- 1 Comparing Economic Systems
- 2 Market Economies
- 3 Command Economies
- 4 How Economic Systems Relate To Development
- 5 Pop Quiz!
Comparing Economic Systems
There are many different economic systems that try to result in more equality or faster growth. The structure of a country’s economy has a lot to do with the country’s politics and the values of its population. However, the economy of every country also changes over time, and how it falls between these broad categories will often change with it.
“Market Economies” are economic systems where production is determined by a system of prices and profits. This is also called the laws of Supply and Demand. These economies are subject to relatively little direct control by a government or economic planner, allowing people and businesses to try to distribute resources to maximize wealth. Market economies also have a certain level of income inequality. This is partially because profit is a large motivator behind how resources are allocated, higher profits and higher income usually result in higher income compared to everyone else.
Capitalism is a type of Market Economic System. Under a pure capitalist economy, there is little or no direct government regulation of the economies. Instead, the economy is regulated by the “invisible hand” of the markets. Companies that are inefficient or unpopular simply lose business to their competition. This should give companies incentive to always innovate. This also applies to the environment and business practices. If consumers do not like companies that heavily pollute or engage in worker exploitation, they will take their business to other companies. In contrast, companies that put emphasis on environmental stability would attract the business of consumers who value the environment. This also applies to prices. Companies with high prices will quickly lose business to companies with lower prices. The balance between prices and values (worker exploitation, the environment) should then reflect the population’s values as a whole.
The labor market is also dictated by the market. This means that workers get hired and are paid both according to their productivity. Their “replacement cost”, or how many other workers the firm can hire who are just as productive, is also a major factor. This gives incentives to workers to obtain new skills and renegotiate their salaries as they become more productive.
Criticisms of Capitalism
There are many movements emphasizing the problems with the capitalist economic system. One major problem is how the economy copes with large monopolies, or companies that are able to put all of their competition out of business. If a company has a monopoly, customers are not able to switch to a competitor if they do not like the company’s business practices. It also removes much of the incentive to keep prices low and to innovate.
This economic system can also be difficult for workers. If a worker starts with low skills, it can be very hard to save the time and money to build new skills to increase their income. This means that low-skill workers can be trapped with no way to increase their skills. This leads to greater income inequality as the rich can get richer because they have the means to do so. At the same time, more and more workers with low skills means that their “replacement cost” is very low, pushing wages farther down.
“Socialism” is not a clear economic system itself, but “Market Socialism” is a form of a Market Economy that places emphasis on equality. The main characteristic is that the “means of production”, meaning factories, farms, and resources, are at least partially “collective”, meaning everyone in the economy gets some part of the ownership. However, people still decide what kind of business they want to start, and companies still decide their levels of production and what exactly to produce.
This economic system sometimes says that the profits of a company should be shared with all the members of a society, instead of just investors. Instead, all revenue that is more than costs is distributed between everyone in the economy (called a “Social Dividend”). Under the current economic system in the United States, profits are either directly re-invested in companies, or distributed to the company’s stock holders as dividends. Other times the profit is instead distributed only to the workers in the factory which earned the profit, giving workers and managers a bigger incentive to work harder and continue to innovate. In both cases, there is an incentive to earn more profits, either for the sake of everyone in the economy or just for the workers who are earning them.
Workers in Market Socialism are paid only according to their productivity, and not their replacement cost. As part of the “Social Dividend”, workers are given some degree of ability to build new skills (sometimes including free education).
Criticisms of Market Socialism
The biggest problems with this economic system are practical. Some overseeing agency needs to be responsible to distribute the social dividend, which has a high chance of being corrupted or playing favorites. There is also a huge disagreement about how it should be distributed between the population (see: the socialist calculation debate). It is difficult to decide how much of the “profits” should be re-invested in growth and how much should be distributed back to all the workers. In a pure capitalist economic system this is determined by the “invisible hand” – companies that re-invest more generally grow more, but it does not apply in a socialist system.
There is another problem with full employment. Since workers are paid according to their production only, with no consideration of replacement cost, each worker costs more in a socialist system than a capitalist system. This means for the same production, fewer people have jobs and unemployment is higher. This also means that the profits for the same level of production will be smaller, which means less is available for re-investment. While the lowest-skilled workers will certainly be better off in a Market Socialism economic system than a pure Capitalist economic system, it is not clear if the lower re-investment and lower profits would make middle-income workers better or worse off. It is clear, however, that fewer people would be working in total, and people who are not working but are still earning a “social dividend” are not as beneficial to the economy as people who are working and producing.
Market Economies In The World
In the real world, most countries are some form of market economy (especially in North America and Europe). However, none is a full “capitalist” economic system or fully “Market Socialist”. Instead, all countries fall somewhere in the middle.
