Why are some countries so rich and others so poor? Does the presence of abundant natural resources account for a country’s wealth? Why is there such a lack of economic development among different indigenous groups around the world? How important is government to an economy and what are the government’s appropriate economic roles? A study of different economic systems will shed some light.
In order to survive, societies must make decisions about how to best use their scarce resources (land, labor, capital, and entrepreneurial ability). Economists have concluded that for societies to survive with their limited resources, they must answer three basic questions:
The eighteenth century, also known as the Age of Reason, or the Enlightenment, saw a fundamental shift in the way people viewed their world. The year 1776 was especially important, for it not only was the year that Thomas Jefferson wrote the Declaration of Independence, but it was also the year that Adam Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations was published.
Throughout history, people have developed a variety of systems to answer these questions. Most primitive societies developed what economists refer to as traditional economies. With the development of civilization came command economies, and following the Enlightenment, market economies finally emerged. In addition, combinations of these primary systems developed, including communism, socialism, and capitalism (discussed later in the book).
In a traditional economic system, the questions of what and how to produce and whom to produce for are answered by tradition. If you’ve seen a documentary on a primitive culture, then you’ve also seen a traditional economy in action. The Kalahari Bushmen live in one of the world’s harshest environments, where even the most basic resources are in meager supply. In order to survive and have enough food, the Bushmen have developed a division of labor based on gender. Women perform the food gathering and men perform the hunting. The food is then shared with the whole tribe. In this type of system, stability and continuity are favored over innovation and change. The roles of the people are defined by gender and status in the community. In this system, the old, young, weak, and disabled are cared for by the group. The group shares the few possessions they have, and private property is an alien concept. For the most part, everyone in this system understands his or her relationship to the community, and as a result, life hums along in a fairly predictable way.
As hunter-gatherer societies grew and eventually exhausted their natural food supplies, some survived by becoming sedentary farmers. With the advent of farming came a need for an organized system of planting, harvesting, and storing crops. This required a greater amount of structure than existed in a traditional economy. In order to ensure the survival of the society, decisions had to be made about what crops to grow and how much of the harvest to store. Over time, decision-making became centralized, and the command economic system developed. The key characteristic of the command economy is centralized decision-making. One leader (or a group of powerful individuals) makes the key economic decisions for the entire society.
Examples of command systems include most, if not all, ancient civilizations, plus the communist countries of today. The pharaohs of Egypt represent the centralized decision-making present in a command economy. The pharaoh and his various officials made the key economic decisions of what to produce, how to produce, and for whom to produce. The decisions might have gone something like this, “I command you to construct a big pyramid of brick and mortar using slaves for labor, and all of it is for me.” The advantage of this type of system is the ability for decision-makers to produce rapid changes in their society. For example, Soviet dictator Josef Stalin’s five-year plans quickly transformed the Soviet Union from a peasant-based agrarian society into one of the world’s industrial superpowers.
During World War II, the United States practiced command economy when the government took over factories and planned production for the war effort. Every aspect of American life was in some way influenced by government involvement in the economy. Even today you can see the influence. The modern payroll withholding system was instituted during the war to provide the government with a steady stream of tax revenue.
History reveals the tragic downside of command economic systems. As previously discussed, the pharaohs used slave labor, and Stalin’s five-year plans were only accomplished through the forced relocation of millions of people and at the cost of millions of lives. Rarely do the decision-makers meet the wants and needs of the common citizen. The citizens serve the economy and state as opposed to the economy and state serving the citizens. North Korea is a perfect example. Property belongs only to the state. Many workers have little personal incentive to produce, and those that do may have little regard for quality. Individuality, innovation, and variety are completely lacking in the command system.
In total contrast to the command economic system is the market economy. Market economies are characterized by a complete lack of centralized decision-making. As opposed to top-down planning, market economies operate bottom-up. Individuals trying to satisfy their own self-interest answer the questions of what, how, and for whom to produce. Private citizens, acting on their own free will as buyers or sellers, trade their resources or finished products in the market in order to increase their own well-being. Though it might appear counterintuitive, market economies achieve greater abundance, variety, and satisfaction than either traditional or command economic systems.
Although they cannot be classified as pure market systems, Hong Kong, the United States, Australia, and New Zealand are representative of market economies. In each you will see a greater variety of goods and services being produced than anywhere else. Also, because the focus is not on serving the state, individuals are free to choose their vocation, own private property, and determine for themselves how to best use the resources they possess. Markets reward innovation, productivity, and efficiency but discourage complacency, idleness, and waste. If markets have a downside, it is that those who are unable or unwilling to produce because of either circumstance or choice are often sidelined and unable to enjoy the benefits of the system.
The amount of output produced with a given amount of resources.