Comparative Economic Systems

This article examines the defining features of the world's three major economic systems: Traditional, free market and command. Each system addresses the fundamental problem of how to allocate scarce resources in a different way. In all three cases, the decision revolves around what and how much to produce, for whom to produce and to whose benefit. Kinship, custom and religion enter into these decisions in a traditional economy. In a free-market economy, self interest alone matters; buyers and sellers bid freely and openly on goods and services, and the price of purchases directly affects supply and demand. Unlike both traditional and free market systems, orthodox command economies ban all forms of private ownership; the state employs everyone and resources are allocated by central planners.

Keywords Allocation of Resources; Command Economy; Division of Labor; Distribution of Wealth; Economic System; Free-Market Economy; Mixed Economy; Traditional Economy

Economics > Comparative Economic Systems

Overview

At its most basic level, Economics concerns itself with the complex ways we rely upon each other to meet our material needs. Writ large, this pursuit gives rise to hundreds of millions of people engaging in trillions of exchanges (i.e. transactions) on a daily basis. Nothing remotely approaching the sheer scale of this activity could ever be sustained purely randomly. It takes structure to coordinate the innumerable elements that go into the production and distribution of goods and services that respond dynamically to changing conditions and needs. A system, in other words, made up of institutions, both formal and informal, following mutually agreed upon rules and practices is required to harness divergent individual interests to serve a common good (Dallago, 2002).

In any economic system, the be all and end all is the efficient allocation of resources. This lofty term boils down to the answers of three fundamental questions: What to produce, how to produce it and for whom? Five thousand years ago, the answers to these questions were moot as early humans were only concerned with food and shelter. But as human populations grew from the small, informal groups where the goal was simple survival, a division of labor along functional lines became necessary. How this division was organized and to what ends was and is the preeminent concern of an economic system. Three major models have since emerged: Traditional, free-market and command.

The most long-lived of the major economic systems is the traditional model. It has shaped economic decision-making to one degree or another for over two thousand years. Rooted in custom and often re-enforced by clan, tribal and sectional ties, supply and demand in traditional economies can be governed as much by socio-cultural norms and obligations as by questions of supply and demand. Free-market economies employ a more computational signalling mechanism — Pricing. Here suppliers are free to charge whatever they want. Those who prosper provide goods and services people find useful, desirable and affordable enough to buy. The sum of a given item's purchases over time signals that item's relative economic importance. On the other hand, command economies completely disavow the role of tradition or of a self-regulating marketplace. Here the state decides what and how much will be produced and orders state-owned enterprises to meet specific quotas. These quotas are set based partly on statistical forecasts of existing consumption patterns and partly on economic development plans and ideological agendas.

Such are the broad outlines of each major economic system. Ask any practitioner of comparative economics if such and such a system exists in the real world and he or she will most likely say 'no,' 'not really' or, at best, 'not quite.' This is so because these 'systems' are only conceptual models; clear-cut and idealized versions of much hazier real-world processes. This notwithstanding, they are of value precisely because of the general principles they reveal about the underlying dynamics of supply and demand. Moreover, elements of each system moreover operate to one degree or another somewhere in today's global economy, in many instances cheek by jowl in a mixed economy. Even in the freest of market economies, governments regulate some forms of business. Social, cultural and even religious mores subtly shape the contours of local and regional commerce in developing and advanced nations alike. Vestiges of the command economies of the last century linger in such emerging world powers as Brazil, Russia, India and China.

A lot of 'isms' quickly surface in any comparison of economic systems: Capitalism, Socialism, Marxism, Colonialism (Economy: 4, 2001). Free-market economies can be laissez-faire, corporate or neo-liberal in disposition. Socialism, where the state owns and operates major industries and utilities, is a form of command economy that has had several real-world incarnations: The dirigisme of France and the Social Market system of Post-War Germany, and a number of other variations adopted by developing countries at the advent of the post-colonial era. Marxism, of course, is synonymous with Communism, a system where the state literally owns everything and virtually all economic activity is planned. In its twentieth century heyday, Lenin, Stalin and Mao each sought to shape their national economies in his own decidedly ideological mold. Colonialism, which dominated the global economy in the first half of the twentieth century. Here the major industrial powers occupied and then administered much of the third world for the express purpose of securing access to raw materials and closed markets for their exports.

