Major Economic Systems

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Economics is the study of the economic behavior of individuals concerning scarcity and choices. Economic interaction takes among people when they exchange goods within the framework such as firms, government, or the economy. The broader institutional framework in which or within which economic interactions take place in a country is known as the economy.

So the economy is the logistic framework in which economic activities such as the production of goods and services are undertaken in a way that people are employed and satisfying their wants. The economy can be classified into several types on a different basis. The major economic systems can be shown in the following diagram;

Major economic systems
Major Economic Systems

Developed and Developing Economies

The lifestyle of people living in the world is different from one region to another and from one country to another. For example, an average family in North America or Europe lives in large and comfortable houses, healthy, well-clothed, educated, and travels in luxurious and branded cars.

People in Latin America, Asia, and Africa are living in more poverty with a low level of living standards. A large number of people in such regions live in small houses and getting inadequate food. They even lack the essentials of life, clean drinking water, and sanitation. Health and educational status are also poor. Thus it shows that there is a disparity in the world in terms of wealth, opportunities, and living standards.

UN Classification of Countries

UN has classified the countries into different types based on the World Bank’s Gross National Income (GNI) per capita criterion. The classification of the countries based on data of July 2020 can be shown as;

GroupJuly 1, 2020 (new)July 1, 2019 (old)
Low income< 1,036< 1,026
Lower-middle income1,036 – 4,0451,026 – 3,995
Upper-middle income4,046 – 12,5353,996 – 12,375
High income> 12,535> 12,375
New World Bank country classifications by income level: 2020-2021

Low-income and middle-income countries are considered underdeveloped economies or developing economies. High-income countries are known as developed countries.

UN classification of developed and developing or underdeveloped countries is based on per capita income. Accordingly, developed countries are defined as countries that have a high real per capita income. With high per capita income, it is assumed that people in these countries can enjoy a higher living standard. The USA, Canada, Australia, New Zealand, Japan, the West European Countries, and some East European Countries are known as the developed nation of the world.

On the other hand, an underdeveloped or developing country is a country in which real per capita income is low and that has the potentiality for development. The essential futures of developing and underdeveloped economies are low per capita income and the possibility of development to increase its real per capita income.

Underdeveloped, developing, poor economies are used as a similar meaning. However, developing specifically indicates that development has been initiated in the economy. Most of the Asian, African and Latin American countries are underdeveloped and developing countries.

Characteristics of Developing and Developed Countries

Developing or Underdeveloped CountriesDeveloped Countries
Low per capita incomeHigh per capita income
The Standard of living is lowThe Standard of living is high
The reality of extensive povertyA low episode of poverty
Huge inequalitiesFewer inequalities
Agriculture as a predominating source of employment A large portion of the labor force is engaged in the manufacturing and industrial sector
The higher population growth rateThe lower population growth rate
Higher unemploymentLower unemployment
Lower saving and lack of capital or low capital formationThe high rate of saving and capital formation
Use of conventional and less efficient production methodsUse of modern and advanced methods of production
No proper quality of human capital, low level of education, insufficient health and sanitation facilitiesThe superior quality of human capital, higher educational facility, better health, quality living environment, and adequate social and economic facilities
Majority of primary expert/increasing trade deficitExport of mainly industrial products and services
More spiritualisticMore materialistic
Unfavorable social structure and value systemModern and scientific structure and system

The majority of the underdeveloped countries have started the process of expansion and development. Every country wants to be a developed country and can provide a better quality of life to the citizen. Most of the underdeveloped nations are in transition from underdeveloped to developing to become a developed nations.

In developing countries’ per capita income, saving, capital formation, investment, productivity, and living standard gradually increasing and the unemployment rate, poverty, and inequities are decreasing.     

Types of Major Economic Systems

An economic system can be defined as a combination of all those plans, strategies, devices, and institutions through which economic choices are completed and inadequate resources are used for the motive of satisfying various human wants.

