as the First Welfare Theorem (FWT), is that such equilibria provide Pareto-optimal allocations, which means that there exists no alternative allocation of resources and goods in the economy, given its technological knowledge and the preferences of its members, that would make every individual better off (in terms of the preferences that define the utility that he maximizes in the equilibrium). Pareto optimality is blind to issues of distribution; it is a weak requirement of social welfare in the sense that the test for an allocations Pareto optimality is whether another allocation exists which makes everyone better offeven those who are rich in the allocation in question. Consequently, someone concerned with eliminating poverty, or with some degree of equality of outcome, must also ask about the markets potential for redistribution. The third claim, known as the Second Welfare Theorem (SWT), is that any Pareto-optimal outcome for an economic environment can be achieved as a market equilibrium with respect to some initial private distribution of resources and firm ownership. The popular corollary of the SWT is that capitalism should not be the enemy of the egalitarian, for any desirable final allocation of resources and commodities requires only a redistribution of private ownership rights in the means of production (including, possibly, rights in the income from labour).
The Effects of Uncertainty

These three claims form the theoretical basis of the view that a privateownership market economy is an economic device sufficient to realize the goals of any rational humanitarian. There is, furthermore, an irony: in a general competitive market equilibrium, each economic actor is concerned only with itself. Firms need not try to do their best for society, they need simply behave so as to maximize the wealth of their shareholders, and no consumer need worry about what others need, he may simply act to maximize his own preferences, subject to his economic (budget) and technological (labour supply) constraints. Social efficiency, in the Paretian sense, is the consequence of the pursuit of individual self-interest. Stiglitzs book is a sustained attack on all three claims of the Walrasian world-view, but mainly on the second and third claims, the two welfare theorems. He argues that market equilibria of private-ownership economies are not Pareto-optimal (against the FWT), even in a secondbest sense, and that efficiency (i.e. Pareto optimality) cannot be separated from distribution, contra the claim of the SWT. He does not argue that the theorems of Arrow and Debreu are false, but rather that the hypotheses of those theorems do not describe real-world capitalist economies. Hence, the theorems are inapplicable.
* Joseph Stiglitz, Whither Socialism?, MIT Press, London 1994, 26.95. I thank Fred Block for his comments on an earlier draft of this review.
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The essential reality which the Walrasian tradition ignores, according to Stiglitz, consists in the uncertainty which pervades economic activity: when firms hire workers, they are uncertain what kind of labour they will get; when they write contracts with other firms for the future delivery of resources and commodities, they are uncertain about how well their expectations for delivery of goods of a certain quality will be fulfilled; when firms plan large investments, they are uncertain about future states of the economy, in particular, for the demand of their output; when banks lend to borrowers, they are uncertain as to whether they will be repaid; when individuals make long-range plans, they are uncertain about the future. The reality of uncertainty, Stiglitz argues in great detail, vitiates the hypotheses of the two welfare theorems. But why should this constitute an attack on market socialism? Because, Stiglitz says, the LangeLerner model of market socialism, constructed in the 1930s, was based on the Walrasian world-view. In essence, Lange and Lerner put too much faith in markets and pricesthey were too neoclassical. They believed that social planners could bring about efficient and equitable allocations of resources by asking firm managers to respond to price signals, initiated by the centre. They believed, in particular, that prices carried all the information necessary to direct economic agents to a Pareto-optimal allocation of resources. But the consequence of the incompleteness and asymmetry of information in real economic environments, Stiglitz argues, is that actual economic agents must use all kinds of non-price information. The claim that actual capitalist economies can arrive at Pareto-optimal allocations when economic actors simply respond optimally to prices is wrong, and likewise is the claim that socialist firm managers can engender an efficient resource allocation by responding to price signals from Langes central planning bureau. Stiglitzs criticism of the Walrasian world-view is Hayekian: what economic actors really do in a market economy is much more complex than what they are postulated to do in the ArrowDebreu or Walrasian model. They evaluate all kinds of information which cannot conceivably be communicated to central planners about the complex specifics of their micro-environments, including their perceptions of demands or potential demands of consumers, of the quality of the available labour, and of the reputations of suppliers with whom they must deal. Planners cannot possibly capture the correct response of a firm manager to this informationally incomplete and complex environment by instructing him to maximize profits against some postulated set of prices, or more generally to choose that level of output which equates marginal cost to price. But Stiglitzs own response to this informationally complex reality is far from Hayeks. While Hayek argued that the best thing a government could do was to disappear from the economic scene, letting the economy evolve in a natural (laissez-faire) manner, Stiglitz argues that there is no reason to believe that laissez-faire will engender static or dynamic efficiency or equality. There are many reasons why government can repair market failures of various kinds, that is, failures of the market to perform as it is supposed to, according to the two welfare theorems. The difficult task is to find the optimal mix between government and private economic activity.
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The Lange Model of Market Socialism1

