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Economic Systems Articles

Mr. Stewart’s Economics Class

Spring Semester 2013

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Types of Economic Systems

"You can't always get what you want." That's what the Rolling Stones sang, anyway (check it out: great song even if it's a bit before your time). And while Mick Jagger probably didn't have Econ 101 in mind, he managed to sum up perfectly the core concept underlying all economics.

Scarcity is the fundamental challenge confronting all individuals and nations. We all face limitations... so we all have to make choices. We can't always get what we want. How we deal with these limitations—that is, how we prioritize and allocate our limited income, time, and resources—is the basic economic challenge that has confronted individuals and nations throughout history.

But not every nation has addressed this challenge in the same way. Societies have developed different broad economic approaches to manage their resources. Economists generally recognize four basic types of economic systems—traditional, command, market, and mixed—but they don’t completely agree on the question of which system best addresses the challenge of scarcity.

A traditional economic system is—here's a shocker—shaped by tradition. The work that people do, the goods and services they provide, how they use and exchange resources… all tend to follow long-established patterns. These economic systems are not very dynamic—things don’t change very much. Standards of living are static; individuals don’t enjoy much financial or occupational mobility. But economic behaviors and relationships are predictable. You know what you are supposed to do, who you trade with, and what to expect from others.

In many traditional economies, community interests take precedence over the individual. Individuals may be expected to combine their efforts and share equally in the proceeds of their labor. In other traditional economies, some sort of private property is respected, but it is restrained by a strong set of obligations that individuals owe to their community.

Today you can find traditional economic systems at work among Australian aborigines and some isolated tribes in the Amazon. In the past, they could be found everywhere—in the feudal agrarian villages of medieval Europe, for example.

In a command economic system or planned economy, the government controls the economy. The state decides how to use and distribute resources. The government regulates prices and wages; it may even determine what sorts of work individuals do. Communism is a type of command economic system. Historically, the government has assumed varying degrees of control over the economy in communist countries. In some, only major industries have been subjected to government management; in others, the government has exercised far more extensive control over the economy.

The classic (failed) example of a command economy was the communist Soviet Union. The collapse of the communist bloc in the late 1980s led to the demise of many command economies around the world; however Cuba continues to hold on to its planned economy even today.

In market economies, economic decisions are made by individuals. The unfettered interaction of individuals and companies in the marketplace determines how resources are allocated and goods are distributed. Individuals choose how to invest their personal resources—what training to pursue, what jobs to take, what goods or services to produce. And individuals decide what to consume. Within a pure market economy the government is entirely absent from economic affairs.

The United States in the late nineteenth century, at the height of the lassez-faire era, was about as close as we've seen to a pure market economy in modern practice.

A mixed economic system combines elements of the market and command economy. Many economic decisions are made in the market by individuals. But the government also plays a role in the allocation and distribution of resources.

The United States today, like most advanced nations, is a mixed economy. The eternal question for mixed economies is just what the right mix between the public and private sectors of the economy should be.

Why It Matters Today

Half of the twentieth century went down as a global battle between defenders of free markets (democratic capitalist nations, led by the United States) and believers in command economies (the communist bloc, led by the Soviet Union).

The US and USSR never went to war against each other directly, but dozens of smaller (yet still tragic and significant) wars unfolded around the world as bitter fights over economic systems turned bloody. Korea, Vietnam, Nicaragua, Afghanistan, Angola… millions of people died in the various "hot" theaters of a Cold War fought to decide whether markets or states should control economic affairs.

The great irony was that the Cold War finally ended not on a battlefield, but because the Soviet economy finally self-destructed by the late 1980s. For most of the world, the Soviet collapse proved that command economies were simply inferior to the market-dominated mixed economies of the capitalist world. Of course, China – still ruled politically by an authoritarian Communist Party, even though its economy is now more mixed if not exactly free – is now the biggest creditor nation to the United States.

America’s Mixed Economy

These days, just about everybody in America has made their peace with the mixed economy. Sure, you might be able to find a true-blue libertarian out there somewhere who adamantly believes that the government should play no role whatsoever in economic life. And you might even be able to track down a die-hard communist, some old lefty clinging to the discredited dream of a command economy controlled by the dictatorship of the proletariat.

But those guys are way out there on the fringe. The rest of us live in a world in which the mixed economy seems perfectly normal.

Individuals exercise a great deal of personal control over their economic lives; most transactions occur in a marketplace that is relatively free. The lifeblood of the nation's economic life is found in the private sector.

But the government also plays an important role in the economy as well. It referees the marketplace and through a variety of measures influences the ways in which resources are allocated and distributed.

Where we as Americans will often disagree – passionately! – is on precisely what the ideal balance of public and private within the mixed economy should be. Could we use a bit more government regulation to prevent abuses by businesses? Or do we need to pull government back to keep it from getting in the way of private enterprise?

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Why It Matters Today

Been to a Tea Party rally lately? The first years of the Obama Administration have generated a new surge in controversy over the proper role of government in the economy, with conservatives and libertarians taking to the streets to protest what they see as the dangerous big-government tendencies of the new Democratic government.

Meanwhile, Obama has also taken heat from his left flank, with many liberals criticizing him for not using the government aggressively enough to confront the nation's economic problems.

Whether or not you're a Tea Partier, this is a moment of enormous political and economic importance. What kind of economy do you want to live in? What kind of government do you want to be a citizen of? Now is a time for choosing.

