Economic Systems

Economic Systems

LEAD-IN

There are many forms of economic order, ranging from the mixed private enterprise system to partially or completely controlled economies. Regardless of their form, however, economic system is the system that a society uses for allocation and distribution of scarce resources. Private enterprise means that decisions about what and how much to produce are left to the discretion of owners and managers. In controlled economies such decisions are the responsibility of some governmental agency. There is, of course, no economy today that is completely free of governmental influence, nor is this condition necessarily undesirable. There are many beneficial services and protections available from government. The question then is a matter of degree. Irrespective of the form of economic order, it performs certain valuable functions in the life of organizations of all types.

Among the functions of the economic order the most important one is to provide some means of resource allocation. In a private enterprise this function is basically performed by the price mechanism. This simply means that demand for and supply of goods and services interact to set their market price. In the case of regulated utilities, there are governmental agencies such as public service commissions that determine the rates that may be charged by utility companies. These rates are set at the level that will allow a fair return on investments made by the companies. This form of regulated monopoly is considered, on balance, preferable to unchecked competition. This is true because of efficiency reasons. In taking actions in the area of employment, government is attempting to control the economy in such a fashion as to help the business community operate at the level of production that will yield full employment.

Without a system of distribution economy simply could not exist. A major part of this distribution system is credit. Economy flourishes on credit or extended methods of payment. Such a system literally affects every link in the distribution chain from the supplier of raw materials to the ultimate consumer. Without this vital financing function being performed, the economy would doubtless be forced to a lower order of production.

Economic goals for a nation include price stability, full employment, economic growth, and equitable distribution of income. Price stability contributes to the efficient allocation of resources and facilitates long-term planning. Full employment means that jobs are available for those seeking work. Higher standards of living require increased output per person (economic growth per capita). An equitable distribution of income means that the fruits of the economy are divided in a way that seems fair to the majority of the people. With the long-run trend toward a more sophisticated, highly integrated economic system, it is becoming increasingly important for an individual decision maker to be aware of the macroeconomic environment.

Market Economy 

In a pure  market economy all productive activities are privately owned, as opposed to being owned by the state.  The goods and services that a country produces, and the quantity in which they are produced, are not planned by anyone. Rather, production is determined by the interaction of supply and demand and signaled to producers through the price system. If demand for a product exceeds supply, prices will rise, signaling producers to produce more. If supply exceeds demand, prices will fall, signaling producers to produce less. In this system consumers are sovereign. The purchasing patterns of consumers, as signaled to producers through the mechanism of the price system, determine what is produced and in what quantity. 

For a market to work in this manner there must be no restrictions on supply. A restriction on supply occurs when a market is monopolized by a single firm. In such circumstances, rather than increase output in response to increased demand, a monopolist might restrict output and let prices rise. This allows the monopolist to take a  greater profit margin on each unit it sells. Although this is good for the monopolist, it is bad for the consumer, who has to pay higher prices. Moreover, it is probably bad for the welfare of society. Since, by definition, a monopolist has no competitors, it has no incentive to search for ways of lowering its production costs. Rather, it can simply pass on cost increases to consumers in the form of higher prices. The net result is that the monopolist is likely  to become increasingly inefficient, producing high-priced, low-quality goods, while society suffers as a consequence. 

Given the dangers inherent in monopoly, the role of government in a market economy is to encourage vigorous competition between private producers. Governments do this by  outlawing monopolies and restrictive business practices designed to monopolize a market (antitrust laws serve this function in the United States).  Private ownership also encourages vigorous competition and economic efficiency. Private ownership ensures that entrepreneurs have a right to the profits generated by their own efforts. This gives entrepreneurs an incentive to search for better ways of serving consumer needs. That may be through introducing new products, by developing more efficient production processes, by better marketing and after-sale service, or  simply through managing their businesses more efficiently than their competitors. In turn, the constant improvement in product and process that results from such an incentive has been argued to have a major positive impact on economic growth and development.

Command Economy 

In a pure command economy, the goods and services that a country produces, the quantity in which they are produced, and the prices at which they are sold are all  planned by the government.  Consistent with the collectivist ideology, the objective of a command economy is for government to allocate resources for "the good of society." In addition, in a pure command economy, all businesses  are state owned, the rationale being that the government  can then direct them to make investments that are in the best interests of the nation as a whole, rather than in the interests of private individuals. 