Because Stiglitzs conception of market socialism is the now half-century old proposal of Oskar Lange, we must briefly review that model. A still earlier view of market socialism had presumed that the government knew all the technological blueprints in the economy, as well as the preferences (needs) of all consumers. The centre could then arrange initial endowments among citizens in a desirable (equal, let us say) fashion, calculate the (Walrasian) equilibrium prices for the equilibrium it desired, announce prices, and allow consumers and firms to pursue their selfinterest: the desired allocation would be achieved without further intervention from the centre. The main criticism of this proposal, at the time, was that the government would have to be omniscient to carry out this calculation: how was it to learn the technologies of all firms and the preferences of all consumers? Lange proposed a method that apparently required much less knowledge at the centre. First, the government arranged initial endowments of citizens in an egalitarian mannereach household would receive a fraction of the profits of each firm in proportion to its (household) size, for instance. (He called this the social dividend.) The centre would announce a candidate vector of prices to the firms, asking each firm manager to report how much of its good it would produce, were it to equate the marginal cost of producing an extra unit of output to the price of output. The centre would then sum up, and see which goods were in excess supply (at this candidate price vector) and which in excess demand, at the firm level. It would then readjust prices accordingly (lowering the prices of goods in excess supply, etc.), and ask the firms again to respond. This process of adjustment would, Lange conjectured, converge to an equilibrium set of prices in several iterations. Those prices would then be announced publicly; markets would clear for all industrial inputs, by construction of the prices. There is, however, no guarantee that the markets for consumer goods would clear, a point Lange seemed unaware offor those prices, being the prices of outputs of firms, would have already been set, but consumer demands were not considered in the original price-setting process. One can also ask, if the purpose of the price-iteration procedure conducted by the central planning bureau was simply to find prices that would clear the markets for inter-firm trade, then why not let the market set those prices directly, if one believes as Lange did that markets will find market-clearing prices? Langes answer to this is one that may sound quaint today. He believed that large social costs were sustained during the processs of price equilibration in actual market economies: the virtual price iteration conducted by the central planning bureau would save the economy those costs. Thus, he believed that the centre could find the equilibrium prices faster than the market.
1 For an enlightening intellectual history of market socialism, the reader should consult R. Blackburn, Fin de sicle: Socialism After the Crash, NLR 185 (JanuaryFebruary 1991). A shorter history is available in W. Brus, Market Socialism, Palgrave Dictionary of Economics, London 1991.

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One might further ask: What is the scope for government direction of the final allocation in the Lange model, aside from the distribution of initial property rights among citizens in an egalitarian fashion? After all, Langes procedure (aside from the error of not worrying about market-clearing in the markets for final consumer goods) was supposed to find the market equilibrium that, presumably, real markets would find, if somewhat more slowly (according to Lange). From our reading of the Lange proposal, Joaquim Silvestre and I2 think the other allocation goal of the centre was to alter the composition of output between investment and consumption goods from what it would have been without intervention. This it would do by setting interest rates, which would influence the demand for investment goods by firms. Thus, in our reading, the Lange model of market socialism has the following features: 1) the distribution of consumer goods would be altered from a typically capitalist distribution by redistributing dividends of firms in a quite egalitarian manner among citizens; 2) prices of industrial outputs and inputs would be set by the central planning bureau so as to clear the markets on which the inter-firm trade was conducted; 3) the composition of output between consumption and investment goods would be altered by central setting of interest rates at which firms borrow. That manipulation of prices (including wages and interest rates) would suffice to bring about a desired allocation of resources and commodities is the Walrasian view that Stiglitz attacks. From the perspective of the 1930s, the Lange proposal was innovative because it did not require the centres omniscience; the desirable equilibrium would be found without the centres having to know anything about firms technologies.
Market Failures

The most extensive part of Stiglitzs book is the discussion of the myriad reasons that price information is not sufficient to direct economic actors to bring about a desirable allocation of resources. Hence, as Ive said, follows Stiglitzs attack on the Lange model. Much of the book is devoted to discussing what methods and institutions capitalism uses to carry out economic activity when prices are not sufficient. The difference between Hayek and Stiglitz is that Hayek believed these institutions have, through selective adaptation, evolved to be optimal for the task, whereas Stiglitz believes no such presumption is justified. In particular, Stiglitz believes there is substantial role for government intervention in the economy. There are several classical reasons that markets will not function to bring about Pareto-efficient allocationsclassical, in the sense that these reasons were appreciated a century ago. These consist in the presence of public goods, public bads, and externalities. A public good or bad is one which is consumed by many individuals if it is consumed by any, such as national defence or polluted air. Government intervention has long been justified to alter (increase or decrease) the amounts of these goods/bads, either through the imposition of Pigouvian taxes or subsidies, or
2 J.E. Roemer and J. Silvestre, Investment Policy and Market Socialism, in P.K. Bardhan and J.E. Roemer, eds, Market Socialism: The Current Debate, New York 1993.

