CHAPTER 1 
ECONOMIC SYSTEMS:
CLASSIFICATION AND PERFORMANCE

 

I.    The Economic System, the Environment, and Policies

  Graphic Model

A.   Economic System - Set of institutions that constrain, facilitate and coordinate economic behaviors.

B.   Institution - Organization, practice, convention or custom that is persistent and material in society.
 Alternatively, according to Douglass North, "Institutions are the humanly devised constraints that structure political, economic, and social interaction. . . . Throughout history, institutions have been devised by human beings to create order and to reduce uncertainty in exchange."

C.   Environment - Factors that cannot be manipulated by policy makers. These include natural resources, which, in principle, should be helpful to the economy, but can lead to a "resource curse," which may have political origins (magnet for corruption and lack of citizen involvement when taxes are not needed) and/or economic origins (lack of diversification because of labor/capital attraction and exchange rate distortion).

D.   Policies - Factors that can be manipulated in the medium term to influence economic performance.

 

Auto Analogy

 

Applications - Explanations of Performance

Yugoslav failure - System, Environment, Policies

Asian Crisis - Systems & Policies 

 

Applications - Choice of System

Why did Eastern Europe reform before Soviet Union?

Why does Sweden have preference for Welfare State?

 

II.   Forms of Business Enterprise 

 

 

Ownership and Control

Corporate Legal Entity

Liability of Owners

Lifespan

Private Sector

Sole Proprietorship

Single person

No

Unlimited

Limited to owner

Limited Liability Company;  Limited Liability Partnership

One or more members

No

Limited

Limited to Owners

Partnership

General partners

No

Unlimited for general partners;  limited for limited partners

Usually Limited to Owners

Private Corporation;  Closely-Held Corporation;  Private Limited Company

Stockholders or Members
(closed circle)

Yes

Limited to investment

Perpetual

Public Corporation or Public Limited Company

Stockholders
(traded on exchanges)

Yes

Limited to investment

Perpetual

Non-Profit Organization;  Charity

Controlled by Board, elected by stake-holders or self-appointed

Usually

Limited

Perpetual

Socialized Sector

Government-Owned Enterprise; State-Owned Enterprise;  Public Enterprise

Government (majority) and perhaps Stockholders

Sometimes

Limited to investment

Perpetual

Producer Cooperative

Employee-Members often have equal voting rights, regardless of share holdings

No

Usually Limited to investment

Perpetual

Commune

No

Seldom

Unlimited

Perpetual

 

Transitions:

  • Incorporation - Proprietorship or partnership to corporation
  • Initial Public Offering (IPO); "Going Public" - Private corporation to public Corporation
  • Leveraged Buyout (LBO) - Use of debt (often by a Private Equity Company) to purchase a controlling share of a public corporation, often converting it back to a private corporation.
  • Nationalization - conversion of a firm in the private sector into a government-owned enterprise.
  • Expropriation - Nationalization without compensation.
  • Privatization - Conversion of government-owned enterprise into a form of private enterprise

 

III.   Modes of Classification

 

A.   Ownership - Rights to control an asset, keep income generated, or transfer ownership.

1.    Feudalism - Rights ultimately held by the king, delegated in exchange for loyalty, tribute, and military support.  Labor tied to the land.

2.    Capitalism - Means of production held by private individuals.  Laborers free to change employers.

3.    Socialism - Means of production owned socially, by the government, cooperatives, communes, or workers' councils.

Caution - Formal ownership may be separated from effective control.  Corporate capitalism and Soviet-style socialism.

Private Sector Share of GDP (%Value Added)

1990

2000

2010

United States

86

88

86

Sweden

82

Czech Rep

10

80

80

Estonia

10

75

80

Hungary

25

80

80

Slovakia

10

80

80

Egypt

76

 

Albania

5

75

75

Armenia

10

60

75

Azerbaijan

10

45

75

Bulgaria

10

70

75

Georgia

15

60

75

Kyrgyzstan

5

60

75

Lithuania

10

70

75

Mongolia

10

60

75

Poland

30

70

75

Tanzania

75

 

Croatia

15

60

70

Macedonia

15

55

70

Latvia

10

65

70

Romania

15

60

70

Slovenia

15

65

70

China

53

70

Jordan

67

 

Moldova

10

50

65

Montenegro

na

45

65

Russia

5

70

65

Kazakhstan

65

Bosnia/Hrz

na

35

60

Serbia

na

40

60

Ukraine

10

60

60

Tajikistan

10

40

55

Vietnam

48

 

Uzbekistan

10

45

45

Saudi Arabia

39

 

Belarus

5

20

30

Turmenistan

10

25

25

Kuwait

22

 

Sources: European Bank for Reconstruction and Development,
U.S. Bureau of Economic Analysis, and media sources.

 

B.   Coordinating Mechanism - An institution that coordinates decisions concerning production, sale, and purchases of commodities.

1.    Tradition - Preservation of the status quo.  Dominant only in static economies.

2.    Market - Operation of supply and demand, and free movement of market prices.  Provides for consumer sovereignty.

3.    Plan - Central plan directs the economy toward specified goals.

a.    Directive Planning - A central agency issues instructions to subordinates. 

b.    Indicative Planning - Market coordinates short run while plan directs long run.  The plans are very general, span long time periods.  Compliance is mostly voluntary.

c.    Industrial Policy - Support provided to favored sectors; low-priority sectors are phased out. 

 

C.   Incentive Systems - Reward desired behavior and discourage inappropriate action.

1.    Coercive Incentives - Actual or threatened force.

2.    Material Incentives - Material reward for desired behavior, usually in monetary payments. Automatic in market economies. Must be designed in directively planned economy.

3.    Moral Incentives - Appeal to emotions such as compassion or nationalism.

 

D.   Objectives - Involved both in classification and evaluation of economic systems. Include individual freedom, output growth, military power, equitable income distribution, full employment, dynamic efficiency, protection of natural environment, and price stability.

1.    Free enterprise economy - Individual freedom. 

2.    Welfare State - Equitable distribution of income and full employment.

3.    Mercantilism - Military and economic power.  Governments supported monopolies, subsidized exports, and limited imports.  Fascism and Nazism are exaggerated forms of mercantilism.

IV. An Operational Classification System

 

 

Dominant System of Ownership

Dominant System of Coordination

Dominant System of Incentives

Dominant System of  Objectives

Traditional

Tribal

Tradition

Various

Various

Feudalism

Shared with superiors

Tradition, Market

Material, Coercion

Various

Free Enterprise Capitalism

Private

Market

Material

Individual Freedom

Regulated Capitalism

Private

Market, Indicative Plan

Material

Various

Fascism, Naziism

Private

Market

Coercion, Material

National Power

Command Socialism

Social

Directive Plan

Mixed

Various

Market Socialism

Social    

Market, Indicative Plan

Material

Various

 

IV. Comparisons of System Performance—In order to be fair, comparisons of the performance of economic systems should take the following into account:

A.   Isolation of the economic system - Performance is influenced by policy and environment as well as by the economic system.

B.   Actual and ideal economic systems - For most purposes, an idealized theoretical system should not be compared to an actual system.

C.   Measurement problems - Statistical problems arise from differences in monetary systems, accounting standards, and data collection methods.

D.   Assigning Priorities - Broad performance comparisons depend on individual value judgments.