4

Political and Economic Systems Defined

An economic system can be defined as any method a nation uses to allocate and manage its resources among its population. The three aspects of any economic system involve production, distribution, and consumption. Political systems are defined as the organized set of laws, common values, and institutions that make up a nation’s government; in this definition is included the method in which a state is actually run and is not only limited to how it is supposed to run. Political and economic systems are deeply interwoven and changes that affect one usually impact the other.

There are four types of economic systems in today’s world, they are:

* Command (or Planned)
* Market
* Mixed
* Traditional

The main focus of this chapter will be on command, market, and mixed systems, since it is these three that make up the majority of the world’s economies. Note: Traditional economies can still be found today but are usually limited to regional pockets of tribal, religious, or agrarian subsistence communities. To learn more about traditional economies, please visit the links below:

* https://blog.udemy.com/types-of-economic-systems/
* https://www.worldatlas.com/articles/what-is-a-traditional-economy.html

Resources Defined

In the previous section we defined the term economic system and learned that it deals with resource allocation and management. Resources, in this context, are sometimes also referred to as factors of production. All of a country’s resources can be classified into these five factors of production:

– Land: All the natural resources. It includes farmland, oil deposits, minerals in the soil, bodies of water, wind, etc.
– Labor: Manpower and the available workforce.
– Physical Capital: Refers to goods that are produced with the purpose of being further processed into finished and consumer goods. They constitute a stage in the manufacturing process.  E.g. Steel is mass produced and sold wholesale to companies who will then process it into a variety of items from kitchenware to jewelry. Cash is a form of physical capital.
– Human Capital: Refers to the knowledge and skillset that labor brings to the manufacturing process. It is an intangible resource but it is essential in order to create quality products and insure efficient processes.
– Entrepreneurship: Is another intangible resource, it refers to the select individuals who through ingenuity and self-motivation bring together some of the other factors of production and create new products or industries. Entrepreneurship is different than human capital although some economists argue that both are subdivisions of Labor.

The Economic Spectrums

To better understand the materials in this chapter, including how economies are classified, it helps to look at the figure below, “Economic Spectrums”.

[No royalty required. I made this in Paint]

When looking at the top spectrum (the one that ranges from free-market to command) It is important to understand that in the real world, there is no such thing as absolutes when it comes to economic systems. No economy is purely free-market or command, in practice, every economy is technically a mixed system with some countries leaning more towards command and others towards free-market. Theoretical definitions, although imaginary, help us objectively measure and compare the different systems as used by different countries; so remember, every economy is a mixed economy in practice. That being said, it is generally acceptable to refer to a country based on what end of the spectrum they are closest to. One might say Australia is a free-market economy, while Cuba, up until recently was a strong command economy.

The middle spectrum containing the terms capitalism, socialism, and communism refers to the combination of both economic and political theories. Notice that capitalism is on the same side as free-market, and communism the same as command. Although some of these terms are sometimes used interchangeable in every day speech, there are a few differences that you must be aware of. Capitalism refers to the private ownership of the means of production where trade and industry are carried out for profit by people and not by government. Free-market is a broader term which simply refers to a system where the laws of supply and demand dictate the outcome of commerce and industry. In a similar pattern, communism advocates equality amongst members of a society, property is publicly owned, and the government distributes to each according to his needs. The broader term to describe a system where the government controls prices and production is planned or command economy.

The bottom spectrum simply serves to illustrate what each side favors. A free-market capitalist economy will strongly protect the rights of individuals (companies or people) and each person is left to compete against others for wealth and resources, this can be an unforgiving environment for those who do not fend well. On the other end collectivism places the wellbeing of the group above that of the individual and the group, in theory, takes care of each other, however, this too can have negative outcomes if the authoritative body abuses its power or if a the wellbeing of the whole comes at the expense of a few and you find yourself in the few.

Free-Market Economy

A free market economy is one in which individuals and firms control the means of production through private ownership and minimal government interference. It is a Laissez-faire approach, or a policy of governmental non-interference in economic affairs. Because supply and demand dictate the behavior and direction of the economy, it is for the most part self-regulating.
In a free market economy, the market is simply a mechanism of exchange of goods and services between those who have them and those who want them. Innovation and entrepreneurship thrive best in a market economy.

