4 Types of Economic Systems: Which is Used by the World’s Biggest Economies?

4 Types of Economic Systems: Which is Used by the World’s Biggest Economies?
Imed Bouchrika by Imed Bouchrika
Chief Data Scientist & Head of Content

The prosperity of nations all across the globe can be measured by the way their economies perform. By recognizing the manner in which the wealth and resources of countries are allocated in their respective societies, a deeper understanding of the relationships between government units and organizations is gained, potentially leading to opportunities to improve the quality of life in the long run.

This article navigates economic systems and their pros and cons. It answers questions like “What are the different types of economic systems?,” “Who are the biggest players?,” and “What is my significance as an individual to the economy?” In reading through the write-up, learners will gain a firm grasp of the various economic systems and how they apply to modern society.

Types of Economic Systems Table of Contents

  1. What is an Economic System?
  2. Traditional Economic System
  3. Command Economic System
  4. Market Economic System
  5. Mixed Economic System
  6. The World’s Biggest Economies and Their Economic Systems
  7. The Importance of the Human Factor

What is an Economic System?

Economic systems are a means by which governments and society’s sectors distribute resources throughout a region or country. They are complex and multidimensional, with the decisions made on production, produced goods, and those who would benefit from them having a moral and political context (Duffy, 2014). Encompassing organizational and regional directives, economic systems regulate capital, labor, and trade.

High-quality collective goods—including education, the environment, and even social institutions—are essential to economic development and a well-functioning society (Barney & Rangan, 2019). As such, there are a variety of ways these resources are allocated. Some economies have governments take control over the proceedings while others grant citizens near-free rein over which goods to produce, their prices, and the parties to sell them to. From those differences emerged 4 types of economies. 

Source: IMF 2020

The 4 Types of Economic Systems

Each type of economic system has its own set of special features, and, with the exception of the mixed economy, they are vastly different from one another. None of the systems are universal solutions for all countries, as each has its own strengths and weaknesses (Gemma, 2020), but there are economies that are more likely to yield higher gross domestic products (GDPs) than others. In addition, a country may have one predominant type of economic system, but some of its regions may carry a different system, with real-world economies being more dynamic and more complex than their theoretical counterparts (Duffy, 2014).

Traditional Economic System

Typically agrarian in nature, traditional economies allocate resources based on kinship, custom, and religion. It is the most long-lived of the four types and is reinforced by clannish, tribal, and sectional ties (Duffy, 2014). With this type of system, goods are produced commensurately with the needs of the local populace, thus surplus and profits are limited. Wastage, on the other hand, is also low, making this type of economy sustainable (Corporate Finance Institute, nd).

Businesses in traditional economies are conducted with social and/or religious norms in mind, sometimes at the expense of profits (Duffy, 2014). The barrier to entry is low and many of the items produced are basic consumer goods like farmland crops or woven textiles. In the event that producers gain a significant amount of surplus, they are often paid to more powerful entities like landowners or corporations.

Innovation moves at a far slower pace in traditional economies compared to the other types since there is little motivation for people to do so given that they receive an adequate supply of basic needs. The access to resources necessary to industrialize is also vastly limited, with those concentrated in the hands of a few people like corporations and aristocratic families. Nevertheless, the people, in general, are socially satisfied. After all, the ties that bind individuals and organizations are held in higher regard than profit.

Pros

  • Simple division of work. Since traditional economies are composed of tightly knit families and communities, the people already know what to do and, in some cases, already have preexisting roles prior to working (Study.com, 2015).
  • Minimal wastage. Workers in traditional economies know the maximum capacity of their work areas, be it a plot of farmland or a fishing site, and therefore produce goods in sufficient quantities with limited excess (Gemma, 2020).
  • Earth-friendly. With the land as the source of their trade and basic necessities, their working measures don’t produce as much industrial waste as the other types of economic systems (Study.com, nd). They also don’t have access to a lot of modern equipment that produce harmful emissions in large volumes.
  • Socially satisfied populace. Family, community, and religious ties hold more weight than business profits. The norms that bind the economy are upheld (Duffy, 2014).

Cons

  • Money is in the hands of only a few. A large brunt of the profits earned in traditional economies is in the hands of powerful entities like extended families and corporations, and the same goes for the surplus generated (Duffy, 2014).
  • Limited progress. Technological advancements that streamline processes and increase outputs and output quality are hard to come by in traditional economies (Duffy, 2014). The resources are limited and the deployment of such is largely controlled by corporations and aristocrats. This also lends to the lack of centralized utilities in rural areas.
  • A low cap on profits. Since the operations are largely localized and whatever surplus generated is appropriated by powerful entities, the profits obtained by producers are modest. Many of the people are at the subsistence level (Duffy, 2014).
  • Limited access to medicine. The largely localized ecosystems in the agrarian areas is not profitable enough for investors to ply their trade there (Gemma, 2020), thus the inflow of Western medicine is reliant on imports. Also, the resources necessary to produce Western medicine are scarce.