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through direct regulation. The non-classical reasons consist in the following interrelated characteristics of complex economies: principal agent problems, the presence of asymmetric information, and the incompleteness of the set of markets. Let us take, first, the incompleteness of the set of markets. For the FWT to hold, there must be markets upon which are traded all the commodities that consumers desire. In a world of pervasive uncertainty, one commodity that consumers importantly desire is insurance. I would like to be able to purchase today insurance that will pay me off if, in the future, my house burns down. Here, there is no problem: such a market exists. However, a college student might also desire to purchase insurance against the possibility that she will not be able to find a job upon graduation. There is, so far as I know, no such insurance market. There are two reasons for this lack, known technically as moral hazard and adverse selection. Moral hazard is the danger that if the college student could purchase such insurance, she might try less hardor not at allto find a job upon graduation. Adverse selection occurs when only those who are most at risk of not being able to find jobs would purchase such insurance. Both of these phenomena inhibit insurance companies from offering their services. The adverse selection problem can be solved by requiring such insurance to be compulsoryeveryone must purchase itbut that requires government intervention; the moral hazard problem could be solved if the insurance company knew everything the insured did, but it cannot monitor the insured that well. Perhaps, then, it would be possible to introduce such insurance, but only with costly state intervention. Because, in a laissez-faire market economy, such markets dont exist, the FWT is inapplicable. It is also the case that asymmetric information may cause markets, when they exist, not to clearthus, a WalrasArrowDebreu equilibrium is not achieved in the actual economy, and so again the FWT is inapplicable. The most well-known example of a non-clearing market is the labour market: mass unemployment is a situation in which many individuals are offering, unsuccessfully, to sell labour-power for a wage at which others are hired. Traditionally, this non-clearing market has been attributed to the unwillingness of the labour unions to allow wages to fall. But there are also several modern reasons, having to do with information, explaining why, even in the absence of unions, labour markets might not clear. The relation between employer and employee is one of principal and agent. The principal wants a certain job performed, which she must delegate to an agent, whom she cannot perfectly monitor. The agent has objectives different from the principals (for instance, not to perform work at a stressful rate). In this situation, it may be optimal for the principal to offer a wage greater than the market-clearing wage: for this would give the agent a reason to want to keep the job, and hence to work hard, so as to assure not being caught shirking. (If the wage were marketclearing, presumably a dismissed worker could instantly find another job at the same wage.) Thus, payment of a wage above the market-clearing level can increase the efficiency of the worker: such wages have come to be known as efficiency wages. (Henry Ford is said to have said that the
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best cost-cutting move he ever made was to pay his assembly-line workers $5 a day, an extremely generous wage at the time.) A second example of a non-clearing price in a market economy is the interest rate at which individuals or firms can borrow. It is well-known that loan markets do not generally clear: there are would-be borrowers who are prepared to pay the going interest rate who cannot find lenders, yet the interest rate does not rise to clear the market. The reason for this is that lenders are uncertain about the trustworthiness of borrowers. Raising the interest rate to clear the market for loans may, in fact, draw unworthy borrowers into the market: I may borrow funds at an exorbitantly high rate, and then invest them in a very risky project with small probability of a high payoff. If Im lucky and the project succeeds, I can pay off the loan with interest; if, as is more likely, the project fails, the lender receives back neither principal nor interest. (Loans at large interest rates are made in capitalist economies, but only by lenders who are willing to afflict bodily harm upon recalcitrant borrowers.) Thus, rather than raising interest rates to clear the market for loans, lenders tend to keep interest rates lower, and try to screen borrowers, which they can only do imperfectly. The generic problem in these two examples is that manyperhaps mostimportant trades in an economy involve the exchange of a resource today against the expected return of some resource in the future. In the interval between the two half-trades, one party must undertake actions that the other cannot easily observe or monitor. Prices do not suffice to monitor these transactions, or properly to eliminate undependable traders. Reputations (non-price information) and collateral become important. (If a borrower puts up some resources of his own that he will lose should he default, it is less likely that he will engage in foolishly risky investment activities.) Not being able to participate in a market unless you have certain other characteristics (a good reputation, collateral) is a phenomenon not captured in the Walrasian model. Thus, Stiglitzs criticism of the claim that markets engender Paretoefficient outcomes is, broadly speaking, two-fold: first, the premisses of the FWT do not hold (the set of markets is incomplete), and second, the equilibrium of an actual market economy is not the same thing as the equilibrium in the general-equilibrium Walrasian model (where prices clear all markets) of the FWT.
Critique of the Second Welfare Theorem

