ECONOMIC SYSTEMS

Senathon Ipia (08176007687,
senaipia@gmail.com)

In your country’s economy, who owns and controls land? Who owns and controls capital? And who hires and manages labour?

Surely, your answer to these questions is any one of the following:

   1. individuals

   2. the government

   3. both individuals and government

   4. the community as a whole

If your answer is (1) above, then your country’s economy is capitalist economy.  

If your answer is (2) above, then your country’s economy is socialist economy.

If your answer is (3) above, then your country’s economy is mixed economy.

If your answer is (4) above, then your country’s economy is communist economy

Note:

1.         ‘Individuals’ as used here refers to both business owners (entrepreneurs) and non-business owners. Remember it is people that own firms, so ultimately, what firms own are owned by individuals.  So, it is still correct to say “ individuals and privates firms”.

2.         we did NOT say “own labour”. Why? Because human beings (who constitute labour) are NOT property, so you do not own them. Similarly, you do not control labour, because employees can leave working for you anytime they want. But in communism, labour is controlled – because you do not choose what to do and where to work,  rather you are told what to do and where to work – no personal choice of career.     

Definition of Economic System

Long definition:

Economic system is the determination of whether, in an economy, factors of production (means of production) are owned, controlled or managed by individuals, or government, or both, or the community.  

Short definition:

Economic system is how factors of production (means of production) are owned, controlled and managed.  

Every economic system is an attempt to answer the basic economic questions of: (1) what to produce   (2) how to produce    (3) for whom to produce

So, whatever the economic system adopted by a country, its proponents (people and government) belief that, for them, it best answers the questions of what to produce, how to produce and for whom to produce.    

Types of Economic System

Capitalism

This is an economic system where individuals and firms (private sector) own, control and manage the factor of production (means of production). This means that to carry out production of goods and services, individuals and firms own or control their land, employ and manage their labour (workers); own or control their capital such as building, factory, machinery, equipment, etc.

Capitalism is also known as market economy or free enterprise economy.

In capitalism, resources allocation is done by the price system (also known as price mechanism).  This means that price determines what to produce, how to produce and for whom to produce in a capitalist economy, and the forces of demand and supply determine the price.

If the consumer can afford the price, he would demand; if the price is attractive to the producer, he would produce and supply. This price factor in demand & supply of goods/services is what is referred to as price mechanism or price system.

This system where government does not fix prices, but the forces of demand & supply determine prices through the individual interactions of producers, consumers, distributors and intermediaries could be termed the invisible hand. Ultimately, the invisible hand works to benefit the society as a whole – not the individual actors.      

   

Characteristics of Capitalism

1.         Price system (Price mechanism), where price and forces of demand and supply determine the production and distribution and consumption of resources and NOT the government authority. This means the resources a producer and a consumer gets are determined by their prices. This market where the ‘force of demand’ is on one hand and the ‘force of supply’ is on the other hand, with price at the centre of both is also termed free market.

(Demand and supply for goods/services determine the price. The consumer only buys if he/she can afford the price; the producer would produce if that price is attractive)

2.         Profit motive: Firms and individuals carry out economics activities to make profit.

3.         Competition: True capitalism needs a competitive market. Because, where there is no competition, monopoly exists and instead of the market setting the price of goods/services, the producer/seller is the price setter/giver, which is against the condition for capitalism.             

4.         Accumulation of wealth by private individuals and firms.

(This is why we have richest men in the world today – they keep accumulating wealth as business owners – they are referred to as capitalists)

4.         Minimal Government Intervention: Capitalist societies believe that the market (forces of demand & supply) should be left to operate without government intervention or interference. So, capitalism is based on the doctrine of laissez faire i.e. free from government interference or intervention. (Meaning the economy is allowed to operate without govt. intervention/interference).

5.         Inequality in the Distribution of Income and Wealth:  In capitalism, some people are extremely rich and some people are extremely poor. The saying ‘the rich is growing richer and poor is growing poorer’ is associated with capitalism – because the capitalists own and control the means of making income and wealth.

6.         Production decision is taken by private individuals and business organizations – they decide what to produce, how to produce and for whom to produce.    

7.         Consumer sovereignty: This means that the consumer has the power to decide what goods and services are produced. The producer can only produce what the consumer wants. Therefore, in capitalism, the consumer is king.

8.         Individuals are the entrepreneurs (i.e. owners of businesses)     

Classical Capitalism vs Modern Capitalism

Classical Capitalism (or Pure Capitalism)

Looking at some characteristics of capitalism, you discover that they do not exist in today’s real world. So, from where were they obtained? From the views of Adam Smith! His theory of capitalism is referred to as Classical Capitalism. The term classical means long time, traditional idea. So, classical capitalism is old-time theory of capitalism.

Adam smith’s theory on capitalism was that the state (government) should not get involved in any economic matters. The job of the government, according to him, is to make and enforce laws (including business laws), protect lives and property, maintain internal security, etc. This is the principle of laissez-faire, and what true capitalism entails. Adam smith’s classical capitalism is otherwise known as Pure Capitalism. And he called the competition among capitalists in pure capitalism perfect competition

(For detailed treatment of theory of perfect competition, see the topic “Market Structure”)

But in reality, classical or pure capitalism CANNOT work. Because, for example, to protect lives and property, maintain law, order and internal security, the government has to spend money on equipment and on payment of salaries of policemen, soldiers, and even government officials themselves. 

How would government raise money to do these? Surely, the government has to levy tax. Taxation is therefore the first government interference. Secondly, which of the capitalists would build roads, airports, bridges, schools, hospitals, seaports for free?

