Economic systems

Every country must answer what, how and for whom to produce. "But who actually decides?" That depends on the country's economic system: the way it organises production, consumption and distribution, and who controls the resources. There are three kinds.

1. Planned economy. A central planning authority of the government, such as a planning commission, makes all the big decisions: what and how much to produce, how, who gets it and at what price.

• The government owns most resources: land, factories, banks, transport.
• Enterprises follow the government's targets, not what buyers want, and need strict permits and licences.
• With few producers there is little competition, so little reason to improve quality or innovate.

The book's examples: the former Soviet Union, North Korea and Cuba.

2. Market economy. Here demand and supply decide, with little government interference.

• Individuals and private companies own the factories, shops and land.
• Many producers sell similar things, so they compete: better quality, lower prices, more innovation.

The book's examples: the USA, Japan and Hong Kong.

"So what does the government do in a market economy?" The book says it acts like a referee in a football match. The referee does not play or score goals, but keeps the game safe and fair. The government keeps law and order and safety; it does not control prices or production. Even so, governments play an important role in these economies too.

Picture competition: four car dealers each sell a car for the same price. To win buyers, one adds better brakes, the next adds more space, the next a longer warranty. Buyers get more for their money. That is competition at work.

3. Mixed economy. It combines both. Private individuals, enterprises and the government all make economic choices, and big public sector companies work alongside private firms. The book says almost all economies are mixed. Examples: India (after 1991), China (after 1978), Germany and Sweden. Even the USA and Singapore have significant government involvement.

In a mixed economy, each side brings something (Fig. 8.8):

Public goods are goods and services open to everyone, where one person's use does not stop another's: parks, roads, police, street lights, basic education. A private company would struggle to charge each user for a street light, so the government usually provides them.

India's own story. After Independence, India followed a state-led approach, close to a planned economy: licences and permits, and the public sector dominated banking, transport and heavy industry. By 1991, the country faced serious economic difficulties. So the government brought in major reforms:

• it cut excessive regulations;
• it encouraged private enterprise;
• it opened the economy to global trade and investment;
• it increased competition.

India moved towards a more market-oriented system, while keeping an important role for the government.

Watch out: India today is not a pure market economy. It is mixed: private firms compete, but the government still runs services, sets rules and provides public goods.