The SWT is interpreted as saying that the question of efficiency (i.e. Pareto optimality) can be neatly separated from the question of distribution. Any Pareto-efficient allocation is the Walrasian equilibrium associated with some initial distribution of property rights in assets (labour, firms, other production inputs, and consumption goods). Stiglitz takes the SWT as an ideological foundation of market socialism, for it says that all the state must do is arrange initial property rights, and after that, markets will suffice to bring about any desired allocation. (The most desired allocation must be Pareto-optimal, under a welfarist philosophy. A welfarist should always want a resource allocation with the property that no other
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allocation exists that could improve everyones welfare. This is not to be confused with the false converse, that any Pareto-optimal allocation is desirable.) Now there are some well-known criticisms of the applicability of the SWT to real market economies. If the government were to carry out a massive redistribution of property rights, it would have to convince citizens that this was a once-only redistribution. For if it does not, wouldnt individuals fear investing their resources in projects that might make them fabulously wealthy, hence the object of a second state expropriation? It is difficult, if not impossible, for the state to commit itself to make a once-only redistribution. Second, the distribution of property rights required to bring about, through markets, the desired final allocation may well require not just distributing firm ownership in an egalitarian way, but also giving partial ownership of the labour of highly skilled individuals to less skilled individuals. In particular, if you can produce computer software that sells at a high price, but detest doing so, and if I own half of your labour endowment, then I have a claim against you (in money) that will force you to write software, although you would much prefer to write unpublished poetry. Ronald Dworkin has called this the slavery of the talented. Perhaps what youd really like to do is write software for a year, and then write poetry for five, living off the proceeds. But you wouldnt be able to do that if I owned half of your labour, for once you reveal that you have the software-writing talent, I can insist upon your coming up with the money every year. Stiglitz, however, concentrates on less morally dramatic problems having to do with the applicability of the SWT. Because of principalagent problems, the alteration of property rights may alter the degree of efficiency of an economythus, contra the SWT, efficiency and distribution are not separable. Consider a sharecropper (agent), who receives one-half of the crop, while the landlord (principal) receives the rest. If the land were transferred to the sharecropper, he might work much harder than before, might take better care of the land, invest in conservation, etc. Thus, different property rights cannot just engender a different distribution of a fixed pie, but can affect the size of the pie. Or consider a reliable small peasant who cannot borrow funds to purchase a tractor for his farm (the land he owns is insufficient collateral for a lender who does not know the farmers reputation). If some land were transferred to him from a large landowners estate, he would be able to borrow to purchase the tractor, and arguably produce more on that land than did the sharecroppers who formerly tended it for the estate owner. Thus, redistribution again increases the amount of output. These two cases argue for egalitarian redistribution. But there are cases when egalitarian redistributions can, arguably, decrease output. Consider a large corporation, with highly concentrated ownership. A few shareholders each own 10 per cent of the shares; they have an incentive to engage in costly monitoring of management, for the cost of that monitoring may be far less than they stand to gain by improving managements decisions, Now suppose shares are redistributed in an egalitarian manner among the citizenry. Each citizen now owns 0.00001 per cent of the firm. No citizen has the incentive to monitor the management now, for the costs to her of doing so exceed what expected gain she would garner. Indeed, even
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organizing a group of shareholders to pool funds and monitor management may not be an economically justified activity. Thus, the corporation may become less productive with an egalitarian redistribution of shares. None of these problems exist in the Walrasian model. There is a complete set of markets, so the landowner can write a contract with the tenant in which the latters income is contingent on exactly how well he tends the land. The state of the world in which output is low because rainfall was sparse can be distinguished from the state in which output is low because, last year, the tenant did not bother to fertilize as he should have. Enforcing the contract is costless. The shareholders of a corporation can write a management contract in which management is paid exactly according to how hard it works, and enforcing that contract is costless.
The Implications for Market Socialism