This means that even countries that call themselves “capitalist” do have controls to prevent monopolies from getting too powerful. They also do put taxes on profits and people with high incomes to pay for social programs, like unemployment benefits, universities, and environmental protection, which is a form of the “social dividend”. However, they also allow people and companies to keep profits to use as they want, and allow some level of income inequality. The balance between “capitalism” and “market socialism” does vary between countries, with some countries having higher taxes, regulations, and social benefits than others.
Command Economies describe economic systems where a central planning agency determines what and how much is produced. The planner also determines how much of each resource is allocated to each person in the economy. Money and currency generally play very small roles in this type of economic system.
Feudal economic systems describes much of the world before 1800. The primary source of economic activity is farming, with any industrial production limited to Cottage Industry. A feudal system is comprised of an elite class, making up kings, lords, and knights, ruling over a large peasant class who are responsible for farming. The peasant class usually had no rights of their own, and were not permitted to leave the estate of their lord without permission.
Profits are generally very small and are kept by the ruling classes, with re-investment limited only to what is necessary to keep the population alive and working. There may also be a merchant class that lives in cities and engages in trade, but these are the “special” cases and do not comprise a large part of the economy.
All production was determined by the lords and kings, which instructed the peasant class on what to produce. This generally was what kinds of crops to harvest, but also included the instructions to the cottage industry producers on what kind of products to make. This resulted in the most extreme income inequality, with the rich owning everything and the poor left as little more than slaves.
Feudal societies generally do not exist today, apart from some small pockets in extremely under-developed parts of the world.
Communist economic systems are also known as “non-market socialism”. The factories and materials are “owned” entirely by everyone in the economy. The central planning agency determines who much of each item is produced, and who gets the finished products. For example, the central planning agency would decide how many shoes are produced, and then distribute the shoes to all the people it determines needs them the most.
People are paid a certain amount by the government, and then are allowed to buy only certain types of items. If they want something that they do not have permission to buy, they need to request permission. The central planner then takes the requests and uses them to determine which factories are producing how much of each item. Since the central planner is deciding how much of each item is being produced, they generally also choose what kinds of work people do. In theory, this is based on people’s strengths – strong, healthy workers might be manual laborers, while very smart people would be researchers. People are given a set of jobs to choose from based on what the economy needs the most of at that time.
The strength of Communism is that the central planning agency can try to distribute all resources to obtain absolute peak efficiency, producing what is needed of every item and using any extra resources for development and social benefit. The hope is that with careful planning, there will be less wasting of resources, and instead of profits being distributed, all savings goes directly towards growth. There is also strength in equality – theoretically all people are equal in a communist economic system, and prosper equally with growth.
Criticisms of Communism
Communism is generally not popular in the West because of the high value placed on individual freedoms. In a communist system, people cannot decide what kinds of companies to start, companies cannot choose their levels of investment or production, and people generally cannot decide what they can purchase. Historically, communist economic systems arose out of countries that were previously Feudal, meaning the majority of the population (the peasant class) did not previously have a history of personal freedoms to begin with. This meant that the restrictive nature of the central planning was not a new burden.
Communism is also characterized by shortages of many “popular” goods, and surpluses of “junk”. This happens because people need to ask the central planner to increase production of a good, and it can take months or years before those goods to be produced. Until the new goods are produced, it is in a shortage. If the population wants an improved version, or it has fallen out of style, by the time the goods are produced, it is “junk” by the time it comes out of the factories. This usually leads to large black markets of illegally-traded goods.
In the real world, communist economic societies also have big problems with corruption. Factory managers and workers have a high incentive to try to sell goods on the black market before sending it to the central planner, which can make the “official” shortages worse. Central planners themselves are easily corrupted, since they have the power to distribute more goods to their own friends and family. Individual workers also can have a hard time to find motivation to work harder. In a market socialist economic system, workers can be motivated both by individual profits and by the social dividend. However, in a communist system, the individual profit is removed entirely, and the social dividend does not increase by much with the extra effort of one single worker.
Command Economies In The World
Full command economies are fairly rare in the world today. An example of a purely Communist economic system is North Korea. Other countries, like Cuba, still maintain a central planning agency, but have begun to introduce more elements of market economies.
How Economic Systems Relate To Development
The paths that countries take towards development out of a Feudal-type economy based in agriculture has a lot to do with what type of economic system they use. Generally speaking, feudal economies that experience a gradual increase in strength of the Merchant classes based in cities will develop into Capitalist economies. If power is seized by the Peasant classes, either through revolution or a military coup, the economy has generally started development under Communism.
Countries that develop with capitalist economic systems eventually feel pressures from the people to add protections to prevent exploitation and control the power of monopolies. The United States would have been considered a Capitalist economic system until 1900, when laws began to be passed to limit monopoly power, enforce minimum wages, and protect the environment. These protections have become stronger over time.
By contrast, Cuba, which was a market economy until 1950, underwent a Communist revolution in large part in reaction to the extremely strong control monopolies (like the United Fruit Company).