Economic Systems

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Economists will often produce explanations for behavior within economic systems. The laws, patterns, and rules of economic theories are not universal laws of human nature; rather, they apply in certain economic systems where market participants understand established rules of trade.

Economists will often produce explanations for behavior within economic systems. The laws, patterns, and rules of economic theories are not universal laws of human nature; rather, they apply in certain economic systems where market participants understand established rules of trade.

What are these economic systems? According to the Journal of Economic Literature, economic systems are studied to understand how large enterprises, governments, and groups of market participants trade with one another, create welfare systems to combat poverty, create new systems to encourage greater prosperity, manage natural resources, and create legal institutions that protect the legally defined property that individuals or groups within those systems own.

These systems are complex and grow more complex over time as market participants negotiate more refined, new rules about trade and resource allocation. However, there are four broadly, agreed-upon economic systems that have been dominant in human history, and many economic proponents will support one of these four systems as the “ideal” economic system for many, if not all, people on Earth to adopt.

Studying economic systems is important because they influence much more than markets. People who live in each economic system will tend to have different political ideals and aspirations, and different systems tend to be more successful. Additionally, as the world begins to harmonize towards one global unified economic system, the pros and cons of each system need careful scrutiny to be able to implement the benefits of each in future markets, while carefully avoiding the failures.

1. Traditional Economic Systems

One individual cannot create a traditional or pre-modern economic system.  Instead, it develops over time.  These economic systems tend to be organic; rules evolve slowly over time, and those that are popular and successful tend to survive while other less popular rules tend to disappear. In traditional economic systems, the rate of change tends to be slow, making it difficult for an individual economic actor to encourage social change.

In traditional economic systems, market participants are rarely aware that there is such a thing as an economy at all. Rather, the rules of trade develop over time and form a tradition considered a large part of the ethical and moral system of the society. However, sometimes these ethical rules can be economically counterproductive, leading to stagnation or an urge to change. A good example would be medieval European rules against charging interest—considered a sin in the Christian faith of the time. This slowed the economic development of many large-scale projects in Western Europe, and urged non-Christians to specialize in finance to allow Christian civilizations to enable those big projects.

In these systems, technological innovation that can disrupt traditional economic systems can be threats and shunned or outright banned. Examples of traditional, economic systems are abundant in pre-modern Europe, as well as in pre-colonial tribes in the Americas, Australia, Africa, and the Pacific islands.

2. Market Economic Systems

Sometime in the late middle-ages and early modern period, Europe began to develop an economic system that was different from the rest of the world that many historians argue is one of the reasons it grew in wealth beyond the rest of the world. This is the market-based economic system, in which individuals meet in markets and decide what economic decisions they want to make for themselves.

The emphasis in market systems is on trade, which can be restricted by private market regulators (for instance, buying and selling stocks on the NYSE is restricted by the stock exchange itself), but in their most radical ideal form, a free-market economic system has virtually no oversight from any agency. This entirely free-market system has only existed in small pockets in history, and even then, there is a debate about its existence. The regulated, but mostly free market system is what the United States enjoyed in the earliest years, and some argue it has created more wealth for humanity than any other system in history.

3. Command Economic Systems

The command economic system is in many ways the exact opposite of the market economic system. In this system, an overseeing government decides how resources are distributed amongst individuals within the system; trade and individual choice at the consumer and worker level is minimal or, in some cases, entirely non-existent.

The ideal of a command economic system is to enforce equality and efficiency on markets. In market economic systems, some market participants become substantially more prosperous than others, the command system tries to ensure this does not happen by making sure to allot everyone an equal amount of wealth. In reality, the distributors of wealth at the government level often hoarded wealth for themselves, making the command system collapse.  This was the case with the USSR.  Reform, as is the case with the current People’s Republic of China, or remain prone to death, humanitarian crises, and extreme poverty, as is the case with North Korea.

4. Mixed Economic Systems

The final economic system is perhaps the most common on Earth, and some would argue that the United States is currently a mixed economy, along with those of Western Europe and parts of East Asia. Many developing economies are striving to become mixed economic systems, and many policymakers and economists agree that the flexibility of this system makes it the most desirable system to enforce in a nation.

The mixed economic system strives to combine the best parts of a market and command economy. Mixed economic systems will usually allow most people to decide how to obtain and spend capital, what work they would like to pursue, how much they would like to save, and what lifestyle they want to enjoy. At the same time, a command-based system from the government places restrictions on making choices and encourages market participants to move towards one decision over another.

This “nudging” of free markets is largely the role of many modern institutions such as the Federal Reserve, the Food and Drug Administration, and similar government and quasi-government institutions. Almost every modern economy is a mixed economic system and many economists believe it will be the ultimate system to win, so most economists develop models to explain behavior in these systems.

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