What matters here is not the distinguishing traits of each off shoot but rather how each major system deals differently with the question of ownership. Private property is a major pillar of the free market economy; it is what people compete to acquire. But, there is always just a fixed amount of land, stocks, savings and the like. One person adds to his or her wealth (property) at the expense, theoretically-speaking, of another. This Scarcity of Resources inevitably leads to an unequal distribution of wealth. Free market enthusiasts believe this imbalance is not only natural but morally just. In their view, the rich achieved their wealth by dent of hard work and business acumen. More importantly, they reinvest a portion of their wealth, thus stimulating economic growth. That investment, in turn, creates jobs and provides additional goods and services and, so, furthers the common good. Proponents of command economies reject these arguments outright. The only cure for a grossly unfair and exploitive economic system, they argue, is collective ownership. And the fairest arbiter of the subsequent egalitarian redistribution of income and investment capital is the state.

Applications

Economic systems are complex, multidimensional entities where decisions about what is produced, how to produce and for whose benefit have a moral and political context. An economy and the society it serves are inseparable. What differentiates one from the other is the nature of the basic problem being addressed. Social cohesion and regeneration are society's most pressing perennial concerns. Capital formation, productive capacity and full employment are necessary for a healthy economy. For, without adequate levels of investment, an efficient manufacturing base and enough wage earners to buy the goods produced, economies fail. If this happens, the social order itself has the potential to unravel. More often, though, economies simply under perform, and tight credit, high prices, and low wages thwart the average person's aspirations for 'the good life.' Even when an economy performs well, the prosperity created may be far from universally enjoyed and come with very real social costs. Traditional, free-market and command economies approach each of these problems differently. Let us see how.

The Traditional Economy

Over time, methods of production are perfected and kinship or tribal-based patterns of ownership and distribution take root. Material needs are met adequately enough that the community-at-large grows complacent and/or compliant. Typically, traditional economies are agrarian in nature. And relatively static; for example, cultivation techniques changed very little over the centuries, for there was little reason or incentive to innovate. That's because whatever surplus was generated from crop production was usually appropriated by the aristocratic elite. Basic consumer goods like pottery and linen were produced by craftsmen in small-scale, decentralized industries. Farmer and tradesman alike lived at the subsistence level. Extended family and clan networks fostered the pooling of capital, labor and technical resources, mitigating the harshness of their predicament.

It would be a mistake, however, to think that this system is now just a fossilized relic of a pre-industrial world. In much of the developing world, economies are still agrarian based and land ownership still passes from one generation to the next through inheritance. Extended families are still the primary economic unit and affiliation with clans and tribes are still a ready source of investment capital, labor, technical expertise, employment and care for the ill and indigent. China and India, two of the world's most dynamic emerging industrial economies, still have in excess of three hundred million landed peasants a piece.

The principle underlying traditional economies, are asserting themselves in new ways even as their structural characteristics recede. The sense that an economic actor has concrete obligations to others and must conduct business in accordance with social and religious norms, even at the expense of profits, still resonates in some of the most advanced economies of the Middle East and Asia (Rosser & Rosser, 1999). Islam, for example, forbids the charging of interest and requires the devout to donate a percentage of their annual income to charity. Similarly, family ties proved instrumental to the formation of giant industrial manufacturers in Japan and South Korea. "Crony capitalism," where third world dictators reward friends and family with lucrative contracts and business franchise, is still a fact of economic life in the emerging world.

The Free Market Economy

Unrestrained competition motivated purely by self gain is the paramount virtue in a Free-Market Economy. Purists contend that government intervention of any sort interrupts and detracts from the efficient functioning of the marketplace. Now, despite the almost mystical status assigned it, the marketplace is actually just the sum total of buyers and sellers. Each rational actor decides upon what he or she needs and wants, then looks to the marketplace to find the greatest value at the least cost. The free-flow of so-called 'perfect' information is vital in this respect. No one likes to buy something only to discover it costs less down the street. Likewise, no one likes to find out that a product does not perform advertised. Perhaps the single most important piece of information is product price.

