Top 3 Types of Economic Systems: Nature, Economic Development and Ownership

Top 3 types of economic systems: 1. On the basis of nature 2. On the basis of economic development 3. On the basis of ownership of resources.

1. Types of Economies-On the Basis of Nature:

1. Simple Economy:

An economic system where production, consumption and exchange of goods is carried out on a limited scale is referred to as simple economy. This economic system operates with limited population which has limited needs. However, in the contemporary world, such an economy does not exist.

2. Complex Economy:

An economic system where production, consumption and exchange of goods is carried out on a larger scale is referred to as complex economy. In this economic system, production of goods is carried out with the help of modern technology and by taking the help of auxiliary services like transport, banking, warehousing etc. Such an economy produces surplus goods which promote domestic and foreign trade.

3. Agricultural Economy:

Agricultural economy refers to an economy where a large proportion of the population depends on agriculture for their livelihood. The production, distribution and consumption largely revolve around the agriculture and its allied activities. Some small scale and cottage industries are also found but they are also dependent on agriculture for the supply of raw material.

4. Industrial Economy:

Industrial economy refers to an economy where a large proportion of the population depends on trade, industry and commerce for their livelihood. The production of goods is carried out on a larger scale using advanced level of technology. In such an economy, Gross Domestic Product (GDP) of the country is largely determined by trade, industry and commerce.

5. Open Economy:

Open economy is the one that allows exchange of goods and services between countries without any restrictions. Such an economy promotes international trade by permitting export of surplus goods and import of deficit and better quality goods from abroad. Today, open economies all across the world have intertwined into a ‘Global economy’. This implies that any positive or negative event in one economy has spillover effects on all the economies with which it has trade relations.

6. Closed Economy:

Closed economy is just the opposite of an open economy. It is defined as an economy having no trade relations with the rest of the world. Such an economy produces goods for its own domestic needs and believes in self-reliance. Therefore, international trade is completely absent in such an economic system.

7. Free Economy:

It refers to an economic system where production, consumption, distribution and price determination of goods and services and other economic activities are carried out without state intervention. Usually, prices are not regulated by the state and are determined with the help of the market forces of demand and supply.

8. Controlled Economy:

It refers to an economic system where production, consumption, distribution and price determination of goods and services and other economic activities are controlled by the State or Central Government. Usually, prices are regulated by the state and are not determined with the help of the market forces of demand and supply. In such an economic system, the government plays a role of regulatory authority and decides on all matters pertaining to an economy.

2. Types of Economies-On the Basis of Economic Development:

Economies all over the world are in different stages of the developmental trajectory. Some are developed and some are still considered as underdeveloped economies. A country that has a low Human Development Index (HDI) and a smaller industrial base as compared to other countries is termed as a less developed or an underdeveloped or a developing economy.

1. Developed Economy:

Industrialized economies, also called More Economically Developed Countries (MEDC) are those economies that have advanced technologies and higher standards of living. Their HDI indices are also much higher. Such countries are also called the First World Countries. The erstwhile Communist countries including Soviet Union are termed as the Second World Countries.

The common measures used to judge the developmental stages of an economy are per capita income, gross domestic product, and amount of infrastructure, general standards of living, and the Human Development Index which includes per capita income, literacy rate and life expectancy.

HDIs of some of the countries as per the UNDP’s Human Development Report, 2016, are given below:

As is evident from the table given above, India, with the HDI value of 0.624, does not fall into the category of developed nations. India is still a developing economy and has a long way to go to achieve the status of a developed economy.

Main Features of Developed Economies:

1. High GDP:

Developed economies register a very high rate of economic growth due to the use of modern technology and efficient use of factors of production and other resources. Service sector and industrial sector are well developed and contributes the most to the GDP in such economies.

2. High per Capita Income:

These economies experience high per capita income due to high growth rate and high national income. High per capita income increases the purchasing power of the people which accelerates the productive capacity within the economy. This promotes the standard of living of the people.

