The key theoretical basis for market socialism is the negation of the underlying expropriation of surplus value present in other, exploitative, modes of production. Socialist theories that favored the market date back to the Ricardian socialists and anarchist economists, who advocated a free-market combined with public ownership or mutual ownership of the means of production.
Proponents of early market socialism include the Ricardian socialist economists, the classical liberal philosopher John Stuart Mill and the anarchist philosopher Pierre-Joseph Proudhon. These models of socialism entailed "perfecting" or improving the market-mechanism and free-price system by removing distortions caused by exploitation, private property and alienated labor.
This form of market socialism has been termed "free-market socialism" because it does not involve planners.
John Stuart Mill
Mill's early economic philosophy was one of free markets. Later he altered his views toward a more socialist bent, adding chapters to his Principles of Political Economy in defence of a socialist outlook, and defending some socialist causes. Within this revised work he also made the radical proposal that the whole wage system be abolished in favour of a co-operative wage system. Nonetheless, some of his views on the idea of flat taxation remained, albeit altered in the third edition of the Principles of Political Economy to reflect a concern for differentiating restrictions on "unearned" incomes, which he favoured, and those on "earned" incomes, which he did not favour.
Mill's Principles, first published in 1848, was one of the most widely read of all books on economics in the period. As Adam Smith's Wealth of Nations had during an earlier period, Mill's Principles dominated economics teaching. In the case of Oxford University it was the standard text until 1919, when it was replaced by Marshall's Principles of Economics.
Mill promoted substituting capitalist businesses with worker cooperatives. He says:
The form of association, however, which if mankind continue to improve, must be expected in the end to predominate, is not that which can exist between a capitalist as chief, and work-people without a voice in the management, but the association of the labourers themselves on terms of equality, collectively owning the capital with which they carry on their operations, and working under managers elected and removable by themselves.
Pierre-Joseph Proudhon developed a theoretical system called mutualism, which attacks the legitimacy of existing property rights, subsidies, corporations, banking, and rent. Proudhon envisioned a decentralized market where people would enter the market with equal power, negating wage slavery. Proponents believe that cooperatives, credit unions, and other forms of worker ownership would become viable without being subject to the state. Market socialism has also been used to describe some individualist anarchist works which argue that free markets help workers and weaken capitalists.
For American anarchist historian Eunice Minette Schuster "[i]t is apparent ... that Proudhonian Anarchism was to be found in the United States at least as early as 1848 and that it was not conscious of its affinity to the Individualist Anarchism of Josiah Warren and Stephen Pearl Andrews ... William B. Greene presented this Proudhonian Mutualism in its purest and most systematic form". Josiah Warren is widely regarded as the first American anarchist, and the four-page weekly paper he edited during 1833, The Peaceful Revolutionist, was the first anarchist periodical published, an enterprise for which he built his own printing press, cast his own type, and made his own printing plates.
Warren was a follower of Robert Owen and joined Owen's community at New Harmony, Indiana. Josiah Warren termed the phrase "Cost the limit of price", with "cost" here referring not to monetary price paid but the labor one exerted to produce an item. Therefore, "[h]e proposed a system to pay people with certificates indicating how many hours of work they did. They could exchange the notes at local time stores for goods that took the same amount of time to produce". He put his theories to the test by establishing an experimental "labor for labor store" called the Cincinnati Time Store where trade was facilitated by notes backed by a promise to perform labor. The store proved successful and operated for three years after which it was closed so that Warren could pursue establishing colonies based on mutualism. These included "Utopia" and "Modern Times". Warren said that Stephen Pearl Andrews' The Science of Society, published in 1852, was the most lucid and complete exposition of Warren's own theories.
Later Benjamin Tucker fused the economics of Warren and Proudhon and published these ideas in Liberty calling them "Anarchistic-Socialism". Tucker said: "[T]he fact that one class of men are dependent for their living upon the sale of their labour, while another class of men are relieved of the necessity of labour by being legally privileged to sell something that is not labour. . . . And to such a state of things I am as much opposed as any one. But the minute you remove privilege. . . every man will be a labourer exchanging with fellow-labourers . . . What Anarchistic-Socialism aims to abolish is usury . . . it wants to deprive capital of its reward".
Early 20th century
Beginning in the early twentieth century, neoclassical economic theory provided the theoretical basis for more comprehensive models of market socialism. Early neoclassical models of socialism included a role for a central planning board (CPB) in setting prices equal marginal cost to achieve Pareto efficiency. Even though these early models did not rely on genuine markets, they were labeled "market socialist" for their utilization of financial prices and calculation. Alternative outlines for market socialism involve models where socially owned enterprises or producer co-operatives operate within free markets under the criterion of profitability. In recent models proposed by American neoclassical economists, public ownership of the means of production is achieved through public ownership of equity and social control of investment.
