Types of Economic Systems

It has been already pointed out that the way in which the three basic economic questions are answered depends on the economic system which functions in a country. To understand how these answers differ among the economic systems, we should understand the different types of economic systems.

Major Types of Economic Systems

Economic systems may broadly be classified into three categories: Capitalism, Socialism and Mixed economy. A number of other types also emerged but all of them came close to any one of the above three types of economic systems. Let us now discuss the features, strengths and weaknesses of each one of these economic systems.

1. Capitalism

Capitalism is an economic system based on the principle of free enterprise. Individual ownership of resources is an important feature. With control and command over resources, individuals can conduct any type of business. The object in such a system is to maximize private gains. Any type of enterprise or production of any commodity or service is permitted, so long it is wanted by the society. In such a system the market forces determine the resource allocation and price. That is, the demand and supply forces together determine what to produce, how to produce and for whom to produce. Price mechanism is the nucleus of the capitalistic society. The price mechanism clearly reflects the wants of the people. Once this is known, the producers would allocate the resources to manufacture and sell the products in great demand. While doing so, there is no control or regulation over production. In other words, oligopoly environment prevails. But each producer differentiates his product that he would be able to stay in the market. Technology and innovation ensure the stability and growth of organizations. As a result only efficient organization would survive. The resources would be fully utilized. The system is so flexible that it can adjust itself for any economic condition. The workers get equal opportunities and those with skills would be able to command better wages and salaries. On the whole capitalism offers scope for growth of efficient individuals and organizations.

But capitalism has a number of weaknesses. The important ones are discussed below.

  1. Economic inequality is invariably found in capitalistic societies. Individuals and organizations with ownership of resources and hold over the market for their product or service, would be able to maximize their gains. Those who have no such property would remain poor and become poorer. So it is said that under capitalism, rich becomes richer and poor becomes poorer. The inequality in wealth and income widens over a period under capitalism.
  2. The scope for the emergence of monopolies in capitalistic societies is very high. Organizations by virtue of their economic power would be able to easily eliminate rivals and competitors in the market. There is also possibility of such monopolies influencing the government in policy making and intervention.
  3. Though it is said that capitalism would always lead to ideal allocation of resources and fuller utilization of resources, in reality the experience is that resources are held by individuals and organizations and under utilization is the result. Sometimes, products which are not really national priority are produced and forced on the public, through advertisements and sales promotion techniques.
  4. Though it is expected that in capitalistic societies the output would increase to optimal level. In practice this is never found. Producers always restrict output to maintain a high price and also maximize profit. So excess capacity would exist in many industries.
  5. In a capitalistic society the divide between the haves and have-nots widen that over a period. Existence of poverty among the sophisticated sections of people is also seen. This results in built up of frustration in the society. Over a period this might lead to revolution and social upheaval.

2.  Socialism

Socialism refers to an economic system in which the following features predominant:

The resources are owned by the state or state owned institutions. Production takes place in the interest of the society and not for maximizing profits of individuals or organizations. Government decides the type of productive efforts to be permitted. In other words, in a socialist country, government can adopt licensing system and other types of regulations to prevent the emergence of monopolist and exploitative tendencies. Maximization of community welfare is the objective than profit maximization. Another very important feature is the government ensures equitable distribution of national product. Public distribution system assumes enormous significance in such an economic system. On the whole, the socialistic society differs from capitalist society in every sense. In the broad spectrum of economic systems, socialism and capitalism occupy two extremes. In the world today, pure capitalistic society is not seen in any country. Even in USA, government interference in various economic activities is found. For example, in the field of national defense, atomic energy, space technology, social security, etc., the presence of government is almost complete. Government also retains the right to interfere in the market system, whenever there is deliberate and intentional attempt to monopolize the resource ownership or the market. Similarly, in the erstwhile Soviet Union, socialistic principles were followed. But even here, there were instances of private ownership of property, enterprises, etc., were reported. That is why it is very difficult to come across pure capitalistic or socialistic societies.

The merits of socialism includes:

  • Collective ownership eliminate emergence and existence of monopolies.
  • Resources utilization is planned and achieved in the interest of the society.
  • Government with its control over the resources is able to use resources fully utilized and avoid wastage and production of unnecessary goods.
  • As equality in distribution is the fundamental feature of socialism, there is no scope for widening inequalities rind the government takes steps to narrow the gap between the rich and the poor through various measures.

However, socialistic states suffer from the following limitations:

  • Excessive dependence on government decisions often result in delay in offering any public service.
  • Bureaucratic control becomes an integral part of the socialistic principles. As a result the benefits and its direction of flow is determined by the bureaucrats.
  • Government by undertaking excessive responsibility on its shoulders, abets inefficiency and corruption in the society.
  • No incentive and motivation for individual excellence or achievements is possible in such a society and so innovations and inventions do not really take place in large scale in such a society.
  • With governmental presence in every walk of life, efficiency and productivity suffer.
  • Lack of support for individual liberty kills initiatives.

Types of Economic Systems - Capitalism and Socialism

3. Mixed Economy

There was no reference to the mixed economic system in Economic literature in the past. Economists were mainly familiar and advocated the Laissez faire or free enterprise system, as several countries could develop fast following the free enterprise system, in which there was no or little government intervention. The entire economic system operated with the price mechanism at its center point. The producers produced what the consumers wanted and this provided very little scope for the government to intervene in the system. The Classical economists and their ardent supporters believed that the invisible hand will direct the economy and with private initiative and enterprise, every country should be able to record a faster growth as proved in the case of UK, USA, Europe, Australia, and other countries.

