LESSON : ECONOMIC SYSTEMS

LESSON : ECONOMIC SYSTEMS LEARNING OBJECTIVES: • Define what is an economic system • Identify the three types of economic systems • Define the term ‘market’ • Describe the three forms that a market can take • Describe the three types of economic systems • State the advantages and disadvantages of each, with examples

Economic systems defined: • Economic systems refer to the structures which have been put in place to deal with the economic problem (how scarce resources are allocated among competing or conflicting wants). It involves the ways in which a society organizes for the production and distribution of goods and services to satisfy the needs of its people. How the society decides to provide for the needs and wants of its people will influence the type of economic system that is adopted.

Types of economic systems • The three main types of economic systems adopted by countries are: • The market driven economy, free market economy, capitalist economic system, or laissez-faire economic system, right wing system • The planned, controlled, communistic, collectivist or command economy, left wing system; • The mixed economy, centralist.

Market defined: A market is an arrangement in which buyers and sellers are brought together to transact business. It could be a physical place or it could be a situation or a set of conditions that facilitates the trading process.

The Market Driven Economy: • In this type of economy, private individuals (and not the Gov’t), own the resources of the economy. The answers to the economic questions of what, how and for whom to produce are provided by the price mechanism, or system.

Key features of a free market economy: • There is very little gov’t interference (guidance and financial aid to private businesses); • Market forces of supply and demand largely determine prices; • There is much competition among firms for patronage, which keeps prices down but not necessarily low; • Unregulated use of factors of production;

Key features of the free market economy • Ownership of all profits after payment of taxes; • By driving costs down, in order to maximize competitiveness, the system tends to disadvantage labour with low wages; • It also tends to suppress trade unions, regarding their demands as a curb on market freedom; • By maximizing profit, it tends to promote actions that may be against the public interest, e.g. monopoly pricing, shoddy goods, tax evasion; • Monopolies are allowed to proliferate – they help gov’t by paying high taxes, and may also support political parties in fighting elections; • Laws, rules and regulations have to be introduced to protect consumers from unscrupulous traders.

Advantages of the market economic system: • Manufacturers are free to produce what the consumers require, and the consumers in turn are free to spend their money as they see fit. • Decision-making is not controlled, so there is greater participation in the decision on what is to be produced to satisfy the needs of the consumer. • A large variety of goods and services are produced to satisfy the needs of the consumer.

Advantages of the free market system • The market economy is adaptable to changes that arise from time to time. E.g. if there is any shift in the demand for a product or service, the economy can adjust to meet the new demand. Whether it takes a short or a long time to adjust to the new demand depends on the type of, or nature of the goods or service involved. • There is very little gov’t intervention in the market economy. As a matter of fact, there is a lack of gov’t intervention. • There is a greater degree of competition as goods and services providers scramble for a share of the market.

Disadvantages of the market system: • Since the making of a profit is the dominant motive of the private sector, only goods or services that yield the highest profit will be produced. E.g. needed infrastructure such as the construction of roads or bridges or the provision of security for the defence of the country would not find ready investment since their use does not usually provide a profit. • Consumers could be exploited through the imposition of high prices for essential goods if there is insufficient competition among producers or Gov’t regulation of businesses. • This system can lead to a more unequal distribution of income, with the rich get richer and the poor get poorer. The rich can bid up the prices of luxuries, and resources will be used to produce these items rather than necessities.

Disadvantages of free market system • The free market can lead to monopolies which can exploit consumers by demanding higher prices for certain goods and services because they are the only seller in the market. • Too much money may be spent on advertising to attract customers. • The price mechanism may work sluggishly and as a result suppliers will react slowly to demand changes.

Disadvantages of the free market system • The profit motive may not always lead to maximum welfare for the society. E.g., the effect of production on pollution and destruction of the environment may not be considered. • Resources can remain unused if it is thought they will not yield a profit. • When gov’ts intervene with legislation to control undesirable actions (e.g. controlling pollution through large fines), firms tend to raise prices to cover their increased costs.

The Planned Economy: In this type of economy, all the resources are owned by the State (or Gov’t owns and controls the factors of production). The State owns and runs the factories, mines, farms, transportation system, food distribution outlets, among others. The decision about what to produce, how to produce and for whom are made by a centralized planning agency.

Key features of planned economies: • A gov’t central planning body oversees every economic activity and committees are appointed by the head of state to take charge of various sectors of the economy; • Central authorities decide what to produce, how to produce, who gets the output and how much they get; • Command economies may be introduced as a response to bad planning or poor distribution, but they may also suffer from the same problems. When production or distribution go wrong, there is no alternative source of supply, so that rationing can be an unwanted side-effect of a planned economy (as experienced by Guyana for many years). For the same reason black markets can result, drawing on unofficial sources of supply.

Key features of the controlled economy • Much investment is not used on consumer goods but on military goods (army tanks, guns, space exploration). This was especially the case in Russia and China; • Citizens live in a highly regimented society, with gov’t officials, police or even soldiers on nearly every street corner – even on farms, to check on production • Oppression, high unemployment and poverty are prevalent; • Tightly controlled (and often poor) economic and social conditions tend to result in de-motivation, disaffection and ultimately defection of citizens and a brain drain.

Advantages of a Planned Economy: • Wastage of resources would be reduced since the State makes the decision as to what is produced, and directs the resources into these areas. • Profits gained from State industries may be used to generate further production and expand provision of public goods such as hospitals and other welfare services. Consideration may also be given to the improvement of general working conditions of State employees.