The earliest models of neoclassical socialism were developed by Leon Walras, Enrico Barone (1908) and Oskar R. Lange (c. 1936). Lange and Fred M. Taylor (1929) proposed that central planning boards set prices through "trial and error", making adjustments as shortages and surpluses occurred rather than relying on a free price mechanism. If there were shortages, prices would be raised; if there were surpluses, prices would be lowered. Raising the prices would encourage businesses to increase production, driven by their desire to increase their profits, and in doing so eliminate the shortage. Lowering the prices would encourage businesses to curtail production to prevent losses, which would eliminate the surplus. Therefore, it would be a simulation of the market mechanism, which Lange thought would be capable of effectively managing supply and demand.
Although the Lange–Lerner model was often labelled as "market socialism", it is better described as "market simulation" because factor markets did not exist for the allocation of capital goods. The objective of the Lange–Lerner model was explicitly to replace markets with a non-market system of resource allocation.
H. D. Dickinson published two articles proposing a form of market socialism: "Price Formation in a Socialist Community" (The Economic Journal 1933) and "The Problems of a Socialist Economy" (The Economic Journal 1934). Dickinson proposed a mathematical solution whereby the problems of a socialist economy could be solved by a central planning agency. The central agency would have the necessary statistics on the economy, as well as the capability of using statistics to direct production. The economy could be represented as a system of equations. Solution values for these equations could be used to price all goods at marginal cost and direct production. Hayek (1935) argued against the proposal to simulate markets with equations. Dickinson (1939) adopted the Lange-Taylor proposal to simulate markets through trial and error.
The Lange-Dickinson version of market socialism kept capital investment out of the market. Lange (1926 p65) insisted that a central planning board would have to set capital accumulation rates arbitrarily. Lange and Dickinson saw potential problems with bureaucratization in market socialism. According to Dickinson "the attempt to check irresponsibility will tie up managers of socialist enterprises with so much red tape and bureaucratic regulation that they will lose all initiative and independence" Dickinson 1938 p214). In the Economics of Control (1944) Abba Lerner admitted that capital investment would be politicized in market socialism.
Late 20th century
Economists active in the former Yugoslavia, including Czech-born Jaroslav Vanek and Croat-born Branko Horvat, promoted a model of market socialism dubbed the Illyrian model, where firms were socially owned by their employees and structured on workers' self-management and competed with each other in open and free markets.
American economists in the latter half of the 20th century developed models based such as "Coupon Socialism" (by the economist John Roemer) and "Economic Democracy" (by the philosopher David Schweickart).
Pranab Bardhan and John Roemer proposed a form of Market Socialism where there was a "stock market" that distributed shares of the capital stock equally among citizens. In this stock market, there is no buying or selling of stocks, which leads to negative externalities associated with a concentration of capital ownership. The Bardhan and Roemer model satisfied the main requirements of both socialism (workers own all the factors of production – not just labour) and market economies (prices determine efficient allocation of resources). A New Zealand economist, Steven O'Donnell, expanded on the Bardhan and Roemer model and decomposed the capital function in a general equilibrium system to take account of entrepreneurial activity in market socialist economies. O'Donnell (2003) set up a model that could be used as a blueprint for transition economies, and the results suggested that although market socialist models were inherently unstable in the long term, in the short term they would provide the economic infrastructure necessary for a successful transition from planned to market economies.
In the early 21st century, the Marxian economist Richard D. Wolff refocused Marxian economics giving it a microfoundational focus. The core idea was that transition from capitalism to socialism required the reorganization of the enterprise from a top-down hierarchical capitalist model to a model where all key enterprise decisions (what, how, and where to produce and what to do with outputs) were made on a one-worker, one vote basis. Wolff called them workers self-directed enterprises (WSDEs). How they would interact with one another and with consumers was left open to democratic social decisions and could entail markets or planning or likely mixtures of both.
Another form of market socialism has been promoted by critics of central planning and generally, of neoclassical general equilibrium theory. The most notable of these economists were Alec Nove and Janos Kornai. In particular, Alec Nove proposed what he called feasible socialism, a mixed economy consisting of state-run enterprises, autonomous publicly owned firms, cooperatives and small-scale private enterprise operating in a market economy that included a role for macroeconomic planning.