Command Economic System

In a command economy, the state decides what and how much will be produced and orders state-owned enterprises to meet specific quotas (Duffy, 2014). This type of economic system often takes shape if a country is in possession of large volumes of a valuable commodity; for instance, oil and precious minerals. The government controls that commodity’s production and distribution locally and internationally.

Command economies also occur in egalitarian forms of government like socialism and communism. In the former, the state owns and enforces the production of capital goods but allows the people to handle labor. Communism, on the other hand, grants state control and ownership of all the factors of production (Study.com, nd). Central planners are tasked to determine the goods needed by the public based on their perceived needs and wants along with their respective quantities.

With the government lording over an entire country’s production, there are enough jobs to accommodate a majority of the public, more than what the other economic systems have to offer in theory (Duffy, 2014; Gemma, 2020). Government initiatives are also unimpeded, rolled out with a concerted effort from the public, which potentially propels an economy. Certain public freedoms, however, are given up for the “greater good” of the country and the welfare of the people.

Pros

  • Affordably-priced capital goods. The margins are lowered when command economies sell capital goods to their citizens (Gemma, 2020). After all, they receive a bulk of their profits from international trade.
  • Jobs for everyone. With the government controlling the industrial sector, it creates countless jobs for its citizens, ideally taking everyone within its jurisdiction into account (Gemma, 2020). This, in effect, also reduces the number of homeless and hungry people (Duffy, 2014).
  • Plans are easily rolled out. Since the government has complete control over production, it can execute economically sound plans without any roadblocks. This could potentially raise a country’s GDP in the long run or provide citizens with projects like universal healthcare (Depersio, 2019).
  • Less inequality. The work, pay, and positions of people in the industrial sector are dictated by the government. So those in lateral positions should more or less receive the same compensation (Depersio, 2019).

Cons

  • Inefficient procedures. While production plans may go unimpeded, the processes by which those initiatives are executed might not receive upgrades since the government is the only player in the market (Depersio, 2019). The absence of competition could also lead to substandard goods (Duffy, 2014).
  • Prone to abuse. Too much power in the hands of one entity leads to laws or rules that infringe on human rights and workers’ rights. For instance, the state can mandate shifts that exceed 12 hours to achieve a particular quota. Not meeting the desired quantity of outputs could lead to serious financial consequences (Duffy, 2014).
  • Inferior products. The strict quotas mandated by a command economy can lead to workers cutting corners in production, resulting in subpar products. Oddly low projections may also be given by workers just so their quotas will be reduced (Duffy, 2014).
  • Uneven distribution of commodities. It is not easy for central planners to come up with the exact type and quantity of commodities to be afforded to citizens since the needs of individuals and households vary (Duffy, 2019). This can lead to an oversupply in certain consumer goods and a scarcity in others.

Market Economic System

In a market economic system, the control and direction of financial and other resources lie preponderantly with entrepreneurs, enterprises, and executives operating in a diverse array of organizations within markets (Barney & Rangan, 2019). The government does not control the land’s valuable commodities nor does it figure heavily in the production and distribution of those commodities.

The market economic system, in theory, alludes to a free market with barely any government intervention in regard to producing and distributing a nation’s vital resources, but that is not really the case in real-world economies (Duffy, 2014). Governments in market economies regulate trade to maintain fairness within markets and prevent enterprises from gaining too much power over industries. This is also a means of curbing or preventing inflation and market volatility.

With enterprises in charge of their respective industries, the gaps between supply and demand can be quickly acted upon. Meanwhile, the competition in the market affords the public lots of options per commodity and also pushes producers to improve the quality of their goods. A downside, however, is the huge disparity in wealth among social classes.

A key identifier of this economic system is the separation between the market and the government (Gemma, 2020), with supply and demand dictating how resources are allocated (Amadeo, 2020).

Pros

  • Constant innovation. As enterprises try to gain a larger share of the market, they constantly improve on their products or services, incorporating new technologies and methods wherever possible.
  • Economic growth. With enterprises helming their respective industries, goods are produced at a fast pace, with surpluses coming in huge numbers. This leads to growth in an economy (Corporate Finance Institute, nd)
  • Responsive to public demand. The decentralized market features a multitude of producers trying to gain a larger share in profits. To do that, they have to meet the demands of the buying public (Duffy, 2014) and sometimes exceed them to outperform their competitors.
  • Fosters economic activity. New players are welcome to ply their trade on the market, whether one opens a business or gets employed, to make money (Study.com, 2015). Individuals have the freedom to find ways to earn as long as they are within the bounds of the law.