If we consider the history of human civilization we also can see several major economic systems emerged in different periods. Some systems looked always relevant and some are unforgotten due to their implications. Among them, slavery, feudalism, colonization, etc were very early economic systems. The most important types of the major economic systems which are pertinent to date are as below;

Capitalism or Capitalistic Economic System

Capitalism can be defined as an economy in which the productive resources are owned by private individuals who can use such resources to earn profits and in which the state intervention is minimum so that economic activities are mostly unplanned and unconditional. It is considered one of the popular economic systems among the different major economic systems.

Capitalist economies are free enterprise economies having a minimum role of the government. So this economy is also known as the free enterprise economy or the market economy or laissez-faire economy. It is practiced by the USA, UK, France, Japan, Australia, and most of the countries of Western Europe.

Major Features of Capitalism

Private Property

In the capitalist economy, all the factors of production like land, factories; mine, machine, and all the other resources are owned by private individuals. It is the spirit of the capitalist system. This means that the owners of the productive resources take important decisions like what to produce, how to produce, and the amount of saving and investment in the economy.

This right however is not absolute and unrestricted. This private ownership of the property is subjected to certain restrictions made by the government. Major infrastructural forces are owned by the government.

Right of Inheritance

This means the property owned by an individual can be legally passed on to his or her legal hers like sons and daughters. This ensures a powerful incentive for people to save and accumulate wealth.

Freedom of Enterprise and Occupations

Freedom of enterprise and occupations means that private enterprises are free to use productive resources for the production of a product as per their own choice and preferences. Similarly, individuals are also free to choose their desired occupations. They can move from one job to another in search of better opportunities.

Freedom of Choice for Consumers

Consumers are free to buy consumer goods and services as per their choices. They are free to spend their income no matter what goods and services they prefer to purchase. So consumers are considered as the supreme ruler or king in a capitalistic economic system.

Price Mechanism

Price or market mechanism is another important feature of a capitalist economy. It is the process through which prices of the products are fixed by the interface of demand and supply. It is a fundamental aspect of the working of the capitalist economy. The price mechanism allocates the available productive resources and income of the consumer in the purchase of different goods and services. Adam Smith has called the price mechanism an invisible hand.

Competition

There is the existence of competition in a capitalist economy. It means there is a rivalry between the market participants. There is a high level of competition in the product as well as the factor market. In the product market firms do compete with each other to sell their products and in the factor market owners of inputs do compete with each other. Competition is therefore a critical pillar of the capitalist economy. Competition in the capitalist economy is believed to promote efficiency and welfare.

Profit Motive

Profit is an integral part of the capitalist economy. Producers are participating in the market for the maximization of profit. The profit motive is the heart of the capitalistic economic system. It motivates producers to produce more and introduce new products in the market. The efficient allocation of resources is done for earning profit.

Self-interest

Each of the participants of the capitalist economy is guided by self-interest. The produces are guided by profit maximization motive, consumers are guided by satisfaction maximization motive. Similarly, the laborer is motivated to get a higher wage rate as much as possible. Self-interest in a capitalistic economy helps to the smooth operation of the economy. It works like an invisible hand to make coordination between millions of participants.  

Minimum Government Role

There is the least interference of the government in the capitalist economy. Consumers and producers are largely free to their decision rights. The government has to make laws and can intervene in a necessary case only. So there is little intervention of government in the economy.

Merits and  Demerits of the Capitalistic Economic System

Benefits/merits Defects/demerits
Encourage enterprisesIt may increase the gap between the richer and poor classes or between haves or have-nots. It means there is a possibility of increasing inequalities.
Space and motive for technological progressThere is a continuous class struggle in the capitalist economy. One may have to struggle for survival.
Ensure efficient use of productive resourcesThere is a high possibility of economic instability. The market is prone to economic fluctuations in capitalist economies.
There is an incentive for capital formationThe possibility of misallocation of resources is always there in the capitalist system.
Ensure new and quality consumer goods regularlyIn the capitalistic system of production and operation, some of the systems and works might be considered ineffective and got wastes. 
It is flexible and adaptiveThere is a high possibility of a monopoly. So it reduces consumer’s welfare.
Automatic working of a complex systemThe profit motive of capitalist may ignore social welfare.
There are an economic choice and freedomDomination of economic values. It promotes materialism and with such human sentiments, culture, value, and ethics may get destroyed.
Increase in standard of living by using quality products and servicesDomestically owned cultural and traditional industries to suffer and may get permanently closed op.
It encourages international trade and investmentHigh competition among producers may invite strong domination of larger industries and ultimately control of the entire market by a single firm.
Sense of competition makes people more advanced