Historically, command economies were found in communist countries where collectivist goals were given priority over individual goals. Since the demise of communism in the late 1980s, the number of command economies has fallen dramatically. Some elements of a command economy were also evident in a number of  democratic nations led by socialist-inclined governments. France and India both experimented with extensive government planning and state ownership, although government planning has fallen into disfavor in both countries. 

While the objective of a command economy is to mobilize economic resources for the public good, just the opposite seems to have occurred. In a command economy, state-owned enterprises have little incentive to control costs and be efficient, because they cannot go out of business. Moreover, the abolition of private ownership means there is no incentive for individuals to look for better ways to serve consumer needs; hence, dynamism and innovation are absent from command economies. Instead of growing and becoming more prosperous, such economies tend to be characterized by stagnation.

Mixed Economy 

Between market economies and command economies can be found mixed economies. In a mixed economy, certain sectors of the economy are left to private ownership and free market mechanisms, while other sectors have significant state ownership  and government planning. Mixed economies are relatively common in  Western Europe; although they are becoming less so. France, Italy, and Sweden can all be classified as mixed economies. In these countries the governments intervene in those sectors where they believe that private ownership is not in the best interests of society. For example, Britain and Sweden both have extensive state-owned health systems that provide free universal health care to all citizens (it is paid for through higher taxes). In both countries it is felt that government has a moral obligation to provide for the health of its citizens. One consequence is that private ownership  of health care operations is very restricted in both countries. 

In mixed economies, governments also tend to take into state ownership troubled firms whose continued operation is thought to be vital to national interests. The French automobile company Renault was state owned until recently. The government took over the company when it ran into serious financial problems. The French government reasoned that the social costs of the unemployment that might result if Renault collapsed were unacceptable, so it nationalized the company to save it from bankruptcy. Renault's competitors weren't thrilled by this move, since they had to compete with a company whose costs were subsidized by the state.

State-Directed Economy 

A  state-directed economy is one in which the state plays a significant role in directing the investment activities of private enterprise through "industrial policy" and in otherwise regulating business activity in accordance with national goals. Japan and South Korea are frequently cited as examples of state-directed economies. A state-directed economy differs from a mixed economy in so far as the state does not routinely take private enterprises into public ownership. Instead, it nurtures private enterprise but proactively directs investments made  by private firms in accordance with the goals of its industrial policy. For example, in the early 1970s, the Japanese Ministry of International Trade and Industry (MITI) targeted the semiconductor industry as one in which it would like to see Japanese firms have a major presence. Industrial policy often takes the form of state subsidies to private enterprises to encourage them to build significant sales in industries deemed to be of strategic value for the nation's economic development. Thus, the Japanese government subsidized research and development (R&D) investments made by Japanese semiconductor companies. It also used direct administrative pressure to persuade several companies to enter the industry. To help targeted industries develop, the state may also protect them from foreign competition by  erecting barriers to imports and foreign direct investment. Accordingly, Japanese semiconductor companies were protected from foreign competition by barriers to imports and restrictions on the ability of foreigners to establish operations in Japan. 

The intellectual foundation for a state-directed  economy is based on the so-called  infant industry argument. This argument suggests that in some industries, economies of scale are so large firms from developed nations have such an advantage that it is difficult for new firms from developing nations to establish themselves. Industrial policy is seen as a means of overcoming this economic disadvantage. Moreover, it is argued that state-directed industrial policy may allow a country to establish a leading position in an emerging industry where scale economies will ultimately be of great importance.

One criticism of state-directed  economies is that government bureaucrats don't necessarily make better decisions about the allocation of investment capital than the market mechanism would. For a long time, the economic success of countries such  as Japan and South Korea allowed advocates of state involvement to dismiss such criticisms. However, a decade of stagnant growth in Japan coupled with the 1997 implosion of the South Korean economy have added legitimacy to these criticisms. The South Korean collapse, in particular, has been  widely attributed to uneconomic investments by Korean companies in industries that the government deemed to be of national importance, such as semiconductors.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Vocabulary