3. High Rate of Literacy:

Developed economies allocate huge amount of resources on education and promotion of skills and knowledge. Consequently, literacy rate is very high in these economies.

4. Developed Infrastructural Base:

High rate of economic growth in these economies also promote the development of physical infrastructure. The communication system, transportation system, power generation etc., are well developed in these economies.

5. Use of Modern Technology:

Developed economies allocate a substantial amount of resources on research and development. Consequently, they use modern technology in the production process. Use of modern technology enhances productivity and provides the benefits of economies of large scale production.

6. High Rate of Life Expectancy:

Developed economies allocate huge amounts of funds on the development of health care services. This, in turn, brings down the mortality rate, resulting in increase in life expectancy in these economies.

7. High Standard of Living:

Well-developed health care system, comprehensive learning opportunities and strong infrastructural base in developed economies promote high standard of living.

2. Underdeveloped or Developing Economy:

According to the United Nations “an underdeveloped country is one in which per capita real income is low when compared to the per capita real income of the United States of America, Canada, Australia and Western Europe. In this sense, an adequate synonym would be poor country”.

Hence, the characteristic feature of an underdeveloped economy is poverty. It must be noted, however, that such countries do have a potential to develop. As Jacob Viner has described: An underdeveloped country is one “which has good potential for using more capital or labor or more available natural resources, or all of these to support its present population on a higher level of living or if its per capita income level is already fairly high to support a larger population on a not lower level of living”.

Hence, there is a potential to develop. It is for this reason that such underdeveloped countries are now referred to as developing countries. The developing countries are also called Third World Countries.

3. Types of Economies-On the Basis of Ownership of Resources:

Scarcity is a fundamental problem of all economies. However, each economy deals with it differently. Economies are different from each other based on the extent of government control. Based on the extent of ownership of resources, there are three main kinds of economies. These are capitalist economy, socialist economy and mixed economy.

At one end of the spectrum lies a fully planned economy, where the government takes all the decisions pertaining to an economy. On the other end lies a free market economy, where the market decides what to produce, how much to produce, how to produce and for whom to produce.

1. Capitalist Economy:

It represents a free market economy. Under capitalism, all individuals and firms have the right to own private property. They are free to use it and earn profits. The central problems of what to produce, how much to produce and for whom to produce are all resolved by the market forces of demand and supply. This means that the price mechanism or what Adam Smith called as the invisible hand operates freely and is the main deciding force in such economies.

However, no country in the world today is fully free with respect to economic decision making—not even countries like the US, UK or Germany.

Features of a Capitalist Economy:

1. Right to Private Property:

People and organizations can own private property and there is little or no restriction on the amount of wealth they can amass. They have the right to use their private property to trade and earn profits. The aim of the individuals and institutions in such an economy is not social welfare but to maximize their private profits.

2. Freedom of Enterprise:

An individual is free to take up any occupation. He can enter into trade and production contracts or he can use his property to harness more profit or he can set up firms and plants for production. There is little or no restriction. But, it must be stated that total or absolute freedom is not possible in any economy and some controls do exist even in the most capitalistic economies of the world.

3. Consumer is the King:

What the consumer demands is produced through the signals of price mechanism. If demand of a commodity is greater than its supply, its production is increased. Hence, consumers freely express their desire for goods and services. Their likes and dislikes go a long way in deciding what is produced, for whom and in what quantities.

4. Profit and Satisfaction Driven:

The main aim of individuals in the economy is to derive satisfaction and to maximize profits. People are driven by selfish motives and not by altruism. It is always the ‘I’ that matters when economic decisions are taken. What the other has or does not have is not the concern of the individual rational agents in such an economy.

5. Risk Takers Must Control:

This is the golden rule of capitalism. The ones who own the capital and the ones who risk their money in business must alone control its operations. If not, it will lead to irresponsible choices and chaos.