Socialism or Socialistic Economic System

The socialistic economic system is the type of economic system in which the factors of production are owned and controlled by the entire society and moved or operated by the public authority as per the general economic plan for the benefit of the entire community. Soviet Russia was considered the first country to set up a socialist (communist) economic system in practice.

Socialism is also one of the popular economic systems among major economic systems of the world. China, Cuba, Vietnam are following the socialistic economic system. After WW II most of the East European countries adopted some major features of the socialistic economic system. But no country is practicing pure socialism in modern times.

Features of Socialism

Socialistic Ownership of Productive Resources

The most prominent feature of socialism is collective or combined/social ownership of productive resources. It means all the productive resources such as land, mines, mills, factories, banks, trade, etc. are owned and guarded by the state. Private property may exist to some extent in the form of productive resources for instance if it is owned by handicraft workers and personal possessions like clothes and household goods owned by households.

Economic Planning

It is an essential character of a socialistic economy. The price mechanism of the capitalistic economy is replaced by planning in this economy. There is a central planning authority in every socialistic economy and which allocates all the productive resources according to a definite plan in corresponding with social and economic goals set by it. All the important decisions like what to produce, how much to produce, and how to produce, allocation of resources, saving, and investment in the economy are made by the central planning authority.

Social Welfare as the Motivating Force

Social welfare and social equality is the chief motivating factor in socialism. This motive is the alternative to the profit motive in capitalism. The interest of the entire economy’s well-being is major in socialism.

Economic Equalities

This economy is based on the doctrine of egalitarianism. It aims to maintain equality in the distribution of income and wealth. It also aims to provide equal opportunities to all. But absolute equality is not the issue of even socialism. Socialism also recognizes that some income differences are vital because of differences in skill, talents, and efficiency.

Classless Society

A socialistic economy aims to establish a classless society. Since all the inputs are owned by the state so capitalist class simply does not appear in socialism. All people can earn income by working for the state.  So there is no possibility of economic exploitation in socialism.

Elimination of Competition

The socialistic economic system removes all types of competition. The government has all the authority and right to decide and produce so there is no question of competition in the production and distribution. The Spirit of cooperation is considered rather the feeling of competition in socialism.

Merit and Demerit of Socialistic Economic System

MeritsDemerits
It is assumed that Socialism allocates resources in better ways.There is no appropriate guideline for the allocation of resources intelligently. 
Full utilization of resourcesLoss of efficiency. It means socialism may not ensure maximum satisfaction of motives.
Eradication of economic inequalities and disparitiesThere is no presence and provision of incentives in the socialistic system. All is done with governmental order and regulation.
No class struggleLoss of consumer sovereignty. Consumers are no king in socialism. 
There are provisions of social safety netsThere is no freedom of choice and freedom of occupation in socialism. Everything is as per government set up and employees are government servants.
May ensure higher production efficiency with equal opportunities and accessThere is more concentration on economic and political power over consumers and economic activities.
Rapid economic growth with planned and fuller allocation and utilization of resources.There is no more concern about consumer’s preferences and choices. There is no more statistical investigation about consumers and markets. So making planning without such basic requirements may keep some loopholes in the process of the plan.
More production of social and essential goods is possible only in the socialistic system.People are fully dependent on what the government will do and there is no private ownership and freedom. All will discourage innovation and invention in the economy.

Differences between Capitalism and Socialism

Following are the major differences that existed between two major economic systems practiced in the modern world.