Advantages of the planned economic system • Since profit maximization is not the motive, there may be greater employment of resources and the social cost may be taken into consideration. Thus planners can ensure that adequate resources go into the production of social (public) goods, and advertising can be limited to providing information only. • Since the State determines the price of goods and the amount paid in salaries, then no group of workers by themselves can force prices up. • Income is more evenly distributed.

Advantages of the planned economic system • Workers may tend to increase their efficiency since they may feel that they are working both for themselves and for their country. • The monopoly power of the State can be used for the welfare of the society as a whole.

Disadvantages of a Planned Economy: • There may be much inefficiency and wastage of resources as the profit motive for production is missing. E.g., there may be wastage of manpower because large numbers of persons (officials) are usually required to do the planning in this system than are required in the free market system. • Conflicts of interest arise because what the country needs may not be what the people want • The Gov’t protects workers by setting a minimum wage (which may be inadequate or subsistence)

Disadvantages of the planned system • The lack of scope for individual incentives may lead to a lack of initiative. Furthermore, since people are not free to choose what they want to produce, how and in what quantities, initiative and morale may be further reduced. In addition, the State ownership of resources reduces the incentives of the members of the society to work harder. Since they are working for the State and not for themselves, their effort will not be as great. • Gov’t can freely intervene in areas where there is an imbalance to protect the firm or the consumers from unfair practices. • Production usually takes place ahead of demand and this could lead to waste as once the consumer’s needs are satisfied, they may not purchase goods. In many instances they may find the goods to be unattractive or of poor quality. Furthermore, it is impossible to estimate accurately the needs of the consumers. This may lead to shortages of some goods and a glut of other goods. Moreover, the Gov’t can impose its choices on the rest of the society, for e.g., producing more military goods and fewer consumer goods.

Disadvantages of the planned economic system • There is usually a large bureaucracy to administer the workings of such a system and the problems associated with these tend to arise. The needs of society has to be determined and their provision has to be arranged by politicians and bureaucrats (civil servants) who may not be trained in the management of large organizations. Moreover, large organizations are unwieldy and difficult to manage efficiently. This may lead to coordination problems. E.g. in the former Soviet Union, in spite of goods harvests there were episodes of food shortages because there were not enough trucks to transport the food.

The Mixed Economy: • In this system both the gov’t and the private sector participate in making the decisions regarding what is to be produced, how to produce and for whom to produce. The society recognizes the important role of the gov’t in the provision of certain goods and services that are large-scale in nature, e.g. education and health, road construction and maintenance, social welfare, amongst others, and accepts this input. The gov’t undertakes these responsibilities as the more efficient provider of such services. • In this system, trade unions tend to play a more powerful role and are in many instances, responsible for a faster increase in wage and salary rates.

Key features of a mixed economy (in the region): • There has been a marked rise in the formation of non-governmental organisation (NGOs). These are autonomous, or nearly autonomous, bodies in the private sector that have been charged with running or overseeing the provision of services and goods in the public interest; • Consistent with this weakening of the public sector in the region, there has been a strengthening of private sector participation as gov’ts have invited foreign companies to take on former public sector responsibilities. In Guyana since 1992, for e.g. more than 30 public sector enterprises have been privatized; there are now only a handful of public enterprises;

Key features of the mixed economy • There is more trade union activity than in a planned economy, where trade unions might hardly exist; • A greater premium is placed on consumer protection, and there is zero tolerance of environmental pollution; • With the growth of tourism in the region, some industries have mushroomed – not just hotel building, hotel catering services and the hospitality industry, but also telecommunications (including cell-phones) and computer based technology; • Tourism has become the main attraction for most investment, replacing traditional investment interest, e.g. sugar, bananas or oil, according to the country;

Key features of mixed economies • There is a markedly high level of poverty, unemployment and crime. This seems to be the most persistent feature of all economic systems that have been tried, and of all political parties and gov’ts; • There is growing dependency on foreign aid, imports and the transfer of technology from developed countries. T&T and Jamaica, for e.g., regularly get financial and other types of assistance (e.g. ships and aircraft to fight the drug trade) from the USA and Britain, and cheap loans from Canada, China, Germany and the OPEC countries;

Advantages of the mixed economic system: • The state can intervene in areas of the economy through the passing of laws to protect citizens from unfair trading practices. • Both gov’t and private sector can cooperate in the delivery of certain services through franchising as seen in the transport sector and hospital catering. • It is believed by some that this form of economy is more equitable since it avoids the creation of huge numbers of poor people (through the activities of trade unions who represent workers).

Disadvantages of mixed economies: • One disadvantage often levelled at this system is that the State should not participate in business enterprise since they are not efficient managers of resources. • Too much gov’t regulation may dampen the free enterprise spirit. • Some Sate-owned industries are allowed to operate inefficiently thus wasting resources. • Where gov’t intervenes in the market by setting maximum or minimum prices, this may cause either excess demand or supply which may be difficult to regulate in the long run.

Comparison of the three economic systems: • The goal of all three economic systems is the efficient allocation of the society’s scarce resources between competing wants. • The market economy also tries to preserve individual choice in the allocation of those resources. Market economies usually have democratically elected gov’ts. • Planned economies strive for equality in the distribution of resources among members of the society, in addition to their efficient allocation. They also try to produce adequate amounts of social goods which would not be produced by the pure market economy. • The mixed economy recognizes and tries to solve this by leaving those activities which can be efficiently done by the private sector in their hands. The activities which the private sector cannot undertake efficiently are handled by the gov’t.

LESSON : ECONOMIC SYSTEMS