But over a period under the leadership of Karl Marx, a new economic system was developed called socialism, in which there is no scope for any private enterprise as everything owned and controlled by the government. The government decided the type of developmental activities and me requirements of the society and used the available resources in the provision of these requirements. Several countries like USSR, Communist China, Vietnam, Cuba and others preferred this socialist system in which government is made the custodian of the society. The main reason for the emergence of this new economic system was the failure of capitalism during the 1929 depression to revive every economy from depression. Keynes himself thought that capitalism without some of its evils could certainly help economic recovery. Hence, a time came when economists felt that cent per cent free enterprise or cent per cent government governed economic development cannot work satisfactorily. A compromise between these extremes was thought of as an ideal economic system. The new system called ‘mixed economic system’ contained the merits of both the capitalism and socialism and appeared to be full of promise. This mixed economic system is adopted by India as indicated by the First Industrial Policy Resolution 1948.

The main characteristics of mixed economy are:

  • Co-existence of public and private sectors:  In a mixed economy, one will find the existence of both the private and public sectors. In such a system, the government will undertake the responsibility to build and develop certain sector activities and leave the other activities for the private initiative. The government clearly earmarked the industries to be completely under the state control, the industries which are to owned and controlled by the state as well as the private sector and industries which are completely left for the private sector.
  • State participation in economic development:  This is the second feature of mixed economy, according, to which the state reserves its right to design and decide the type of development to be achieved. In such a set up, the government strives to promote the welfare of the country by ensuring social order, social justice and establishing all the necessary institutions which are required to achieve the desired pattern of growth and development.
  • Distribution of ownership and control of resources:  This is the next feature of mixed economy. In this system, the government itself enters the field of production so that the available resources are fully utilized. This will also help to avoid concentration of wealth in the hands of a few and enable distribution of ownership and control of productive activities. As a result there is no scope for exploitation of any group, say labor, by any other group. In this way the weaker section of the community is well protected and taken care of.
  • Directing the investment in socially desirable projects and channels:  Mixed economy facilitates the flow of investment into channels which confers the society with several benefits. For example, the Indian government has invested huge amount in several projects to develop the infrastructural facilities. This forms the basis for the development of other sectors. The investment in these infrastructural areas will not come forth from the private sector as the return is nil. Hence, the government in a mixed economic set up provides the thrust by developing the necessary background and strength which will encourage the private sector to invest in profitable opportunities. In this way the government plays a key role in a mixed economic system.
  • Scope for achieving balanced economic development:  The private sector would establish its enterprises only in urban or sub-urban areas and that too in already well developed states. This will mean other areas will have no scope for development. But in a mixed economy, the government will itself undertake the initiative to set up industries in backward areas and encourage the private initiative to set up industries in such areas by offering several concessions and exemptions.
  • Ultimate control and regulation in the hands of government:  This feature of mixed economy clearly spells out that in every activity affecting the economy, the government will be the ultimate authority. Though the private sector is assigned its role to perform, the government will still monitor and control the way in which the private initiative is performing its role.
  • Co-operation in the field of economic development:  According to this feature of mixed economy, the government formulates the design for development and invites the private sector to participate in the development. It clearly spells out the guidelines which would govern such  cooperative  efforts and the limits of freedom granted to the private sector. Hence, there is scope for the development of private sector, though only according to the design developed by the government.

Planning Process under Mixed Economy

As has been already stated, in a mixed economy there is a need to achieve a compromise between self-interest and social interest. This is a very difficult task as the government has to carefully foresee the type of development it wants to achieve and closely monitor the activities of the private sector to ensure that the social interest is never at stake. Obviously, planning is a very difficult exercise in a mixed economy set up. The success of planning will depend upon;

  1. The extent to which the public sector is able to rise to achieve the social gains aimed for,
  2. The success of the state in guiding and regulating the private sector activities towards social goals and
  3. The extent to which the state is able to check the distortions taking place in investment by private sector affecting the interest of the public sector.

Hence in the planning process the state has taken up the following steps to ensure the accomplishment of the objectives of the mixed economy,

  1. By holding complete ownership of defense and heavy industries, the government has provided an industrial base with which the private sector is expected to plan its investment activities.
  2. The state also has made huge investments in economic infrastructures so as to help the extension of market for goods, raising the productivity in agricultural and industrial sectors, encouragement of further productive investment.
  3. The government has complete control of the financial institutions including banks so that it can ensure that the banks and other institutions play a key role in the development activities of the state. The government could also realize the expected gains by encouraging the priority activities in every sector. The economic institutions are made to support the weaker sections of the community.
  4. Through powerful legislation’s the government could ensure that there is no scope for exploitation of the common people by the private enterprise. Such a legal framework lays down the rules of the game and ensures fair play in a mixed economic set up.
  5. As a method of protecting the weaker and downtrodden people, the government has policies like rationing, price controls, etc. Such regulations are built in the planning mechanism itself, so that the private sector cannot exploit the community.
  6. Towards the improvement of welfare in the economy, the state has undertaken several specific programs aimed at specific target groups. For example schemes aimed at the backward and schedule tribe providing them reservation in educational, employment and other opportunities, rural oriented schemes for the rural folks, health for all schemes, provision of free educational and medical facilities up to a certain level, etc. All these schemes aim at improving the social welfare. In all these activities the private sector is also welcome to play its role.
  7. The government makes effective use of the tools of fiscal policy viz. taxation and public expenditure, so as to achieve the objectives of economic planning.

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