Capitalist EconomySocialist Economy
Productive resources are owned by private individuals.All the productive resources are owned and controlled by the state.
There is the presence of private property rights and ownership.There is no private ownership and full absence f private property right.
Economic entities are free to take their decisions regarding consumption, production, and allocation of resources.There is a loss of economic freedom concerning the consumer’s choice and allocation of resources.
The market mechanism is the basis coordinating mechanism. All the economic decisions are taken through the mechanism. Planning takes all the decisions in the place of the market mechanism.
Profit maximization is the main motiveSocial welfare maximization is the main motive
Competition is essentialElimination of competition is essential
Minimum role of governmentIt is the entirely state-regulated economy
Economic power is in the hand of capitalistEconomic and political power in the hand of government
There are large inequalities in the distribution of income and wealthIt is based on the thought of egalitarianism
There is a struggle for survival and classThere is a classless society

Mixed Economy or Mixed Economic System

An economy that is the fusion of the elements of both capitalism and socialism is called a mixed economy. It is an effort to include the best features of both economies. Thus a mixed economy is characterized by the existence of both public or government and private sector in the economic system of the nation. It is also one of the popular economic systems among major economic systems of the world.

Considering the nature and extent of the intervention of the government, we can see two different forms of the mixed economy.

One model is that where the government sector aims to control the activities and programs of private sectors through different policies like taxation policy, public expenditure, monetary policy measures, labor, and wages law, etc.  In such a model major economic activities are left for the private sector with comparatively greater interventions of the government policies. It means to say that the government is not directly part of the production. This type of model is seen in developed countries like the USA, UK, etc.

The second model is one where the government intervenes in economic affairs and also becomes a part of the production as well. The government also takes the part of production in the economy along with regulating the private sector. Most of the developing economies have been following this model of a mixed economic system.

Features of Mixed Economic System

Coexistence of Public and Private Sectors

It consists of both public as well as the private sector in the economy. The public sector represents that part of the economy which is operated and managed by the governmental authority. Larger investments with lower profitability come under the governmental part. Thus the public sector operates infrastructural development projects, communication development projects, heavy and larger industries, etc.

The private sector includes that part of the entire economy which is owned, managed, and controlled by the investment of the private sector. They operate with an expectation of profit maximization. The private sector in mixed economies is working as a supplement to the public sector rather than competing with governmental investment.

Coexistence of Socialism and Capitalism

A mixed economic system includes the features of both socialism and capitalism. There is the presence of private property rights, freedom of choice, profit motive, competition, and price mechanism from capitalism. Similarly, economic planning, government regulation, etc are from socialism.

Economic Planning

Economic planning is essential to ensure the smooth and systematized operation of the economy on the mixed economic system. A mixed economic system requires planning to regulate the private sector and fix the task of government and making all the necessary coordination between these two sectors. But planning is not so comprehensive and dominant as in socialism.

Regulation and Control of the Private Sector

The government is there in a mixed economy to regulate and control the tasks of the private sector. There is no room for an unregulated private sector in a mixed economy. Different policies like taxation, subsidies, monetary policy, licensing policy, anti-monopoly controls, etc. are used by the government to control and regulate the private sector. The rationale behind such regulation is to promote higher welfare and efficiency in the economy. 

Promotion of Social Welfare   

A mixed economic system is guided by socialism as well as capitalism. It puts an important objective which is purely an objective of socialism that is the promotion of social welfare. So in the mixed economic system, the government makes efforts to promote and enable the welfare of the entire community. Various social security schemes are used by the government to help the poor and back-warded propel. It provides various facilities like health, education, transportation, food security, etc. at very cheap prices or without any cost for the welfare of people.  The government protects the right of its citizen by making several legal provisions. Law is taken as the protector of people’s interest in a mixed economic system. 

Price Mechanism

The price mechanism plays a vital role in the mixed economic system also. The price mechanism or market mechanism is allowed to function in the mixed economy with certain regulations. Prices of essential products are in the control of the government and other prices are determined by the market mechanism.