Space prevents me from giving a complete account of Stiglitzs rich discussion of the problems due to asymmetric information in market economies: the analysis of these problems is, indeed, the central contribution of Stiglitzs distinguished career. It is useful, at this point, to pose two questions: 1) Granted that real market economies are not perfectly described by the Walrasian model, is the approximation (of reality by the model) nevertheless good enough to permit one to use the lessons of the model to design a version of market socialism? 2) Granted that real market economies are characterized by an incomplete set of markets, asymmetric information, and incomplete contracts, only enforceable at considerable cost, can a version of market socialism nevertheless be designed which works at approximately the level of efficiency of a modern capitalist economy, but in which the distribution of income/resources is considerably more egalitarian than it is under capitalism? Stiglitzs answer to the first question is decidedly no; the answer to the second question depends on how socialism is defined, as I will articulate further below. I do not pretend to be able to answer either question definitively. With respect to the first question, I believe it is prudent to be less negative than Stiglitz is. There is an obvious analogy to physics. Newtonian mechanics is a complete logically consistent description of the physics of moving bodies. Although its premisses are indeed an incorrect description of the real universe, they are not so far off as to vitiate entirely the usefulness of the theory. The question, let us say, is whether the Walrasian model is more like Newtonian mechanics or Ptolemaic mechanics. If we look at the practice of economists today, we would have to say that, for many purposes, the Walrasian model is useful. Governments, for instanace, estimate the consequences of changing tax schedules, imposing investment credits, changing unemployment benefits, and many other important policy interventions using the Walrasian model. Large (Walrasian) general equilibrium models are used to calculate the changes in prices, employment, and income that will result from changes in tariffs (NAFTA, for instance). At present we have no substitute for the Walrasian model: there is, that is to say, no Einsteinian model which would enable the
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economist to study the effects on employment and income from policy changes, taking account of the Stiglitzian criticisms. At present, Stiglitzian insights enable one to analyse what will happen in a few markets, but the Walrasian model gives us an answer when we model the economy as one with, let us say, a hundred thousand markets. Stiglitz might respond that the completeness and consistency of the Walrasian model are false virtues: whats the use of getting a precise answer to an irrelevant question? Policy-oriented economists still use the Walrasian model as their main tool, and although that model is incapable of predicting some extremely important economic phenomena, such as the Savings and Loan crisis that occurred in the US several years ago, it seems to do well in predicting many important and less chaotic events (such as the change in employment due to a decrease in tariffs). Although Stiglitz writes that interest rates are only a trivial determinant of the volume of investmentmost investment decisions, he writes, are based on noninterest-rate informationthe US Federal Reserve still uses interest-rate intervention as its main tool to warm up or cool down the economy. To sum up, I am not convinced that Stiglitzs criticisms of the Walrasian model indeed vitiate the possibilities for using it as a guide to policy formation in capitalist economies. More to the present point, and by extension, I believe the Walrasian model can be used as a tool to explore the income-distributional consequences of market-socialist proposals. What must be added is that for a market-socialist proposal to be viable, careful attention must be paid to set up institutions that are incentive compatible, in the senses that Stiglitz discusses: account must be taken of the multitude of market failures that will arise because of principal agent relationships, asymmetric information, and missing markets. Granted that, because an actual market-socialist economy would suffer from market failures, one cannot claim that its equilibrium would be Pareto-efficient. But the salient question is, rather, can one create an economy that is about as efficient as capitalism, yet has qualitatively better distributional properties? This is, indeed, the second question enumerated above. In the book under review, Stiglitz unfortunately limits the conception of market socialism to the LangeLerner model. But that conception is what Hayek called, sixty years ago, the third generation in the genealogy of market-socialist ideas, and there exist today models that I have elsewhere called instances of a fifth generation.3 The salient differences between the Lange and fifth-generation models are that the former is based upon using a surrogate market (the iteration process conducted by the central planning bureau) in an environment in which firms are state-owned, while the latter rely upon actual markets in an environment where firms are not owned (exclusively) by the state. Thus, because these fifthgeneration models do not direct all economic activity with prices issued by the centre, but allow price formation on actual markets, they are, at least by initial presumption, innocent of the main false conception for which Stiglitz attacks the LangeLerner model. I shall elaborate further below.
3

J.E. Roemer, A Future for Socialism, Verso, London 1994.

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Managing and Monitoring Private Firms

Lange, and even Hayek, accepted the presumption that state-owned firms would be able to recruit managers who were loyal and capable managers, that is, who would carry out to the best of their abilities the dictates of the centre. Hayeks central criticism of Langes market socialism was that the centre would never be able to give good instructions to managers, because it could not possibly know everything that was relevant, what Hayek called the particular knowledge of time and place. In Stiglitzs terminology, only individuals at the plant level could possibly know all the relevant economic datawhat kinds of goods consumers were interested in buying, how to alter existing commodities or develop new ones that would satisfy demand, etc. Even Janos Kornai, the Hungarian economist who attacks market socialism as a chimera,4 assumes that managers are loyal and capable. What distinguishes Stiglitz and most other Western economists today from Lange, Hayek, and Kornai is their presumption that managers are self-interested careerists. Thus the state must provide incentives for managers which will induce them to satisfy social needs in the process of building their careers. The most general scepticism about the possibility of socialism, market or otherwise, among Western economists, is based upon the belief that no such incentives can be provided unless firms are privately owned by shareholders bent upon maximizing profitsmore precisely, such an ownership form is necessary, but not sufficient, for the creation of good firms. Stiglitzs views on this question are quite unconventional within contemporary Western economics, and I shall argue that if they are correct, they indeed bolster arguments for the possibility of market socialism, though not of the Langean variety. Before getting into details, I should say that I think the problem at handhow to give the proper incentives to firm managersis the key problem for market (or any) socialism. Alternatively put, I do not think one should base a blueprint for socialism on the possibility of being able to pick a cohort of selfless and socially minded managers to run firms. (Even worker-owned firms must have managers, if they are of appreciable size.) Any feasible socialism in the foreseeable future, I think, must design its institutions so that they can be run well by people without supernatural characteristicspeople, in particular, who spend a good deal of time thinking about themselves, and not the revolution. Consider, by way of example, the issue of pollution in the former Communist countries. It may have been that firm managers were loyal and capable, and disliked industrial pollution. But would it have been rational for a particular firm manager to introduce costly pollutioncontrol devices? After all, the difference his firm would make in the total amount of pollution would be virtually unnoticeable. And incurring extra costs would not have improved his reputation, in the supervising ministry, for being an efficient producer. Those ministers, in turn, although they personally may have disliked pollution, arguably would
4 J. Kornai, Market Socialism Revisited, in P.K. Bardhan and J.E. Roemer, eds, Market Socialism.