6. Competition:

A capitalist economy is characterized by free competition because producers compete for getting the highest profit. Producers compete with one another to attract the consumers and they use methods such as a price cut or advertisement or different kinds of rebate and sale offers to achieve this objective.

7. Inequalities:

Due to the fact that there is stiff competition, there is also the rule of the jungle that prevails viz. survival of the fittest. The logic is that the best alone can survive and this leads to a widening gap between the haves and the have not’s. Those who have wealth can obtain resources and start big enterprises. The property less classes have only their labor to offer. Profits and rents are high but wages are much lower. Thus, the property holders obtain a major share of national income.

8. Role of Price Mechanism or the Philosophy of Laissez Faire:

In capitalism, price mechanism plays a major role. Price mechanism means the free working of the forces of supply and demand, without any intervention of the state. Producers are helped by the price mechanism in deciding what to produce, how much to produce, when to produce and where to produce.

Merits of Capitalist Economy:

1. The entire economy works automatically as minimum government control is required. Any kind of control brings in imperfection and slows the system; hence automaticity is good for the economy. As explained earlier, the system works automatically through the working of the invisible hand or the price mechanism.

2. It is a just and rewarding system for hard working individuals, prudent investors and risk takers who are enterprising. Laid back workers, however, are not rewarded. Hence, the system is considered just and fair.

3. Since the consumers are the kings of the market and they are the ones making the major decisions, there is a democratic flavor that creeps into this system.

4. Another important merit is that it encourages the risk taker, the innovator and the creative producer to step out and produce. It gives room for creativity and enterprise and hence, is good for the economy. Due to this, the economy grows and develops, accompanied by technological growth.

5. The capitalistic system adapts well to calamities. Economic history of the capitalist countries of the world can easily bear witness to the fact that this system, though has been buffeted by all kinds of pressures, has always come out victorious. It is hence, extremely acclimatized to the forces of the market.

6. The capitalistic system is efficient in all ways. The system guarantees efficiency as only the best survives. There is no room for mediocrity in this kind of a system.

Demerits of Capitalist Economy:

1. Competition is wasteful and leads to a lot of environmental damage along with a wastage of resources and time. Due to cut throat competition, firms and industries waste a lot of money on advertisements, selling, packaging and marketing. All this does not really benefit a society, especially if the country is not a very rich economy.

Also, since there is rampant competition, there will be a variety of products created and this will impact the resource base of an economy. Tremendous environmental damage results from such production. The problems of global warming and ozone hole, all emanate from such unprecedented levels of competition.

2. With stiff competition and a mad race to be at the top, the concept of human welfare is completely ignored. In fact, in the face of such competition, economic decisions are based on selfish profit seeking motive and not on human welfare. There is also a minimum role of the government and no one really exists to support the poor and the ones who do not own capital. This leads to widespread income inequality and class conflicts.

3. Such economies are susceptible to economic trade cycles. The great depression of 1929 to 1933 is an example of how unstable capitalistic economies are and how depression can lead to unemployment and pessimism. The recent economic crisis of 2008 also underlined the fact that due to the nature of such an economic system, any kind of disturbance in one sector of the economy has spillover effects on the other sectors, leading to loss of jobs and a drop in income levels. Only the government can rescue the economy from such a situation.

4. In a capitalistic system, political instability can emerge based on class conflict. With some individuals being super rich and others being poor, this kind of conflict can emerge and disturb the political fabric of the nation state. The widening gap between the haves and the have not’s can lead to lockouts and strikes and this impact the output levels of the country.

5. This system also brings along social injustice and economic inequities. It leads to the emergence of monopolies, especially when some individuals who own capital get richer and richer. Sometimes, these monopolies buy or eliminate the smaller firms to establish their supremacy in particular lines of production. They charge high prices and do not have any compulsion to improve efficiency of the production processes.

6. Another bane of this system is the emergence of corruption and immense malpractices. There is nepotism and red tapism which increases levels of bribery in the country.