Profit Motive

In the mixed economy, profit motive also exists. The profit motive and private sector always walk together. The government has allowed making a profit mechanism to the private sector subject to certain regulations. The private sector however cannot make a profit at the cost of societies and people.

Preservation of Freedom

There is the existence of economic and political freedom in the mixed economic system. A mixed economy provides sufficient room for private inventions and enterprises. Freedom of choice, as well as occupation, exists. Consumers are free to choose the product and dispose of their income freely.  But such freedoms are not absolute. Certain restrictions are there to control over extreme freedom of the participants.

Merits and Demerits of Mixed Economic System

The following table shows the advantage and disadvantages of one of the popular economic systems among the major economic systems practiced around the globe;

MeritsDemerits
Resources are allocated in the best possible way combining the efforts of both private and public sectors both.Non-cooperation between two different sectors having a different interests may become devastating for the entire economy.
In the mixed economic system, economic instability is rare.It is short-lived in nature. In the long run, both of the sectors may want to expand themselves at the cost of one another and create conflicts.
For developing countries, a mixed economic system may ensure rapid economic growth and expansion.There may be the possibility of emerging inefficiency in the economy. There is no established rod for the determination of optimal role or intervention of the government over the private sector. Excess domination from the governmental side may discourage the private sector from its best and efficient practices.
Market forces and resource distribution can be controlled and checked in desired ways.It is seen that in the countries following mixed economic systems, the public sector has performed poorly.
There is economic as well as political freedom.The practice of a mixed economy may encourage excessive regulation. Which creates economic inefficiencies.

Other Types of Economies

Apart from the above major economic systems, the classification of economies can include a simile economy and complex economy, a closed and open economy, an agricultural economy, or an industrialist economy.

Simple Economy

The degree of specialization of economic activities and division of labor economy could be simple or complex. A simple economy is such an economy in which each individual specializes in the production of one commodity. This economy assumes that all the individuals of the economy have the specialized skill and they produce one particular commodity per individual and due to specialization they produce more than they want. Some become farmers, other artists, and so on. They made trade by barter.

Traditional and early economies were called simple economies. Goods were mostly produced for consumption. The scale of production and productivity was low in such an economy.

Complex Economy

A complex economy is that economy in which there is a high degree of specialization, a complex division of labor, and mutual dependence on one another.

In a complex economy, a producer does not produce absolute goods. There are specialization and chain of production within the entire production process of a particular product. The entire work implicated in the production procedure is divided into and each individual performs one task they provided regardless of its size.

There is a high degree of specialization, the complex division of labor, exchange and monetization, and large-scale production with the use of advanced techniques of production in the complex economy. All the modern economies are complex economies.    

Closed Economy

Based on the economic relationship of a particular economy it could be closed as well as an open economy. A closed economy is that particular economy that does not have any economic transaction with other countries of the world. Such an economy is not involved in international trade and transactions. There are no import-export elements and no factor payment as well as factor income to foreign owers and from the foreign employers. Domestic product counts as a national product. This type of economy is rare in modern times.

Open Economy

An economy that has economic transactions and relations with other countries of the world is called an open economy. It is necessarily engaged in international trade and transactions.  There are an import and export of goods and services. Import and export of products, factors, capital, and technology all are included in an open economy. A national product in an open economy is not only a domestic product. Open economies are interrelated and integrated. Economic shocks in one country directly affect the health of the economy of another country in the case of an open economy. In modern times almost all economies are open economies.

Agricultural Economy

Based on the foundation of economic activity an economy may be an agricultural as well as an industrial economy. 

An agricultural economy is an economy in which primary economic activity is agricultural activities. It means if the majority of the labor force is engaged in agricultural activities then it is called the agricultural economy. Essentially in such an economy agricultural contribution to national output is higher. Most of the underdeveloped and developing nations are agricultural economies.

Industrial Economy

An economy that is primarily engaged in industrial and manufacturing activities then it is called an industrial economy.  Major sources of employment are industrial activities in such economies. Most of the production activities are done through hired factors or workers. Almost all the developed countries of the world are industrial economies.