While buyers are busy maximizing the utility of their purchases, firms are equally busy trying to maximize their profits by earning as much revenue as they can at the least cost to themselves. The higher this sales revenue on aggregate grows, the greater the number of enterprises supplying the good or service being offered. Conversely, the lower the sales revenue go, the fewer the suppliers. This agile responsiveness to supply and demand is widely considered to be the free market's greatest asset. When supply exactly matches demand, the market is said to be in equilibrium. Any imbalance between the two results in price fluctuations until supply once again matches demand. It is an article of faith among economic theorists that markets are self regulating and that they will naturally move towards equilibrium.

For an economic system with such anarchistic leanings, free markets operate in a remarkably orderly fashion. This is not to say that they operate smoothly or to everyone's benefit, but simply that, on aggregate, the behavior of buyers and sellers over time exhibits a degree of cyclical predictability. In the short term, though, the behavior of free market economies can be notoriously unpredictable. Herein lies an uncomfortable truth: Risk is ever present in free-market economies. Uncertainty and the potential for failure are constants: Some businesses succeed while others go bust, just as some people grow rich and others poor. Limited liability and bankruptcy laws can stem the losses but only to a certain point. Whenever unemployment rises, consumption declines and supply soon exceeds demand. In more severe cases, prices fall so precipitously that some firms go under while others retrench by cutting costs resulting in longer unemployment lines. Examples of such a situation can be seen in the major American economic depressions of the 1850s, 1870s and 1890s.

The Command Economy

There is, by definition, no unemployment in a communist command economy. In retrospect, this may be its singular virtue. The state owns and runs everything and therefore is in a position to hire everyone. No one, theoretically, ever goes hungry or ends up homeless. Such an outcome is only possible when competition is eliminated from both the supply side and the demand side of an economy. In its place, state planners decide what goods to produce; essentially, which state-run monopolies then manufacture and distribute. In such a system, the consumer plays an indirect role. Central planners factor the needs and wants of consumers into their resource allocations along side the considerations of industrial development and building public infrastructure. In addition, the ideological appropriateness of any decision is always carefully weighed.

A command economy, simply put, values egalitarianism over efficiency; the collective good over individual freedom. Out of necessity as much as choice, it is highly centralized, a system steeped in top-down decision-making of mind-boggling scope and proportion. No matter how well-intentioned, hard-working and conscientious, critics contend, central planners are all too easily overwhelmed by the sheer complexity of their task. Faced with so much uncertainty, they all too readily fall back on orthodoxy and bureaucratic procedure. Insulated from day-to-day economies, these coddled functionaries arbitrarily decide what people want and then pre-order production runs down to the last item. Not surprisingly, scarcities in the consumer goods people truly desire occur regularly. The quality of the goods actually produced is often inferior, too, for the simple reason that, lacking rivals, state monopolies have little incentive to do better.

Whatever dynamism that may have once marked its economic activity is irretrievably lost, in effect, in a command economy. In its place is an endless series of quotas workers and managers must meet. As deadlines loom, production short-cuts, artificially low projections of productive capacity, laborers working frenzied 20 hour shifts; anything and everything that inches them towards their quota, is resorted to. If a quota is not met, there are real consequences; one's living stipend, housing allotment, and clothing allowance are, after all, the state's way of recognizing the extent of one's contribution to the 'socialist economy.' One may be always able to make a living in a command economy, but the 'quality' of that life can vary dramatically. The irony here is unmistakable. Even in an egalitarian society where the collective good is the supreme virtue, the economic order still rewards some individuals more than others.

Discourse

The miserable performance and hasty demise of the command economies of the Soviet Union and Eastern Block countries is a testament to how unworkable these systems were in practice. In the end, central planning proved far too slow and cumbersome a mechanism of resource allocation. Likewise, developing countries are growing impatient with the glacial pace of progress countenanced in traditional economies. Where is the pool of labor and capital necessary to industrialize going to come from, they ask, if the populace and much of the national wealth are still tied to the land? Free-market economies, though clearly in the ascendant, face pressing dilemmas of their own: periodic recessions and bouts of unacceptable levels of unemployment chief among these.