7. Resources are misallocated in such a system. Since individuals work with the profit motive in mind, they seldom produce items of mass consumption. They indulge in the production of those goods which yield them highest profits. For example, they will not be interested in the distribution of polio vaccine at a discounted price as it will not be lucrative. The poor, however, may not be able to afford such vaccines.

2. Socialist Economy:

In this kind of economy, the resources are largely owned and controlled by the government. In short, private property is restricted. In this sense, socialist economy is just the opposite of capitalist economy. Karl Marx is known as the ‘Father of Socialism’. He was absolutely against the ownership of private property and considered capitalism as the cause of class conflicts.

Features of a Socialist Economy:

1. Ownership:

Ownership of the means of production is not in the private hands. Land, factories, railways, mines etc., are all owned and operated by the government.

2. No Private Enterprise:

Only the government initiates and controls production. No private individual or institution is involved in this process. There are no land lords and co-operative farming in such a system.

3. Economic Equality:

Economic equality is not guaranteed but there are no glaring disparities in the distribution of income and wealth under this system. In fact, no system can vouch for full equality. It has been proved that inequality in the distribution of income rises the saving and investment rates and this allows the economy to grow. If there is absolute equality in the distribution of wealth and income, the national output will drop.

4. Equal Opportunity:

Under this system, individuals do get equal opportunity to training, obtaining education and skills, employability etc. This is definitely guaranteed to the poor unlike in the capitalistic system. The poor are supported by various social security measures and are, in fact, looked after by the state. Hence, the poor and underprivileged too have a chance to try and move upwards to the higher classes in society.

5. Planning is Involved:

Since the government plays an active role in monitoring the economy with respect to consumption, production, and distribution decisions, the economy needs to be planned very well. Planning, hence, forms an integral part of the socialistic system. Price mechanism is not allowed to guide the decisions. In its place, it is planning and the budget mechanism that takes precedence. Only an increase in production is not enough under socialism, rather it works towards a fair and equitable distribution of the national output.

6. No Class:

This system believes in a class less society. No individual is allowed to be super rich and the poor are given many opportunities and support to try and become better off. This system advocates total annihilation of the gap between the haves and the have not’s.

7. Social Welfare and Social Security:

Since everyone, cannot face stiff competition the poor, the marginalized and the downtrodden are supported by social security cover. The public distribution system ensures that they get their quotas of sugar, rice, oil etc. This is practiced in India by issuing each poor family a ration card.

There are various schemes for the distribution of polio vaccines, subsidized health care, education, polytechnic and other forms of skill formation. In India, every state has its own schemes and then, there are centrally controlled schemes. All these are traits of a socialistic economy.

Merits of a Socialist Economy:

1. The system works towards social justice. Under socialism, inequalities of income are reduced and this is its chief merit.

2. There is a more humane allocation of resources. The needs of the society are considered before allocating resources for various schemes where production is undertaken.

3. This system aims at improving efficiency by bringing the fruits of development to majority of the residents of the country. This system enables the marginalized to be included in the development paradigm. Production is undertaken with the motive of welfare of the society in mind and not just the profit of individuals.

New techniques of production and research and development are undertaken with the government sponsoring and this leads to greater efficiency.

4. Social security cover is a large arm of this system. There are many schemes supporting the old, the women, the poor and the children. It is important that no one is ignored in the development process and this is possible not by stiff competition but by the support of the government in terms of guiding and directing the economy in such a manner that there is inclusive growth.

5. Socialistic systems are supported by the government and are not subject to the vicissitudes of the market. Hence, they are more stable and do not get affected by trade cycles adversely.

Demerits of a Socialist Economy:

1. Business is not as successful as under capitalism. Since the government is responsible, slack enters the system as individuals are not really held accountable. Profit too is not the motive and incentives are non-existent. Hence, individuals have no drive to work hard and their efficiency drops.