Regional and Global Economic Groups

After WW-II there has been a noteworthy argument of interest and activity in both regions and regionalism. At the same time, there has been an increasing awareness of the possibilities of regional cooperation. This had finally led to several regional organizations formed by the government of different countries. Such regional organizations and groups had emerged both in developed and developing countries. They had formulated intending to consolidate their economic, social, and political relationship with each other. The following are the major regional and global economic groupings.

South Asian Association for Regional Cooperation (SAARC)

SAARC is an organization of South Asian Countries. It was documented in 1985 with seven member countries. Its membership enlarged to eight in 2007. Afghanistan recognized its membership in 2007. SARC was set up to promote economic social and cultural cooperation among its member courtiers and also for promoting amity and cooperation with other developing countries. It believes in respect for sovereignty, territorial independence, and non-interference in the state’s internal affairs. Major economic objectives of SAARC are listed as

To endorse the well-being of the people of South Asia and look up their quality of life,

Help to accelerate economic growth, social advancement, and cultural development in the region,

To promote, reinforce and strengthen self-reliance among the countries of South Asia

Association of South-East Asian Nations (ASEAN)

It was established in 1976 by five founding member countries including Indonesia, Malaysia, the Philippines, Thailand, and Singapore. Its membership increased to ten countries including Brunel, Vietnam, Laos, Cambodia, and Myanmar. It was established to promote regional economic, social, and cultural cooperation among the member countries. In 1999 it has created a free trade zone among its members to compete in international trade.

European Union(EU)

In 1957, six major economies of Europe including West Germany, France, Italy, Holland, and Luxemburg signed the Treaty of Rome and documented the European Economic Community (EEC). After 1993 it turns into the EU. In 1997 its membership and the geographical area had extended. EU had 15 member countries in 1997. In 2004 it has reached a new landmark with the addition of 10 new members. EU has shaped its own common currency, the euro. In the initial two decades of its formation, it has eliminated the internal tariff barriers and established common external tariffs and common agricultural policies. EU is still in the process of making a single common market but this has not been achieved yet.

The EU has now 27 countries and within their geographical scope, they allow free movement of goods, services, capital, and human resources freely.

You might have encountered a world Brexit. It means the exit of the British. In 2016 there was a referendum and 52 percent of British had voted for the left side and as a result, the UK has left the EU formally on 31 January 2020.

The Group of Eight (G-8)

In 1997, a collection or gathering of the leading and advanced industrialized countries of the globe had a meeting at an annual summit conference and agreed to set economic, political, and military goals for the global future. Earlier, there was a group of seven countries ( the United States, Britain, Germany, France, Italy, Canada, and Japan) called G-7.

Russia joined in 1997 at such an annual conference and subsequently, it became G-8. These countries have pledged to collectively coordinate their economic policies through global monetary management. They have been attempting to coordinate their economic policies collectively to assist the growth of employment across the G-8 nations. Politically they are on the common agenda to promote democracy as a political priority.

The Group of Twenty (G-20)

G-20 was formed in 1999 as an expansion of G-8.  It is a group of finance ministers and central bank governors from 19 of the world’s largest economies, including emerging markets like Brazil, South Korea, and South Africa, and other developing nations, along with the European Union.

Along with G-8 members now addition 12 emerging economies including Argentina, Australia, Brazil, China, India, Indonesia, Mexico, Russia, Saudi Arabia, South Africa, South Korea, and Turkey made the group of 20. Altogether, the economies of the G-20 countries account for about 90% of the gross world product (GWP), 80% of world trade, and two-thirds of the world population.

References

Sethi, D.K. & Andrews, U. (2018). Economics. New Delhi: Frank Bros. & Co.

Gregory, P.R. & Stuart, R.C. (2014). The Global Economy and Its Economic Systems. Mason: South-Western Changing Learning Publisher

Retried from Investopedia.com article by Will Kenton

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