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have enjoyed no career benefits from insisting their firms be green. There probably were such free-rider problems all the way up the chain of command in altering the pollution-intensive production methods. At the very top, no popular mechanism existed for changing the leadership of the party. In fact, the central committee may have justified its brown policies by considering the trade-off between investing in a clean environment and providing national defence at the levels thought to be necessary. The separation of ownership from control, to use the classic phrase of Berle and Means, is a fact of any large corporation, be it publicly or privately owned. The management team is not the same set of individuals as the owners of the corporation. Essentially three methods, in capitalist economies, have evolved to solve the principalagent problem thus inherent in firm management, that the goals of managers and owners are not the same. Owners are interested in the long-run viability and vigour of the firm, managers are typically interested in their careers and income. It is not a simple matter for owners to design salary schemes which reward managers for taking actions which will further the long-run viability and vigour of the firm, for owners cannot observe exactly what managers do, and what alternatives are open to them at any decision juncture. The three methods are family or tightly-held control, the threat and occasional act of takeovers via the stock market, and the monitoring of management by other large organizations, such as banks or pension funds. Under the first method, firms do not become corporationsthey remain owned by a small circle of individuals, who manage the firm personally or monitor the management very closely. This solution cannot be a general one: most firms become publicly held because the original owners do not themselves possess the wealth to expand the firm. The takeover method is used to discipline management chiefly in the US and UK. If a firm is being poorly run, its shareholders will start to sell stock; the price of the stock will fall, making the firm an attractive takeover target for another large firm which would purchase it at a discount on its true value and install a new management team, who would again increase the value of the stock by good management. The raider then enjoys a large capital gain. In the third method, employed chiefly in Germany and Japan, banks which are closely connected to the firm through credit relations, and perhaps even stock ownership, actively monitor the management. Although stock markets exist, takeovers essentially never occur: indeed the banks prevent such takeovers, if necessary. Managers are replaced if the banks (and other institutions represented on the board of directors) cannot teach them to run the firm properly. Stiglitz is very critical of the Anglo-American takeover device. He writes that, in practice, firms that take over other firms do not benefit from doing so, and he gives several theoretical reasons why this should be so. (For instance, if the raiding firm correctly believes it can raise the value of the stock, then the current shareholders should not sell stock to it; they should hold on and enjoy the capital gain themselves. If there are two bidding raiders, A and B, then neither should outbid the other: for if A bids a price of p, and B contemplates bidding a higher price pd, it must consider why A didnt bid that higher price: does A know something about
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the firms prospects that B doesnt?) Moreover, he shares Keyness view of the stock market, that it is a gambling casino for the rich, not an effective device for raising capital. Suppose a firm offers to create new stock at a price of p per share: prospective buyers, for whom it is not economically rational to learn a great deal about the firms prospects, would initially believe that p is too high a pricefor why should the firm, which knows more than the prospective buyers about its prospects, not try to sell this asset for more than its worth? Thus, firms offering new stock must sell it at very attractive prices: Stiglitz estimates that firms which sell new equity generally undervalue it by a third. For this reason, selling equity is the least attractive alternative for a firm; most financing is done with internal funds or with bondsagain, the relative unimportance of the stock market as a way of allocating capital. Here again, Stiglitzs fundamental point of the importance of non-price information is brought to bear. The price of a firms stock is just too coarse a statistic for making a prudent investment decision. Because of the incompleteness of markets, whether it is socially optimal to put capital into a given investment project cannot be decided by looking just at the stock price. One must have first-hand information about the particular project, the situation in the industry, and so on. Banks are better situated to have such knowledge. A bank which has a large interest in a firm, either through owning its stock or lending it funds, has the resources (and incentive) to study in depth project proposals by the firm. This is, essentially, the Japanese system, where a main bank operates as the key lending institution for a group of firms. The bank not only lends to the firms in its group, but also arranges consortia, assembled from other banks, for such operations. To arrange loans at favourable interest rates, the main bank must have a good reputation as a project assessor; it must monitor the firms in its group effectively, for the main bank will not easily be forgiven (by other lending institutions) if one of its family of firms defaults on loans. Stiglitz recommends a system of bank monitoring for the emerging capitalist economies of Eastern Europe, rather than a takeover/stock-market mechanism. I said earlier that Stiglitzs views on the monitoring of firm management could bolster an argument for market socialism, by which I meant that, if the stock market and private ownership of firms are unnecessary devices to create efficient firms and capital allocation, then an economy without private ownership could also solve the firm-monitoring problem. If banks can successfully monitor firms in Japan and Germany, could they not do so in an economy with no private ownership of firms? I shall return to this topic below.
State-Owned Firms