Cons

  • Inequality in wealth. Wealth is concentrated on those who hold power in the economy. The poor do not have access to a lot of opportunities that can make them wealthy (Study.com, 2015).
  • High risk. While people are welcome to open businesses, succeeding in those ventures is an entirely different matter (Duffy, 2014). The competition is fierce in high-demand industries and those who do not have sufficient capital will likely lose a price war with corporate giants.
  • Hard to enter high-paying jobs. Due to the fierce competition in the market, finding a job that pays well is not easy. Some people experience stagnation in their incomes while others see their job prospects erode (Barney & Rangan, 2019).
  • Environmental damage. A lot of manufacturers operate in factories that produce harmful emissions. For them, finding earth-friendly solutions is too tedious and costly (Study.com, 2015).

Source: The Heritage Foundation 2020

Mixed Economic System

The mixed economic system, also known as the dual system, combines some of the characteristics of traditional, command, and market economies (Amadeo, 2020). It has myriad variations, with the most prevalent ones incorporating free market systems in the industrial sector while applying some of the principles of command economies in utilitarian sectors like public utilities or education (Gemma, 2020). Meanwhile, the traditional economies in rural areas are left untouched.

The models of mixed economies tend to vary based on the needs and priorities of the public (Amadeo,2020). In some economies, governments are allowed to map out plans to raise economic performance akin to the planners in command economies. In others, governments take charge of international affairs and spearhead programs for aeronautics, banking, and other key sectors.

As mixed economies assimilate the traits of the other three economic systems, they gain some of the advantages and disadvantages that come with those systems. Moreover, the flexibility that a mixed economy affords is more applicable to real-world economies given their complex nature. After all, the states or regions that make up a country tend to vary in governance and the manner in which resources are produced and distributed.

Pros

  • Free market. Although mixed economies vary, the industrial sectors in most economies are controlled by private firms (Gemma,2020). Competition breeds innovation and progress, while collective industrial effort boosts a country’s economic performance.
  • More sectors covered. Producers in market economies focus on the most profitable industries, leaving other sectors out. In mixed economies, the government can enter and fill in those gaps, as it takes control of areas like defense and agriculture (Amadeo, 2020).
  • Partially addresses the inequality in market economies. Once again, the government’s entry can help individuals and small organizations that do not have the resources to compete with their corporate counterparts. Subsidies and tax breaks, among other incentives, can be released (Fedele & Depedri, 2016).
  • Strategic taxation. The government can add taxes to certain industries to gain funds in furthering its social objectives (Chappelow, 2020).

Cons

  • Weaknesses of the free market. Like market economies, the competition is fierce and can leave the smaller players folding up or barely surviving. There is huge inequality in the country’s distribution of wealth (Amadeo, 2020).
  • Weaknesses of the command economy. Increased government control in the industrial sector could curb the flexibility provided by free markets (Gemma,2020).
  • Uneven market regulation. A government, in trying to maintain a free market, might forgo of regulations that promote fair trade. On the other hand, it might end up funding oligarchies and monopolies in the sectors they control (Amadeo, 2020).
  • Confusion in the government’s role. Determining where the government should and should not intervene is subjective and has been the subject of debates (Gemma, 2020). The prevailing model could end up changing when new government officials are elected to power.

The World’s Biggest Economies and Their Economic Systems

United States

As the world’s largest economy, the United States has mostly recovered from the Great Recession as it enjoys favorable rates on growth, inflation, and unemployment (Shatz, 2016). In 2019, this mixed economy posted a nominal GDP of $21.44 trillion, a figure that is expected to rise to $22.32 trillion in 2020 (Silver, 2020). It also has a purchasing power parity (PPP), which measures the purchasing power of nations, of $21.44 trillion.

Although it has lost the top spot in terms of PPP to China, the U.S. is projected to maintain its status as the world’s biggest economy in the near future with its projected nominal GDP of $24.48 trillion in 2023.

China

China is quickly catching up to the global economic leader, the United States, thanks to its massive export and manufacturing industries. In fact, it has already overtaken the U.S. in terms of PPP in 2019, amounting to $27.31 trillion, $5.91 trillion more than that of the U.S. In terms of nominal GDP, China stands at $14.4 trillion (Silver, 2020). The gap between China and the U.S. has been shrinking steadily, and it will continue to do so in the next few years, as it is projected to have a nominal GDP of $19.01 trillion in 2023 (Silver, 2020).

