What is an Economic System ?

Any system that involves the mechanism for production, distribution, and exchange of goods apart from consumption of the goods and services within the different entities can be classified as an Economic System. The various kinds of economic systems and their classifications broadly follow the methods by which means of ownership are established. Thus, the mode of ownership of capital leads to the different kinds of economic systems in vogue.

Types of Economic systems

The different kinds of economic systems are Market Economy, Planned Economy, Centrally Planned Economy, Socialist, and Communist Economies. All these are characterized by the ownership of the economics resources and the allocation of the same.

For instance, in a Capitalist Economy, the capital is privately owned and distributed with governmental oversight and regulation. On the other hand, in a Communist Economy, the state itself takes on the task of allocation of resources according to the needs of the different sectors. In a mixed economy, the state looks after some sectors whereas it frees up the other sectors for private participation.

Apart from this, the extent of governmental or state intervention determines the kinds of economic systems that are classified accordingly. In many ways, each of these systems has their own pros and cons when it comes to the welfare of the citizens.

1. Capitalist System

   This is the predominant economic system in the world today. In this system, the capital is privately owned and distributed. The distribution mechanism is left to the market to allocate the resources with the emphasis being on efficient allocation of capital. Going by the “Invisible Hand” of Adam Smith that guides the allocation of resources, it is deemed that the market does a good job of determining which sectors receive the capital and how much.

   Thus, perfect knowledge and perfect competition are assumed to be given and the market mechanism is taken to determine the beneficiaries and the recipients. In the modern context, this kind of system has come to be associated with the laissez faire mode of capitalism where the state has minimal responsibility and is seen as a “hands off” player rather than being interventionist.

   Of course, the state is expected to have regulatory mechanisms in place and ensure that the market corrections are supervised and the state steps in whenever there is a crisis of liquidity or other market failures.

   As we are currently witnessing the different kinds of state interventions arising out of the credit crunch, it becomes apparent that this kind of economic system may not be the ideal one as was being propounded over the last few decades.

   In this economic system, the four kinds of land, labor, capital, and entrepreneurship are the types of production that make up the mechanism for production and distribution of resources.

   The capitalist system of production and distribution has proved to be highly successful in western countries and it has spawned several clones in the east as well.

2. Communist System

   In this kind of economic system, the state takes upon itself the allocation and production functions as well as distribution of the goods and services. In this system, capital cannot be privately held and there is communal ownership or what is known as “Communism”. The workers are paid uniform wages and what Marx called the “participation of the workers in the collective bargaining” is a feature of the system.

   This model was pursued in the erstwhile USSR before it broke up and has been considered a failure though there is debate whether it was an ideological failure or an implementation failure. Like capitalism, communism also had several takers in the newly independent economies of the east. Thus, the Cold war was fought as much between two blocs as between two competing ideologies.

3. Socialist and Mixed Economic Systems

   In these forms of economic systems, the state has control over some areas which it deems to be of primary importance as regards national security and importance to the welfare of the citizens. Thus, the state does not allow private participation in sectors such as defense and essential goods and services whereas the entrepreneurs are provided incentives to contribute in other sectors that the state thinks fit.

   This kind of economic system was followed in countries like India till the 1990’s when the economies were liberalized and full private sector participation allowed. This parallels the demise of the centrally planned economy where the command and control of the economy is top down rather than bottom up. This has often led to several imbalances in the distribution and allocation of resources.

Benefits to Society and Individuals in Economic Systems

An economic system, in whatever form is necessary for the society to prosper and function as a cohesive unit. From the primitive societies of barter and the hunter gatherers to the new technocratic ages, there always has been some form of economic systems. The economic systems make up the whole system that comprised the political system, the legal system, and the like.

Some of the benefits are self-evident in the sense that the individuals in a society get paid for their work and in return can buy and exchange goods and services. In other ways, the material well being of the individuals is guaranteed with promise of wages and other inducements. On the other hand, the individuals contribute to the collective pool of wealth by paying taxes that in turn make up a portion of the social security nets.

As can be seen from the prosperity of the western world, the economic systems contribute in a major way towards the sense of well being and security of the citizens. The state guarantees the rights of the citizens and in turn expects duties from them. There are instances of breakdown of economic systems in Sub-Saharan Africa that has resulted in chaos and civil war.

Need for a Social Contract

Thus, one of the pre-requisites of the economic systems is that of a “social contract” between the individual and the state along with the legal and other forms of enforceable contracts. As can be seen, an effective economic and social system not only takes care of the constituents but also enforces the mode of behavior through a set of laws and regulations to be followed. Thus this is a kind of win-win situation for all the players concerned.

In communist societies, the state had an additional responsibility to ensure that the material well being of the citizens is taken care under the auspices of the state. Thus, one of the conditions for communal ownership was the co-ordination of the services and the goods.

The society as a whole gains from the distribution of wealth and its effects on the economy are as real as the whole structure of production and distribution of services are concerned. Society participates by providing services and gets paid in return. On the other hand the political economy enforces the contracts of the participants and the players concerned. Overall, society stands to gain from the methods of production and distribution of goods and services.

Individuals perform duties as per the market rules for participation and are guaranteed their share of the profits according to the norms of the wages prescribed.

Current trends

With the advent of the Internet and the rise of the “dot com” companies, a new kind of Economic system based on the “virtual” exchange of goods and services is arising that leads to dramatic shifts of wealth around the world.

However, there is also a need to refine the current market economies for them to have proper regulation and oversight. Unfettered capitalism is as risky as an absence of economic system. The whole edifice of an economic system can come down if not properly regulated and enforced.

As far as the current market crises are concerned, it is imperative that some kind of “paradigm shifts” occur within the systems and these are taken care by the regulatory authorities.

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