Stiglitzs view of state-owned firms has considerably more nuance than the typical view among economists. On the one hand, as Ive discussed, he is less enthusiastic than is typical about capitalisms ability to solve agency problems within the firm by invoking the interests of private shareholders. On the other hand, he is less critical of state-owned firms than most. The two principal problems in constructing efficient state-owned
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firms are the frequent lack of competition for such firms, and the impossibility of government commitment to rational economic policies concerning the firm. The first problem, competition, exists because frequently firms become state-owned (in capitalist economies) precisely because they are monopolies. Monopolies, it is well-known, are socially inefficient (providing the wrong level of output at the wrong price), as well as, perhaps, technologically inefficient (not having the spur of competition to induce innovation and keep costs down). Nationalizing a monopoly is sometimes an attractive alternative to regulating it. As a state-owned firm, the monopoly is still vulnerable to the second problem at least. For example, although it may not control the price of its output, the wage it pays may be too high. State monopolies often become the effective property of their workers, who redirect what should be a social surplus into a personal surplus, through setting high wages. The government, in turn, will finance the deficit the firm may run, rather than take on a large group of workers: this is an instance of the soft budget constraint. Setting hard budget constraints for a public firm is politically difficult: it means allowing the firm to go bankrupt if it cannot pay its creditors. The government is open to attack by voters, who rightly point out that it could have saved the jobs of the firms workers. But without a credible hard budget constraint, it is difficult to induce the firms management to expend the energy necessary to contain costs, and wages in particular. Of course, the soft budget constraint also exists for private firms in capitalist economies. A large firm, at least, knows that with high probability the government will bail it out, should it fail (e.g. Chrysler). Indeed, Chapter 11 of the US bankruptcy code provides a legal method for softening the budget constraint of a firm which, although failing at one instant in time, may have good prospects in the future. The difference between state-owned and private firms is that the cost of employing the soft-budget constraint is larger for the latter. Now a socialist might respond that there is nothing wrong in paying high wages to workers in state firms, and bailing out state firms that operate inefficiently in order to preserve jobs. The response to this view is that such practices entail an inequitable and inefficient use of the social surplus: inequitable, because what the wage workers in public firms are able to command will depend on the industry, and inefficient, because the softbudget constraint will lead to wasteful use of labour and equipment. To put the point extremely, it is inefficient to allow workers to take their leisure time on the job, where they are tying up costly machines which could be put to better use. If workers need larger consumption and more leisure time, that should be arranged through an equitable public financing of certain commodities, income transfers, and regulation of the length of the working day or year, not through decentralized and haphazard methods which waste other productive assets in the process.
The Blueprint for an Economy

Stiglitz writes: if I were to claim that socialism as an ideology can now be officially declared dead, I do not think it would be exaggeration [p. 279].
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But the claim is less damning than it might be, for Stiglitz defines socialism as either the Lange model, or, at the other extreme, that system popularly called Communism, characterized by administrative (nonmarket) allocation of resources, state-owned firms, and political dictatorship by a single party. The future for socialism, so defined, is an uninteresting issue. The interesting question, as I said earlier, is whether economies can be organized to operate at approximately the level of efficiency at which capitalist economies operate (including their levels of innovation) but with significantly more equality of condition. Although Stiglitz never faces this question straight on, much of his analysis strongly suggests a positive answer. One of the most interesting chapters in the book contains the authors recommendations to the East European countries. He is wary of quick fixes, such as privatization of firms through vouchers. The key problem, of finding management who are able to run firms in a market context, cannot be solved by privatization or any magic trick: managers must be trained. Privatization is far less important than putting firms in a competitive environment, by breaking up large firms and opening international markets. Those who are knowledgeable about the industry are better equipped to nominate managers for firms than are shareholders. Other writers have made the distinction between restructuring and privatization: it is restructuring that is desirable, for which privatization is neither necessary nor sufficient. Like many other non-left writers, Stiglitz admires the Chinese township and village enterprises (TVEs), which are essentially local publicly owned firms. One reason for their remarkable success is that they operate with hard budget constraints, as their owners, local governments, do not have the funds to bail them out. Stiglitz writes that the former socialist economies are in the perhaps unique position of being able to obtain a degree of equality of ownership of wealth unattained, and perhaps unattainable, in other market economies and they should not lose this opportunity [p. 265]. Elsewhere he speaks of the myth of the two ways, i.e. that only capitalism and Communism are possible. The question is not whether there will be government involvement in economic activity but what that role should be [p. 253]. Stiglitz admires the egalitarian growth experience of a number of the East Asian countries, and points out that, even today, government appoints the heads of all private banks in South Korea. I might add that Taiwan carried out significant investment planning by the use of interest-rate subsidies, a price-oriented device that Stiglitz is sceptical about, and the Japanese MITI undertook a variety of deep interventions to develop particular industries. Although Stiglitz provides no blueprint for a more egalitarian, marketbased economy, it is clear that he believes such is possible, although he would probably call it peoples capitalism instead of market socialism. He believes there is a significant role for government, not only in the provision and financing of public goods and the regulation of public bads, but in influencing the direction of private investment. On the other hand, he does not believe the government can be a perfect substitute for the lack of markets. The same reasons that prevent private insurance companies from providing certain kinds of insurance may mean the government
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should not provide it eitheralthough this is not necessarily the case, as the government has the ability to overcome certain problems that afflict private firms (e.g. it can solve the adverse selection problem by making insurance compulsory). There are cases in which public ownership of firms may be preferable to private ownership. And Stiglitz does not believe highly concentrated ownership of private firms is necessary for efficiency, for he appears to prefer, at least for most countries, a system of bank monitoring of firms, under which no large individual shareholders need exist. Because highly concentrated ownership of private firms is not, in Stiglitzs view, necessary for efficiency, market socialism becomes feasible. By market socialism, I mean here a system in which most commodities are traded on markets, including labour-power, there is substantial government intervention to influence the level of employment and perhaps the nature of investment in the economy, and a substantial fraction of large firms are not privately owned in the usual sense, as corporations with some very large shareholders. It is this third characteristic which is new, the fact that a substantial fraction of the economys output would be produced by firms in a competitive market environment, but which are not owned by individual shareholders. There is a variety of proposals for what the exact ownership structure of these firms could be. Stiglitz suggests they could be owned by holding companies, which in turn are state-owned, with constitutional provisions which would assure that the holding companies could operate free of political interference. Bardhan suggests a system of ownership based on the Japanese keiretsu model, in which a group of firms would each be associated with a main bank.5 The firms in the group would hold each others stock, giving them an incentive to monitor one another. The main bank of the group would be primarily responsible for raising loans for the firms in its group, and would also monitor the firms managements. Firms in the group would have the right to sell their shares in other firms in the group to the main bank, which would further put pressure on the bank to take actions to strengthen the performance of weak firms. I have suggested a property form which is closer to private ownership, but with some restrictions that would prevent the concentration of shares in the hands of the wealthy.6 There should be a separate currency (call it the coupon currency) which could be used only for the purchase of shares of firms in the public sector, or of mutual funds of such firms stock. Conversely, only coupon currency, not regular money, could be used to purchase such stock or mutual funds. Each citizen would receive an endowment of coupons at the age of majority, and would purchase mutual funds/firm stock with it. The shares of these funds/firms would trade on a stock market, with prices denominated (only) in coupon currency. Since no regular currency would be useful on this stock market, the wealthy could not purchase more shares in these firms than the poor. The profits of firms in the public sector would be distributed to citizens in proportion to their share holdings. It would be illegal to give shares to
5 P. Bardhan, On Tackling the Soft Budget Constraint in Market Socialism, in ibid. 6 J.E. Roemer, A Future for Socialism, and A Future for Socialism, Politics and Society 22.

