Economic systems
While there are many varied solutions to the economic problem as described earlier by Paul Samuelson, there are two fundamental economic systems - those based on the operation of free markets and those based on central planning.
Free market economies
Free markets enable unregulated exchange between producers and consumers. Economic systems that rely solely on markets to solve the economic problem are called free market economies. In a free market economy, resources are allocated through the interaction of free and self-directed market forces. This means that what to produce is determined by consumers, how to produce is determined by producers, and who gets the products depends upon the purchasing power of consumers. Market economies work by allowing the direct interaction of consumers and producers who are pursuing their own self-interest. The pursuit of self-interest is at the heart of free market economics.Capitalism
Capitalism
became the dominant economic philosophy in the ‘western world’ from the 19th
century onwards. A capitalist system is one in which the economic problem is
solved by the unrestricted self-interest of the owners of capital, who fund
entrepreneurial initiative. While each individual economic agent seeks a
positive return on their factor input, the power in a capitalist system lies
with the provider of capital. Entrepreneurs and wage labourers rely ultimately
on capital. The entrepreneur relies on the owner of capital to fund the
business in the short term, and the supplier of labour relies ultimately on the
entrepreneur. Hence, the accumulation of capital is central to the working of
a capitalist economy.
Free market economists
Free market economists believe that markets work best when they are unregulated and where scarce resources are allocated through the operation of a capitalist eco-nomic system. Free market economics is closely associated with the founding father of economics, Adam Smith, and the classical and neoclassical economists of the 18th and 19th Centuries. In the 20th century, the work of Friedrich August Hayek typified the modern free-market approach to the allocation of scarce resources. Markets are, he argued, far more efficient in allocating resources that an individual or group be-cause the market always contains more information than any individual or group of planners. According to the free market economists, private investment is always more effective than public investment, and markets are more efficient than governments.
Command economies
'Command'
economies provide an alternative solution to the economic problem by allocating
resources ac-cording to plans put forward by the state, or by an agency
appointed by the state. This method is referred to as central planning, and
economies that exclusively use central planning are called command
economies. In other words governments direct or command resources to be
used in particular ways. For example, governments can force citizens to pay
taxes and decide how many roads or hospitals are built withe the tax revenue.
In
a command economy, prices are set by the planners and resources are allocated
not just according to price and the ability to pay, but also in terms of the needs
of citizens.
'Command' economies provide an alternative solution to the economic problem by allocating resources according to plans put forward by the state, or by an agency appointed by the state. This method is referred to as central planning, and economies that exclusively use central planning are called command economies. In other words governments direct or command resources to be used in particular ways. For example, governments can force citizens to pay taxes and decide how many roads or hospitals are built withe the tax revenue. In a command economy, prices are set by the planners and resources are allocated not just according to price and the ability to pay, but also in terms of the needs of citizens.
Command economies have certain advantages over free market economies, especially in terms of the coordination of scarce resources at times of crisis, such as a war or following a natural disaster. Free markets fail at times to allocate resources efficiently, so remedies commonly involve the allocation of resources by the government to compensate for these failures.
Communism
The benefits of command economies over free market capitalism became the central economic idea of German economist, Karl Marx, who advocated state ownership of the means of production - namely, land and capital. He also predicted the eventual collapse of capitalism. The real value in economic activity, Marx argued, could always be traced back to labour rather than capital, and hence capitalism’s pursuit of higher profits though the accumulation of capital was always at the expense of labour, who would increasingly have to produce more and more output to satisfy the needs of capitalists. According to Marx, when the ‘reality’ of this sets in, labour would realise it was being exploited and would rise up and overthrow their capitalist ‘masters’. While the ideas of Marx seem out of touch with the reality of history, Marx’s economic theories are widely studied and still influential.
Interventionist economists
In contrast to the unregulated free market approach, and that of centrally planned command economies, the majority of economists favour come form of government intervention to make capitalism work better, rather than to prevent it working at all.
These include Keynesian economists, whose name is derived from British economist, John Maynard Keynes, and modern Libertarian Paternalists, including Richard Thaler, who are influenced by behavioural economics. Keynes laid down the basic ground rules for state intervention in markets, and was, perhaps, the most influential economist of the 20th Century.
Thaler has been instrumental in the emergence of behavioural economics, and the use of experimentation to show how behaviour can be nudged towards more effective actions and outcomes. These groups are pragmatic in that while accepting that capitalism is the most effective system on which to base a modern economy, it requires considerable intervention at significant times.
Mixed economies
Economies where economic activity is organised through a combination of market forces and central planning, are called a mixed economies. Mixed economies may have a distinct private sector, in which resources are allocated solely by market forces - such as the production of motor vehicles, computers and groceries.
They may also have a distinct public sector, where resources are allocated mainly by the government, such as defence, police, and fire services. In many sectors, resources are allocated by a combination of markets and planning, such as healthcare and education, which have both public and private provision.
In reality, all economies are mixed, though there are wide variations in the amount of mix and the balance between public and private sectors. For example, in Cuba the government allocates the vast majority of resources, while in Europe most economies have a fairly even mix of markets and planning.
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