“In market economies, economic decisions are made by individuals. The unfettered interaction of individuals and companies in the marketplace determines how resources are allocated and goods are distributed. Individuals choose how to invest their personal resources—what training to pursue, what jobs to take, what goods or services to produce. And individuals decide what to consume. Within a pure market economy the government is entirely absent from economic affairs.”  – Ghiya Robins

Countries shifting towards a market economy must undergo three critical steps:

1. Deregulation – Removing the legal restrictions to free enterprise in a market economy
2. Privatization – The transfer of ownership of state property to the private sector.
3. Legal Systems – The creation of laws that protect private property rights and contract enforcement.

[Reference: From CH3 PowerPoint – Economic Development]

Command Economy

A command economy is, in a sense, the opposite of a market economy. A command (or planned) economy is an economic system in which the government or other centralized group determines wages, sets prices, and distributes resources and products to the common group, it also oversees the types of industries it will operate.
(from CH 2 Powerpoint)
There are two basic types of command economy are:

Communism: Where the government owns all factors of production and makes all the decisions on how resources within that nation will be used. The government also determines who gets capital and how it is used to build industries.

Socialism: Government controls critical industries but allows individual freedoms, some individual right to own property and start businesses that the government does not consider critical to the overall economy. This type of command economy is the transition between strictly command and mixed system.

[ needs attribution. Website: https://commons.wikimedia.org/wiki/Category:Communism#/media/File:%22Vive_Le_Marxisme-Leninisme!%22.jpg]
Attribution: By Laurent GUEDON from Paris, France – IMG_0978.JPG, CC BY-SA 2.0, https://commons.wikimedia.org/w/index.php?curid=2074160

Mixed Economy

A mixed economy is an economic system in which both the state and private sector direct the economy in the way goods and services are bought and sold, reflecting characteristics of both market economies and planned economies. Mixed economies allow many more freedoms than command economies, this promotes healthy competition and results in profit. Some of the freedoms allowed include the freedom to possess the means of production; to participate in managerial decisions; to buy, sell, fire, and hire as needed; and for employees to organize and protest peacefully. It can be thought of as a middle ground between Free-market and Command. Most mixed economies can be described as market economies with strong regulatory oversight. Overall, businesses, as well as consumers, in mixed economies have freedoms that are important to both. And while government is actively involved and provides support, its control is limited, which is good for structure.

Characteristics of mixed economies on the government side include welfare systems, employment standards, environmental protection, and antitrust policies. The advantage of this type of system is that it allows competition between producers with regulations in place to protect society as a whole. With the government being present in the economy it brings a sense of security to both sellers and buyers. This security helps maintain a stable economy.

Some economists argue that because social democratic (mixed) programs retain the capitalist mode of production they also retain the fundamental problems of capitalism, including cyclical fluctuations, exploitation and alienation. Another disadvantage of mixed economies is that they tend to lean more toward government control and less toward individual freedoms.
Note: The term is also used to describe the economies of countries which are referred to as welfare states (A social system in which the state takes overall responsibility for the welfare of its citizens, providing health care, education, unemployment compensation and social security) such as Norway and Sweden.

Barriers to Free Trade

Free trade means that countries can import and export goods, unencumbered by trade barriers. Trade barriers are government-induced restrictions on international trade. Man-made trade barriers come in several forms, including: tariffs, non-tariff barriers to trade, import licenses, export licenses, import quotas, subsidies, voluntary export restraints, local content requirements, embargo, currency devaluation, and trade restrictions. Employing such barriers is often referred to as protectionism. The methods used to regulate imports and exports strongly depends on the type of political and economic system a country has.
Protectionism
Most trade barriers work on the same principle–the imposition of some sort of cost on trade that raises the price of the traded products. If two or more nations repeatedly use trade barriers against each other, then a trade war results. Economists generally agree that trade barriers are detrimental and decrease economic efficiency. Trade barriers are often criticized for the effect they have on the developing world. Because rich-country players set trade policies, goods, such as agricultural products that developing countries are best at producing, face high barriers. Tariffs also tend to be anti-poor, with low rates for raw commodities and high rates for labor-intensive processed goods. Another negative aspect of trade barriers is that it would cause a limited choice of products and, therefore, would force customers to pay higher prices and accept inferior quality. An export subsidy can also be used to give an advantage to a domestic producer over a foreign producer. Export subsidies tend to have a particularly strong negative effect because in addition to distorting resource allocation, they reduce the economy’s terms of trade.

Why This Matters

We live in a world where technology draws people closer together every single day. Information travels at the speed of light and the continued spread of globalization means that there are less and less commercial barriers between countries. A student might find, once he or she graduates and enters the labor market, that they will be interacting with people from all around the world and from incredibly diverse backgrounds on a daily basis, if not personally they will undoubtedly find themselves partnering or working for a company with suppliers, customers, or even entire departments that operate in different parts of the world under different economic systems. For this reason, it is crucial to understand economic systems and the role they play in modern business.