It is probably true that there is always something right and something wrong about a given economic system. Value judgments are a matter of perspective and people in different circumstances have different perspectives. The whole issue is clouded further by the overly simplistic models of the economic systems themselves. Governments can and do exercise controls over markets capitalists compete undeterred in. Passage of the Sarbanes-Oxley Act tightening financial reporting standards for public companies is just one recent example. They also fund unprofitable but vital ventures like building roads and bridges, and running schools and public health clinics not only to buttress free-market enterprise but also to fulfill obligations considered morally important by the culture at large.

In Cuba, one of the last remaining command economies, people turn to a supply and demand driven 'black market' to surreptitiously obtain goods not available in state stores. While in America and the rest of the developed world, consumers looking for a product stare at shelves filled with a plethora of brands. And in Europe, national governments remain major stock-holders in the 'privatized' reincarnations of formerly state-owned companies. In truth, then, real-world economies are simply too dynamic and too complex to neatly pigeon hole. Look closely enough at any national economy and you are likely to find elements of traditional, free-market and command economies at play.

Terms & Concepts

Allocation of Resources: The method by which an economic system distributes goods, land and labor among producers and consumers.

Command Economy: An economic system where decisions about how to allocate resources are made administratively by a central planning authority.

Division of Labor: Specialization of elements of the work force that optimizes the production process.

Distribution of Wealth: The income enjoyed by each of a number different groups or classes in a society.

Economic System: The distinctive way in which a society parcels out scare resources among its members.

Free-Market Economy: An economic system where supply and demand alone decide how resources are allocated.

Full Employment: When the entire available labor force is involved in the most efficient manner in the production of goods and services.

Mixed Economy: An economic system where certain industries are publicly owned and the government takes an active interest in the efficient, equitable operation of free markets.

Productive Capacity: The total goods and services generated through economic activity.

Scarcity of Resources: The perpetual state of man where there is a finite amount of resources available.

Signaling Mechanism: The means by which suppliers gauge demand.

Traditional Economy: An economic system where custom and cultural reciprocity play a part in the allocation of resources.

Bibliography

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Dallago, B. (2002). The organizational effect of the economic system. Journal of Economic Issues,36, 953-979. Retrieved July 19, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=8709037&site=ehost-live

Economy: 4. The economic process. (2001). In Discretionary economy: A normative theory of political economy (pp. 67-87). Piscataway, New Jersey: Transaction Publishers. Retrieved July 20, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=11829750&site=ehost-live

Hopkins, B.E., & Duggan, L.S. (2011). A feminist comparative economic systems. Feminist Economics, 17, 35-69. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=62609895&site=ehost-live

Katkov, A. (2013). Economic goals ranking approach in comparative analysis of economic systems. Global Conference on Business & Finance Proceedings, 8, 108-112. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=89496801&site=ehost-live

Paun, S. (2009). THE VESTIGES OF COMMUNISM AND THE TRANSFORMATION OF PARTY SYSTEMS IN POST-COMMUNIST STATES. Economics, Management & Financial Markets, 4, 231-235. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=43278166&site=ehost-live

Petr, J. (1987). The nature and necessity of the mixed economy. Journal of Economic Issues, 21, 1445-1468. Retrieved July 20, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=4680362&site=ehost-live

Rosser, M., & Rosser Jr., J. (1999). The new traditional economy. International Journal of Social Economics, 26(5/6), 763-778. Retrieved July 23, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=1976498&site=ehost-live

Suggested Reading

Aharoni, Y. (1981). Performance evaluation of state-owned enterprises: A process perspective. Management Science, 27, 1340-1347. Retrieved July 20, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=7355737&site=ehost-live

Belolipetskii, A. (1992). Economic agents in a mixed economy. Problems of Economics, 34, 82. Retrieved July 20, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=6495703&site=ehost-live

Jacobson, D. (1992). From command economy to market economy with a human face: The potential role of the stakeholder approach. International Executive, 34, 237-249. Retrieved July 20, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=5536708&site=ehost-live

Raikin, E., & Yousefi, M. (1993). Some misconceptions about market and non-market economies. International Journal of Social Economics, 20, 57. Retrieved July 19, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=9503280330&site=ehost-live