China’s economic system has been the subject of research. It was widely thought that the country has a socialist economy, a type of command economic system, after decades of being a communist country (Chappelow, 2020). However, in a study has revealed that the Chinese economy fuses elements of capitalism with socialism (Bada, 2019), making it a mixed economy.

Japan

Japan is the second-largest economy in Asia and the third-largest in the world. In 2019, the Japanese economy was valued at $5.15 trillion in terms of nominal GDP while its PPP was at $5.75 trillion (Silver, 2020). It is still feeling the effects of the 2008 financial crisis but has since taken measures to recover. Though fundamentally capitalist, Japan has a mixed economy, with the government intervening in several industrial sectors (Amadeo, 2020).

Germany

With a nominal GDP of $3.86 trillion and PPP of $4.44 trillion in 2019, Germany is Europe’s largest economy (Silver, 2020). Like most developed countries, it was heavily affected by the Great Recession in 2008 but managed to recover through its manufacturing industry, strategic taxation, and initiatives to cut down unemployment. Germany has a mixed economy, with a market economy in commodities and services and a command economy in defense, education, and healthcare (Amadeo, 2019).

India

India is one of the fastest-growing economies in the world and has become the world’s fifth-largest in 2019. It has a nominal GDP of $2.94 trillion and a PPP of $10.51 trillion (Silver, 2020). Although it has a long way to go before it catches up to the U.S. and China, the South Asian nation is steadily gaining ground on Germany and Japan. According to the Centre for Economics and Business Research, as reported by India’s The Economic Times, the country is poised to overtake Germany in 2026 and Japan in 2034 should the economic conditions remain constant (The Economic Times, 2019).

India has a mixed economy.  Its urban regions carry a market economy while the rural cities have a traditional one (Amadeo, 2020).

Source: Investopedia 2020

The Importance of the Human Factor

With the 4 types of economies primarily concerned about systems and organizations, it is important to note that many laissez-faire economists fail to acknowledge that institutions are only as effective as the human factor qualities of those who design, lead, implement, and manage them (Adjibolooso, 2017). After all, human capital serves as the moving parts of economic systems, with individuals involved in every stage of production and resource allocation.

Human factor decay is reflective of an individual’s negative character traits (Adjibolooso, 2017) and is caused by a wide range of factors, from poor living and working conditions to human rights abuses and other forms of social injustice. If left unaddressed, the negative attitudes of people influence their work performance, which, in turn, yield outputs of lower quality and quantity. It could ripple up to later affect industries and eventually economies.

Solutions to enhancing the human factor are not as simple as offering raises or providing tax incentives, especially in less-developed countries; they are more dependent on their manpower. To fully enhance the human factor, transformational development in 1) spiritual capital, 2) moral capital, 3) human abilities, 4) human potential, 5) aesthetic capital, and 6) human capital should be enforced (Adjibolooso, 2017, p 95).

Transformational development is achieved through education, ingraining the six aforementioned dimensions across school curricula or training modules, then applied in communities. This will result in driven leaders, managers, and laborers who have a good moral compass (Adjibolooso, 2017).

Conclusion

Each type of economic system has its own distinguishing traits reflective of a country’s resources, the brand of leadership applied, and the needs and wants of the locale. A traditional economy is largely primitive as it operates on social norms, religious beliefs, and basic needs rather than prioritizing profit and economic growth (Duffy, 2014). A command economy features the government taking ownership of the production and distribution of major commodities (Gemma, 2020). Meanwhile, in a market economy, entrepreneurs, enterprises, and social organizations control the market (Gemma, 2020), creating a lot of opportunities for economic growth.

And finally, the most prevailing type of economic system among the world’s largest economies is the mixed system, which combines the features of the other types of economic systems (Amadeo, 2020). Countries with this economy typically leverage the profit-generating trade of free markets and implement a command system in sectors left out by market economies. It is by no means a perfect system, but many of the world’s biggest economies have transitioned to this type of economy to raise their GDPs and encapsulate their complex real-world economies, particularly China (Chappelow, 2020).

A variable that should not be left out of the discussion is the human element. After all, unmotivated or dissatisfied individuals influence organizational performance, which, in turn, can spiral to adversely affect economies (Adjibolooso, 2017). Enhancing the human factor is paramount should an economy intend to boost its yield. What countries can do is incorporate holistic transformational development methods into their educational programs, so a competent and driven workforce is produced at the scholastic level (Adjibolooso, 2017).

All that said, a perfect economic system has yet to be discovered. Although having a mixed economic system is a commonality shared by five of the world’s biggest economies, the ideal blend of market freedom and government intervention has yet to be realized. The truth is every economy is still a work in progress, including the most prosperous ones. And it will ceaselessly evolve with society and technology through time. With this, it is safe to assume that learning economics is a never-ending process.

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