Read the following case study:

Mark has recently graduated university with a degree in business administration, he gets an internship with a regional food supplier that is looking to enter the European market. Because the European market has a mixture of different economic systems the company must develop a strategy on how to enter. Mark is called to sit in on a meeting where the different section heads are discussing the best approach to the situation.

One of the attendees argues that the company ought to establish themselves in the United Kingdom first (free-market system), where barriers to entry are relatively low, but competition is fierce and the company runs the risk of suffering heavy loss if the locals do not embrace their product, on the other hand if the company successfully embeds itself into the way of life, the payout will be extraordinary.

Another attendee argues that the best strategy would be to enter through Eastern Europe, with help of one of the company’s overseas partner if a government contracts can successfully be secured. She argues that if they manage to secure a contract as a government supplier, although tariffs on their product may be higher, they minimize other risks by obtaining a steady flow of business for the duration of the contract.  Naturally, it would take detailed logistics and analysis to come to a final decision, but this is just one example on the importance of understanding economic systems and what their real world impact is. In fact we can relate this back to the three fundamental economic questions: what is produced? How is it produced? And for whom will it be produced? Economic systems impact the answer to all of these questions.

But what about non-business students? How does this affect them?

Understanding economic systems is important for non-business students alike. Economic systems as stated above, impact everything from what products are available, to what taxes should be levied across all levels of income.  Read on:

In July of 2016, McDonalds in Venezuela was forced to stop selling Big Macs because it was unable to source the bread needed to make the sandwich. As Venezuela’s political system shifts from a democracy towards an authoritarian rule, its economic system is also changing (from market to command). In this basic example we see that people are the ones who are impacted by these matters.

Link to article: https://www.bloomberg.com/news/articles/2016-07-21/mcdonald-s-venezuela-stops-selling-big-mac-on-bread-shortage

Examples Here in Utah
One of the more interesting economic systems that wasn’t discussed as thoroughly in the chapter is a Traditional economic system. These systems are rooted in tradition, as the name would suggest, and can still be found in many different places around world. In Islamic economics for instance, certain procedures must be observed in order to fully comply with Islamic law, “Riba”, or, interest is forbidden in the Qur’an and so alternative methods for earning lending and borrowing money have been integrated into Islamic banking. In this example tradition was integrated into a mixed system to be in line with values and laws of the region (think about the definition of political system).

But what about here in Utah?

Utah is a great place to showcase the beauty of economic systems at play. Utah, as part of the United States operates largely based on a free-market system. Quality businesses in Utah thrive and customers love buying local to support their communities. Supply and demand dictate prices and competition makes sure everyone in Utah is playing by the rules. But there is more than meets the eye when looking at Utah’s economy.

Worldwide Utah is known for its beautiful landscape (the Rocky Mountains and delicate arches), its quality skiing, and its religious heritage. Utah was founded by Mormon pioneers fleeing persecution in the early 1800’s. Because it was established by Latter Day Saints for Latter Day Saints, Utah’s economy grew side by side with the LDS church. As time went on Utah’s economy and population grew, but the church remains to this day a strong player in the Utah way of life with membership somewhere between 45% and 48% of its population according to recent estimates.
The LDS church has, amongst its many beliefs and practices, a commandment regarding tithing. The church says:
“To fulfill this commandment [tithing], Church members give one-tenth of their income to the Lord through His Church. These funds are used to build up the Church and further the work of the Lord throughout the world.”

The LDS church currently has over 15 million members worldwide, 10% of the income of the working members, even by the most conservative of standards, accounting for those who do or do not participate in the commandment, still accounts for billions of dollars annually. This is a perfect example of a traditional economy at work operating within the larger geopolitical arena of the United States. Because of the LDS church has a global following, their traditional economy extends far beyond the US and has an impact in just about every corner of the globe. Tithes are paid based on tradition and the money generated from that specific economic system is used to further causes such as real estate development, humanitarian efforts, funding education, and many other areas of human development.
At the same time, the LDS church, must abide by the economic system of the countries in which it is engaging in its activities.
Many of Utah’s parks, buildings, shopping malls, and social programs are owned or partially funded by the church. Making the traditional economy that is the LDS church one of the largest players in Utah’s market economy.
Many jobs in Utah come from international trade (more than 1 in 5). Utah export $16.0 billion in goods and $6.1 billion in services. Importing also allows for lower prices and a wider variety of choices for Utah families. Trade barriers, tariffs, and taxes effect trade in Utah a great deal. FTA’s (Free Trade Agreements) have helped Utah grow to partner countries and increase Utah’s export revenue. Free trade is not possible with taxes, tariffs, and trade barriers, and would harm Utah’s exporting. Kennecott Utah Copper is one of the leading exporters, sending copper and other metals overseas to other countries. Without free trade agreements, it would be harder for them to export copper, and would hurt Utah’s economy significantly.

