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In Marxist theory, socialism, lower-stage communism or the socialist mode of production, refers to a specific historical phase of economic development and its corresponding set of social relations that eventually supersede capitalism in the schema of historical materialism. Socialism is defined as a mode of production where the criterion for economic production is use-value, and is based on direct production for use coordinated through conscious economic planning, where the law of value no longer directs economic activity, and thus monetary relations in the form of exchange-value, profit, interest and wage labor no longer operate. Income would be distributed according to individual contribution. The social relations of socialism are characterized by the working-class effectively controlling the means of production and the means of their livelihood either through cooperative enterprises or public ownership and self management, so that the social surplus would accrue to the working class or society as a whole.
Although Karl Marx and Fredrick Engels wrote very little on socialism and neglected to provide any details on how it might be organized, numerous Marxists and neoclassical economists used Marx's theory as a basis for developing their own models and proposals for socialist economic systems.
Socialism is a post-commodity economic system, meaning that production is carried out to directly produce use-value (to directly satisfy human needs, or economic demands) as opposed to being produced with a view to generating a profit (to maximize exchange-value). The stage in which the accumulation of capital was viable and effective is rendered insufficient at the socialist stage of social and economic development, leading to a situation where production is carried out independently of capital accumulation in a supposedly planned fashion. Planning has been understood to mean decentralized planning, participatory planning, workplace democracy or centralized planning.
In contrast to capitalism, which relies upon on the coercive market forces to compel capitalists to produce use-values as a byproduct in the pursuit of profit, socialist production is based on the rational planning of use-values and coordinated investment decisions to attain economic goals. As a result, the cyclical fluctuations that occur in a capitalist market economy will not be present in a socialist economy. The value of a good in socialism is its physical utility rather than its embodied labor, cost of production and exchange value as in a capitalist system.
The advanced stage of socialism, referred to as "upper-stage communism" in the Critique of the Gotha Programme, is based on the socialist mode of production but is differentiated from lower-stage socialism in a few fundamental ways. While socialism implies public ownership (by a state apparatus) or cooperative ownership (by a worker cooperative enterprise), communism would be based on common ownership of the means of production. Class distinctions based on ownership of capital cease to exist, along with the need for a state. A superabundance of goods and services are made possible by automated production that allow for goods to be distributed based on need rather than merit.
The period in which capitalism becomes increasingly insufficient as an economic system and immediately after the proletarian conquest of the state, an economic system that features elements of both socialism and capitalism will probably exist until both the productive forces of the economy and the cultural and social attitudes develop to a point where they satisfy the requirements for a full socialist society (one that has lost the need for monetary value, wage labor and capital accumulation). Specifically, market relations will still exist but economic units are either nationalized or re-organized into cooperatives. This transitional phase is sometimes described as "state capitalism" or "market socialism".
As a set of social relationships, socialism is defined by the degree to which economic activity in society is planned by the associated producers, so that the surplus product of the population is controlled by a majority of the population through democratic processes. The sale of labor power is abolished so that every individual participates in running their institution and no one controls anyone else. The incentive structure changes in a socialist society given the change in the social environment, so that an individual laborers' work becomes increasingly autonomous and creative, creating a sense of responsibility for his or her institution as a stakeholder. The individual is no longer alienated from his or her work; work now becomes a means by which the individual fulfills his or her humanity (pursues his or her interests).
Inequality and incentive-based systems would still exist under socialism, but to a diminishing extent as all members of society are de facto workers. This eliminates the severity of previous tendencies towards inequality and conflicts arising from these. The method of compensation and reward in a socialist society would be based on an authentic meritocracy, along the principle of "from each according to his ability, to each according to his contribution".
In Marxist theory, the state is a mechanism dominated by and utilized in the interests of the ruling class to subjugate other classes, to legitimize the existing socio-economic system and to promote the interests of the dominant class. After a workers' revolution, the state initially becomes the instrument of the working class. Conquest of the state apparatus by the working class must take place to establish a socialist system. As socialism is built, the role and scope of the state changes as class distinctions (based on ownership of the means of production) gradually deteriorate due to the concentration of means of production in state hands. From the point where all means of production become state property, the nature and primary function of the state would change from one of political rule (via coercion) over men by the creation and enforcement of laws into a scientific administration of things and a direction of processes of production; that is the state would become a coordinating economic entity rather than a mechanism of class or political control, and would no longer be a state in the Marxian sense.