When Nigeria became a country, should the Nigerian Government have waited for the private sector (capitalists) to provide electricity, telecommunication services and water supply in our major cities? Certainly not! So the government established the following state-owned enterprises to provide these goods/services. The first two are now privatized, however.

(a)                National Electric Power Authority (NEPA)

(b)               Nigerian Telecommunications Limited (NITEL)

(c)                Water Boards in different state capitals

So for strategic and other reasons, government then established state-owned enterprises.

    

Modern Capitalism

In summary, there is no place for classical capitalism in today’s world economic system. Free market, perfect competition and government non-interference in economic activities DO NOT exist. What is obtainable in today’s world are regulated market and imperfect competition, yet having other characteristics of capitalism, giving rise to what is termed modern capitalism.    

Examples of Countries Employing Capitalism

It is argued that no country in the world today practices true capitalism, but some countries that somewhat have capitalist tendencies (modern capitalism) include:

United States, United Kingdom, Canada, France, Australia, Sweden, New Zealand, etc    

Advantages of Capitalism

The advantages of capitalism are the argument for capitalism. Countries that practice capitalism say it has these benefits and these are the reasons for practicing it:

1.         motivation for quality, hardwork, productivity, professionalism, expertise, excellence and success, because the more the goods or service you sell, the more income and wealth you make – consider Bill Gates, Mark Zuckerberg, Aliko Dangote

2.         existence of competition, which is the impetus for inventions and innovations. This results in constant improvement in technology because everybody wants what he/she offers to be the best – so as to remain relevant and earn profit from it. 

3.         Efficient allocation of resources/resource utilization:

Only goods/services that meet consumers’ tastes and preferences are produced. And how do we measure this? It would be shown in their willingness to pay for the price or not. So, what the consumers do not want is not produced, thereby avoiding waste or irrelevant production, giving some efficiency in resource utilization. 

4.         High economic growth       

Disadvantages of Capitalism

1.         Inequality in the distribution of income and wealth: a few individuals control a greater portion of the resources (wealth), while many in the majority have just very little or nothing.  

2.         Exploitation of other citizens by the capitalists. Those who own and control the means of production keep charging high prices for the goods/services they produce, to maximize profit at the expense of other people.   

 Socialism

This is an economic system where factors of production (means of production) are owned, controlled and managed by the state (country or nation). Private ownership of factors of production is NOT allowed. The citizens of the country collectively own the factors of production.

Socialism is also known as planned or command economy. Government decides what to produce, how to produce and for whom to produce. Examples of socialist countries are       

North Korea, Cuba, etc

Characteristics of Socialism

1.         Government set prices of goods & services.

2.         The state (i.e. govt) owns land and capital as factors of production.

           

3.         Public sector (govt) monopoly: only government owns business enterprises.

4.         Only the products that govt chooses will be available for people to consume.

 5.        The government is the only entrepreneur (owner of businesses)

Advantages of Socialism

The advantages of socialism are the argument for socialism. Countries that practice socialism say it has these benefits and these are the reasons for practicing it:

1.         Equality in the distribution of income and wealth: The government distributes to all citizens, so no big difference exists in the amount of resources among citizens.

2.         Social services such as healthcare, education, housing, etc are made available to all citizens by the government.    

Disadvantages of Socialism

1.         Lack of motivation for quality, hardwork, productivity, professionalism, expertise, excellence and success, because it does not matter whether you work hard or not – every one gets benefits from the government.

2.         Slow economic growth      

3.         Problem of measuring goods/services for national income accounting since competitive prices for them do not exist.      

Mixed Economy

Mixed economy is capitalism with government intervention. Both private individuals, firms and the government own, control and manage the factors of production (means of production). It is a system that combines both capitalism and socialism. Resources are allocated by market forces and central planning (govt) i.e. private sector and public sector participate in economic activites.

Example, govt and private individual can provide education, healthcare, electricity, employ labour, own capital, own media organization etc.       

Communism

This is an economic system where factors of production (means of production) are owned and controlled by the community as a whole. But in real life, people in government in communist countries soon hijack the communal collective function of making economic decisions, making it look like Socialism.

Communism is sometimes referred to as advanced stage of Socialism.

A Comparison of  Each Economic System and the Factors of Production

	Land	Labour	Capital
CAPITALISM	Individuals own, control and manage land	Individuals hire and manage labour	Individuals own, control and manage capital
SOCIALISM	Only govt own, control and manage land	Govt hire and manage labour	Only govt own, control and manage capital
COMMUNISM	Community or govt own, control and manage land	Community or govt control and manage land	Community or govt own, control and manage land
MIXED ECONOMY	Both govt & individuals own, control and manage land	Both govt & individuals  hire and manage labour	Both govt & individuals own, control and manage land

A Comparison of Ownership, Allocation and Basis of Valuation of Resources in Three Economic Systems

	Capitalism	Socialism	Communism
Ownership of production factors	Individuals	Everyone	Everyone
Production factors valued for	their ability to  make Profit	their usefulness to the citizens	their usefulness to the citizens
Resource allocation to citizens	decided by the law of demand  & supply	central plan (central govt.)	central plan (central govt.)
Resource allocated according to	one’s income, wealth and borrowing ability	Contribution to the economy	One’s need

Socialism vs Communism

The two tables above shows that the major differences between socialism and communism are:

1.         In socialism resources are allocated based on one’s contribution to the economy; while in communism it is based on one’s need

2.         There is no labour control in socialism; but labour control exists in communism    

Traditional Economy

This is a system where means of production are owned, controlled and managed by tribal rules or custom. Traditional or custom of a people decides what to produce, how to produce and for whom to produce.