Theories in Market Socialism: Part I

Since the candidacy of Bernie Sanders for U.S. president in 2016, socialism has been garnering more interest, particularly among young people. A Harvard University survey in 2016 found that 51 percent of young people, between 18 and 29, did not support capitalism, and 31 percent support socialism. The survey clearly indicates young people favor an alternative, but the gap in support for socialism suggests an ambivalence toward what that alternative should be. I would also suspect that of the 31 percent that do support socialism, many do not have a clear idea of what it would look like — in no small part due to the robust myths and misconceptions which were propagated by the U.S. government, and that continue to pervade even the academic sphere. Socialists have put forward a plethora of possibilities. These proposals generally fall into one of two categories, market socialism or planned socialism. The focus of this article and subsequent parts will focus on the former. For Part I of this series, I will first will summarize some historical perspective of market socialism as it has existed in the real world.

Market socialism has been generally defined as social ownership of the means of production, but where allocation of resources is predominantly determined by market forces. Social ownership of the means of production may include state, municipal, worker, or cooperative forms of ownership. The historical cases generally defined as market socialist include Hungary, Yugoslavia, and China. Hungary oscillated between planning and market allocation systems to its detriment. Both Yugoslavia and Hungry introduced market reforms fairly rapidly and comprehensively while China’s approach was to introduce market socialism gradually. In all three cases, the state maintained ownership of the means of production, but Yugoslavia was the only country to seriously attempt to introduce democracy into the productive domain through worker’s self-management.

One of the major misconceptions of socialism is that it is synonymous with state-ownership and control. But the core tenet of socialism is not just the socialized ownership of the means of production, but the extension of democracy to the productive sphere. State-ownership while certainly the most expansive form of social ownership, it is not socialism if the economy is not organized democratically. When many thing of socialism, they often think of the Soviet Union, Cuba, and China. However, the problem with these examples are that they lack that fundamental characteristic of socialism, democracy. That leaves with Yugoslavia being the only country that has come close to an ideal form of a socialist economy, which makes it worth exploring the Yugoslav experience, and what factors contributed to its ultimate dissolution.

A very brief history of Yugoslavia and worker self-management

(For a still relatively brief, but more complete history of Yugoslavia, check out my paper here.)

To be clear here, Yugoslavia was not a beacon of democracy. While it introduced greater democracy in the economic and productive sphere, this was much less the case in the political sphere. The government was organized in a similar way to that of the Soviet Union. One party rule by a communist party which dictated the path of the country. The legislature did little more than rubber stamp decisions made by the party’s politburo. However, the country was fundamentally republican in character much like the U.S. in this respect. Six nation states and two independent territories were officially recognized as well as the rights of these nations to their own self-determination. Federal law, however, defined electoral units, the number of deputies in individual republics’ parliaments, the candidate requirements. The communist regime was authoritarian in many respects, particularly when it came to putting down nationalist rebellions. The media was more strictly regulated, but had considerable more latitude than other socialist countries in Eastern Europe.

The Federal Republic of Yugoslavia emerged after World War II. During the war, a communist-led rebellion expelled the Axis powers in 1945. Elections were held, and it should be unsurprising the Communist League of Yugoslavia won. It was the leading organization militia of the People’s Front of Yugoslavia which expelled the Nazis from the country. The republic was established in 1946 under the life appointment of President Marshal Josip Tito, the leader of the rebellion and war hero to his people. Under influence of the Soviet Union, Yugoslavia first opted for a Soviet-type model from 1945–1950. The economy saw rapid economic growth during this time. By 1948, most industries and retail businesses had been nationalized leaving only artisan workshops, retail outlets and peasant farms to be privately owned. However, due to a fallout between Tito and Stalin, Yugoslavia embarked on a new path. The ‘third way’ as it was called, began with the introduction of worker self-management in 1950. Significant central control was retained during this period, but workers had considerable role for decision-making in their enterprises. Workers’ council had authority to appoint managers, fix internal pay structures, determine recruitment procedures, and to allocate the enterprise surplus between wages and investment, but did not own the means of the production. Moderate market reforms were introduced in 1952 and 1953. Resource allocation moved from vertical command planning to direct horizontal relations between autonomous enterprises through regulated markets. Prices were liberalized, and the enterprises were permitted to engage directly in international trade.

The state retained considerable control over the country’s development by allocating investment funds centrally, which was financed through high taxation on enterprises of more than 60 percent of net income. Planned investment averaged 34 percent of gross material product in the country (the conventional measure of national production in socialist systems). From 1953–1956, Yugoslavia experienced exceptional growth of 8.4 percent per annum, and 11.8 percent per annum from 1957–1961, an era that came to be termed as “the great leap forward”.

Given their prior success, in 1965 the federal government of Yugoslavia introduced more market reforms including decentralization of investment to the banking system. Trade and prices were further liberalized, taxes reduced, and enterprises were given greater autonomy. But the reforms proved to be more than the economy could handle. The economy experienced a recession. Unemployment rose. Output fell. Monetary policy helped to restore the economy to the previous growth trend, but unemployment remained higher than before. Despite this experience, Yugoslav economists concluded the solution was to take market reform further. To their surprise, the economy throttled again. Although average output through the 1970s was 5 percent per annum, the cycles were significant. Unemployment and inflation persistently grew, as well as trade imbalances.