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others, and at death, a persons portfolio of such shares would be returned to the state treasury. Firms, in turn, would compete for the coupons of citizens, for they would be able to exchange coupons with the state for investment funds; as in the Bardhan proposal and as in Japan and Germany, they would be primarily monitored by banks. The coupon stock market is a mechanism to induce firms to compete for investment funds, to permit citizens to hold diversified portfolios, and to distribute a substantial share of the nations profits in a fairly equal manner among citizens. But the principal argument for its viability, as a property form which could induce efficient firm management, is the view, held by Stiglitz and others, that highly concentrated ownership is not necessary for monitoring firm management, and that, in particular, banks can do that job well.
Against Hayekian Dogma

In the last chapter of this book, entitled Philosophical Speculations, Stiglitz agrees with many conventional socialist views: that trust is as much the key to a successful economy as self-interest, that the effect of the economic system on the human spirit must be taken into account, that one cannot simply dismiss Marxist concerns about the effects of market economies on the alienation of workers; he refers to the narrowness of neoclassical man. But perhaps the most important of these speculations is Stiglitzs attack on the Hayekian view that a laissez-faire capitalist economy is natural, in the sense of being a fit survivor in the contest among possible economic systems. First, he asks, how do we know what is natural? Why isnt it natural for people to create organizations (governments) that intervene in markets? The fundamental point, he writes, is that there is no reason to believe that market economies naturally make the right trade-offs or that, in particular, market economies with more ruthless competition are more efficient than economies in which competition is more gentle. Moreover, since whether a particular trait (species) survives depends on the environment, which itself is endogenous, there is no reason to believe that the system as a whole has any optimality properties [p. 276]. Indeed, because preferences of individuals are themselves endogenous to (influenced by) the economic mechanism, we have fundamental problems even ascertaining what are appropriate criteria for judging evolutionary processes. For instance, he writes, we need to study forms of economic organization involving more worker participation and ownership. Not too much should be read into the failures of the worker-managed firms in the former Yugoslavia [p. 277]. In sum, Joseph Stiglitz, although posing as a critic of socialism, in fact provides a sharp attack on the neo-Hayekian dogma which has gained such prominence in the past twenty years, and is the real antagonist in the debate concerning the feasibility of more egalitarian societies. The kinds of socialism he attacks (Communism and Lange model) are straw men in that debate. Whether Stiglitzs choice of anti-socialist vocabulary is, like Marc Antonys, a clever rhetorical device, or whether he really believes that socialism is dead, does not much matter. For his arguments lay to rest
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many commonplace false beliefs about the optimality of private property as a social institution, and thus lay the groundwork for fruitful discussion about alternative, and more egalitarian, social and economic organization.

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