2. Bureaucracy is the biggest bane of a socialistic system. Every decision has to pass through various levels and this, in turn, slows the system and in addition, encourages red tapism, nepotism and corruption.

3. There is always the problem of lack of resources. The government is normally unable to consolidate huge amount of capital required for production and hence, shortages creep into the system.

4. Under this system, there is rampant misallocation of resources. Since the price mechanism is controlled and tampered with by government decisions, the most efficient solution is not obtained. This means that resources are not allocated according to their productivity. This happens due to the fact that the system advocates social welfare and not individual profit.

5. Further, consumers and producers are regimented and lack freedom to take risks and innovate. Individuals are discouraged from taking bold steps as the system is slow and sluggish and controlled by bureaucracy. A lot of time is wasted in the process of production and the consumers are not kings in the market. They are in fact advised/told what to consume. Thus, freedom is sacrificed in this system.

6. Lack of incentives, especially for the hard work, is a characteristic feature of the system. A creative assiduous worker receives the same pay packet as the lazy ones. This kills the incentive to work and hence, the production process slows down.

3. Mixed Economy:

An economy may not be fully socialistic or fully capitalistic. In the case of a mixed economy, there is a deliberate mix of the public and private activities. Decisions are taken by both the government and the private individuals. It is a system where the public and the private sectors co-exist but the private sector is not allowed to be fully free. The price mechanism is interfered with by the government and controls are used to monitor the private sector. India is a mixed economy and now, even countries like the US and UK has become mixed economies.

Features of a Mixed Economy:

1. Public and Private Sectors Co-Exist:

Entire production is shared by these two sectors. Normally, the more crucial and basic heavy industries are controlled by the government. It is very important to understand that the public and the private sector generally do not compete with each other. They co-ordinate and work together for the common goal of the country. In India, ports, railways, oil and petroleum, highways are under the control of the government.

2. Decision Making:

The price mechanism operates in the private sector and the budget mechanism operates in the public sector. However, the prices in the private sector, in some cases, may be controlled by the public sector. For example Indian Government may impose a price ceiling on the prices of certain essential medicines manufactured by the private companies, for the welfare of the poor.

3. Control of the Private Sector:

The government clearly regulates the private sector in a mixed economy. The private sector is supposed to function with the good of the nation in mind and not with the vested interests of few rich owners of capital. The government uses various techniques such as administered prices, price floors, price ceilings, subsidies, taxes and public distribution system to control prices.

4. Consumer Sovereignty:

Consumer sovereignty is not destroyed in a mixed economy. In fact, the government protects the interests of the consumers. Price control is one way of protecting the consumers.

5. Bridging Class Gaps:

The mixed system aims for the reduction in income disparities. Various kinds of schemes are implemented for the poor and hapless so that they can improve their standard of living.

6. Monopoly Power is destroyed:

The government controls the monopolist. Monopolist tends to make huge profits by curtailing the output and raising the prices. The government in a mixed economy looks into all these issues.

Merits of a Mixed Economy:

1. Unlike the socialistic system, in a mixed economy, producers and consumers experience freedom in most decisions. In this system, the initiative of the private sector is always encouraged.

2. The state makes an effort to ensure maximum welfare of its citizens. All kind of support is provided to increase the welfare of the people through various social security measures.

3. A lot of importance is given to the Research and Development (R & D)—both in the private and public sectors. The government encourages individuals to undertake projects and research which leads to the use of modern technology.

4. Allocation of resources is the best in this system. Careful attention is paid to the poor and the rich. Resources, therefore, are optimally used.

Demerits of a Mixed Economy:

1. Foreign investors may be reluctant to invest in an economy where there is nationalization of resources and interference from the government.

2. The public sector is inefficient and full of corrupt practices, nepotism and red-tapism.

3. The constant fear of nationalization nags the private sector and they do not have a free atmosphere to invest and grow.

4. At times, the private sector is controlled too much by the government which stifles growth.