References
* Amadeo, Kimberly. “Market Economy, Its Characteristics, Pros, Cons with Examples.” The Balance, 27 Mar. 2018.
* Pettinger, Tejvan. “Command Economy.” Economics Help, 28 Apr. 2017, www.economicshelp.org/blog/glossary/command-economy/.
* Pettinger, Tejvan. “Mixed Economy.” Economics Help, 28 Jul. 2017, www.economicshelp.org/blog/glossary/mixed-economy/.
* Singh J. (2015, August 18). Factors of Production : Land, Labour, Capital and Entrepreneur | National Income. Retrieved from http://www.economicsdiscussion.net/production/factors-of-production-land-labour-capital-and-entrepreneur-national-income/541
* Bryant, C. (2018, March 08). Human capital vs. physical capital: What is the difference? Retrieved from https://www.investopedia.com/ask/answers/062616/human-capital-vs-physical-capital-what-difference.asp
* Heslop, D. A. (2017, March 17). Political system. Retrieved from https://www.britannica.com/topic/political-system
* Shmoop Editorial Team. (2008, November 11). Types of Economic Systems. Retrieved from https://www.shmoop.com/economic-systems/types.html
* Orozco, J., & Zerpa, F. (2016, July 21). McDonald’s Stops Selling Big Mac in Venezuela Due to Bread Shortage. Retrieved from https://www.bloomberg.com/news/articles/2016-07-21/mcdonald-s-venezuela-stops-selling-big-mac-on-bread-shortage
* Tithing. (n.d.). Retrieved from https://www.lds.org/topics/tithing?lang=eng

 

References

Amadeo, Kimberly. “Market Economy, Its Characteristics, Pros, Cons with Examples.” The Balance, 27 Mar. 2018.

Pettinger, Tejvan. “Command Economy.” Economics Help, 28 Apr. 2017, www.economicshelp.org/blog/glossary/command-economy/.

Pettinger, Tejvan. “Mixed Economy.” Economics Help, 28 Jul. 2017, www.economicshelp.org/blog/glossary/mixed-economy/.

 

LICENSES AND ATTRIBUTIONS

Module 3: Different Strokes …. Political and Economic Systems Around the Globe by Lumen Learning is licensed under CC BY-NC-SA 4.0

 

OLD IS BELOW

Economic Systems Defined

An economic system can be defined as any method a nation uses to allocate and manage its resources among its population. The three facets of an economic system are production, distribution, and consumption.

[REFERENCE: https://www.investopedia.com/ask/answers/062616/human-capital-vs-physical-capital-what-difference.asp]

 

The Economic Spectrums 

To better understand the materials in this chapter, including how economies are classified, it helps to look at the figure below, “Economic Spectrums”.

 

If you look at the figure, the top spectrum is the broadest and most encompassing, it is the one labeled ‘Free-Market’ on left and ‘Command’ on right.

 

It is important to understand that in the real world, there is no such thing as absolutes when it comes to economic systems, no economy is purely free-market or command, in practice, every economy is a mixed system with some leaning more towards command and control and others towards free-market. Theoretical definitions, although imaginary, help us objectively measure and compare the different systems used by countries; so, remember, every economy is a mixed economy. That being said, it is generally accepted to refer to a country based on what end of the spectrum they are closest to. One might say Australia is a free-market economy, while Cuba, up until recently was a strong command economy.

The second spectrum includes the terms capitalism, socialism, and communism, this is likely to be the one that causes the most confusion amongst students and people in general. Capitalism, Communism, and Socialism are by definition economic systems. Economic systems are often associated with certain philosophies or political ideologies which is where the confusion arises. People will often, unknowingly, use the term communism as a metonymy to refer to the types of government where communism is most common such as authoritarian governments, oligarchies, dictatorships, semi-presidential federations, Emirates, and so on. Be sure to understand the difference between political systems and economic systems before moving forward.

Lastly, we observe the spectrum between individualism and collectivism. Free markets favor the individual whereas command economies lookout for the public interest or in other words, what is best for the community. We will study these concepts more in-depth throughout the chapter.