Are all economic systems the same?

No, economists usually identify four basic types of economic systems—traditional, command, market, and mixed.

What is a traditional economy?

A traditional economic system is shaped by tradition. The sort of work that people do, the sorts of goods and services they provide, how they use and exchange resources are all shaped by tradition. These sorts of economic systems are not very dynamic—things don’t change very much. Standards of living are static; individuals don’t enjoy much financial or occupational mobility. But economic behaviors and relationships are predictable. You know what you are supposed to do, who you trade with, and what to expect from others. In many traditional economies, community interests take precedence over individual. Individuals may be expected to combine their efforts and share equally in the proceeds of their labor. In other traditional economies, some sort of private property is respected, but it is restrained by a strong set of obligations that individuals owe their community.

What is a command economy?

In a command economic system or planned economy, the government controls the economy. The government decides how to use and distribute resources. The government regulates prices and wages; it may even determine what sorts of work individuals do. Communism is a type of command economic system. In some, only major industries have been subjected to government management; in others, the government has far more extensive control over the economy.

What is a market economy?

In market economies, economic decisions are made by individuals. The unfettered interaction of individuals and companies in the marketplace determines how resources are allocated and goods are distributed. Individuals choose how to invest their personal resources—what training to pursue, what jobs to take, what goods or services to produce. And individuals decide what to consume. Within a pure market economy the government is entirely absent from the economy.

What is a mixed economy?

A mixed economic system combines elements of the market with some government control. Many economic decisions are made in the market by individuals. But the government also plays a role in the allocation and distribution of resources.

What type of economic system does the United States have?

The United States has a mixed economy.

Has America always had a mixed economy?

No. When the nation was founded America’s economy was far closer to a pure market economy. But from the start, many Americans also identified a role for government in the economy. Alexander Hamilton, for example, the first Secretary of the Treasury, outlined an ambitious plan for government support of the economy in 1791. He argued that the federal government should advance economic growth by a program of internal improvements—roads, bridges, ferries, and harbors. It should stabilize the nation’s currency through the creation of a national bank. And most dramatically, the government should collect and funnel capital toward certain sectors of the economy through the careful management of the national debt.

Was the evolution of the American economy toward a mixed economy gradual and steady?

Not really. During certain periods, such as the Progressive Era (1900-1920), the Great Depression (1929-1940), and the 1960s, the federal government assumed a much greater role within the economy.

How did the government’s role increase during the Progressive Era?

During the Progressive Era, policymakers like President Theodore Roosevelt argued that the economic playing field had been distorted by the growth of large corporations. He was not opposed to these new large industries, but he believed that their behavior needed to be supervised by an institution of equal size—the federal government. Following his lead, Congress passed the Pure Food and Drug Act and the Meat Inspection Act to protect consumers. To protect workers, the federal and state government passed a series of workplace safety and minimum wage laws. Congress attempted to restrain the power of corporations with the Clayton Antitrust Act and to expand its oversight of business through the creation of the Federal Trade Commission. And to ensure a more careful use of natural resources, Congress passed a series of conservation measures and created the National Forest Service.

How did the government’s role increase during the Great Depression?

During the Great Depression, President Franklin Roosevelt introduced a set of government programs labeled the New Deal. Premised on the belief that economic conditions demanded far more aggressive government action, the New Deal moved the government beyond regulation and oversight into the role of job creator and income insurer. The government provided direct relief to the needy under the Federal Emergency Relief Act. It created jobs for the unemployed under the Public Works Administration, Works Progress Administration, and Civilian Conservation Corps. Agricultural prices were manipulated through the Agricultural Adjustment Act. Workers’ rights to organize into unions were protected under the Wagner Act. Through the Tennessee Valley Authority, the federal government set about re-constructing the economy of an entire region.

How did the government’s role increase during the 1960s?

During the 1960s, President Lyndon Johnson introduced and advanced even broader economic responsibilities for the federal government in a program labeled the Great Society. Under the Great Society, Johnson pledged to produce “abundance and liberty for all. . . . and an end to poverty and racial injustice.” America’s safety net of social services was expanded through the introduction of food stamps and low-income rent subsidies. The Office of Economic Opportunity was created to assist in training and placing the unemployed. Increased federal aid to education was complemented by the creation of a program for high school dropouts—the Job Corps.

Have all Americans always supported this evolution toward increased government involvement in the economy?

No. In fact, Eras of government expansion were usually followed by periods of counter-reform in which government’s role was reduced. During the 1920s, Congress and the Supreme Court struck down many of the Progressive Era measures. During the 1950s, the liberal principles of the New Deal were stifled by the anti-communist anxieties of McCarthyism. And during the 1980s, President Ronald Reagan worked to reverse the century’s trend towards increased government involvement in the economy.

How did President Reagan attempt to reduce government’s role in the economy?

Under a set of objectives often labeled as the “Reagan revolution”, Reagan pledged to reduce the size of government and eliminate many of the regulations that he believed stifled entrepreneurial initiative and inhibited economic growth.

Was President Reagan successful in shrinking government and reducing its role in the economy?

To a certain extent. He slashed individual tax rates by 25% over three years. And he reduced business taxes further by improving depreciation allowances and research and development credits. He demanded an agency-by-agency review of government regulations. And these efforts led to increased competition and innovation in, most notably, the telecommunications and oil industries.

But he failed to curb spending and as a result budget deficits soared to an average of $175 billion annually during his presidency.

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