Inflation in particular in Yugoslavia accelerated up until its dissolution. This phenomena resulted from multiple factors. But Western analysists attribute one of those factors to the structure of the self-management in enterprises. In Yugoslavia’s reform toward market socialism in the 1960s, indicative planning through the so-called “basic proportions” formula, which regulated the spread between wages and productivity, was lifted. The consequence was accelerating wage inflation. The issue at the core of what Western analysts called the “Illyrian” model was a misalignment in the incentive structure between workers’ short-term interest and the long-term interest of enterprises. Yugoslav workers had no property rights or real stake in the enterprises since the state retained ownership, so workers’ self-interest was biased towards short-run income gains rather than long-term profitability. This bias also fostered reluctance to expand the workforce, particularly in downturns, as equally shared profits reduced incomes.

While market competition would have in theory tempered these tendencies, this mechanism was frequently circumvented by the soft budget constraint, i.e. loans from the state, and later local patron banks. In an environment where cooperative enterprises are permitted to fail, the market mechanism will have more influence in tamping down wage demands. Such inflation can also be held in check through progressive taxation. Taxation on firms might serve this purpose to some extent, and certainly progressive income taxes at the individual level would tamp down demand pull inflation, but not wage inflation. There is an argument to be made that this alignment problem was specific to Yugoslavia given its state ownership arrangement and the soft budget constraint facing firms. Nonetheless, the failure of the Yugoslavia worker self-management system has provoked considerable consternation on this issue by speculators of market socialist systems.

However, my take is that these concerns have been overemphasized in the literature. The failure of Yugoslav labour-management was the result of circumstances specific to Yugoslavia, and its poor policy choices. Yugoslav worker myopia resulted from having no asset stake in the firm, and so higher wage demands were prioritized over reinvestment. The incentive structure was further perverted by the existence of the soft-budget constraint which subsidized failure. And more contemporary skepticism of labour-management ignores the performance of labour-managed cooperatives and worker-owned firms in developed industrial economies which have demonstrated a remarkable competitiveness in production and efficiency (Pérotin, 2016), as well as their resilience in adverse economic conditions (Lampel et al. 2010, 2014).

What are the basic assumptions of a market based socialism? What would it look like?

The market mechanism has its advantages and disadvantages. Therefore, we should assume the following will continue to exist in a market socialist model: The market will be the primary mechanism of price determination and resource allocation. Prices help balance supply and demand, reflect some degree of production costs, and approximate marginal utility of consumption. Firms will maximize profit. Additionally, wages will be determined by the labor market. There will be free movement of labor between firms, constricted only by the vested interest of workers in those firms. However, since wages are market determined, we can assume wage differentials between workers, and therefore we should assume some level of inequality. It is simply not possible to eliminate all inequality, nor would that be desirable. Human effort should be rewarded, and those that put forth more effort should be adequately compensated for it. The goal is to eliminate sources of unearned income.

We still have money, and the state will continue to retain monopoly control of the currency. Banks will still exist to provide services to the public including safe keep of savings, facilitate credit, and small scale investment. And a central bank will be needed to regulate them. Given that the market will be the mechanism of resource allocation, we can assume there will be fluctuations in business investment. Imperfect information will produce errors in judgement and uncertainty. In addition, since money will be the medium of exchange, the above may induce the occasional mindset of thrift across the population, reducing consumption and output; which ultimately induces unemployment. Frictional unemployment will certainly exist, and as innovation runs its course in the way we would expect in a market economy, structural unemployment will be inevitable.

Therefore, the state will be needed to smooth out business cycles, alleviate uncertainty, provide social insurance, retrain the unemployed, and plan for structural changes in the economy. Subsidies, taxes, price controls, and regulation are not excluded to redress negative externalities. We know that private investment is not riskless in a market economy. Firms can fail, and do more often than not. Given an asymmetric information environment, credit rationing is inevitable. Market socialists recognize that capital markets are inadequate facilitators of stable investment. A state that is a sovereign currency issuer, on the other hand, is not revenue constrained, and can therefore absorb such risk. Therefore, the state must be responsible for a substantial portion of direct investment along with the provision of public goods such as education, healthcare, and some basic level of income. A crucial check on the power of the state would be a democratic or republican political system. It is by this mechanism citizens would determine the acceptable tradeoff between public goods and amenities relative to after tax disposable income; though education, healthcare, retirement pensions, unemployment insurance will surely make the list.

Lastly, there will be foreign trade. For large advanced economies like the U.S., foreign trade is a fairly small percentage of GDP, but continues to grow over time. For most of the rest of world, trade is an integral part in meeting the needs of firms and households. Therefore, it is important to design socialist institutions which regulate trade and reduce exposure of the domestic market from fluctuations in the world market. Along those lines, attention will need to be given to laws surrounding foreign direct investment, and the international flow of capital. All of this should be assumed.

Where socialists diverge in their visions is how best to arrange property rights in such a way that the positive attributes of the market are accentuated while negative ones are minimized, individual incentives align with long-term prosperity for the whole, and society is more equal. This theme will be explored in subsequent parts to this series as beginning with theorists such as Alec Nove, author of The Economics of Feasible Socialism. Look for part II under my feed.


Lampel, J., Bhalla, A., Chordia, M. and Jha, P. P. (2010). “Model Growth: Do Employee-Owned Businesses deliver sustainable performance?”. Cass Business School, City University London. Retreived from

Lampel, J., Bhalla, A., Chordia, M. and Jha, P. P. (2014). “Does Employee Ownership Confer Long-term Resilience?”. Cass Business School, City University London. Retrieved from

Pérotin, V. (2016). “What do we really know about worker co-operatives?” Co-operatives U.K. Retrieved from



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