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8.2: Political Economic Systems

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    Learning Objectives

    By the end of this section, you will be able to:

    • Define, and discuss significance of, Political Economic Systems.
    • Identify the four political economic systems.
    • Compare and contrast the four political economic systems.


    Political economies also vary in how they are implemented, with a major variable being the role of the state in its economy. This role can include a number of attributes. One major attribute is level of involvement or intervention. In some political economy systems, the state is much less involved, sometimes mostly absent, referred to as laissez-faire, which translates from French as ‘let it be’. Laissez-faire is defined as a type of political system where the government chooses not to interfere or intervene in its national economy. At other times, the state acts simply as a referee, only getting involved when there are disputes or when there are major threats to the economy. At the other end of the spectrum are states that have complete control of an economy. Command and control is defined as a type of political economy where the government owns most, if not all, means of production in a society. In this system, there is no market and all economic decisions are made by the state or some agent representing the state, such as a political party.

    Almost all contemporary political economy systems fall somewhere in between, usually clustering along the continuum. Countries that have inherited their political economic systems from England, such as Australia, New Zealand, South Africa and the United States, trend more towards less government involvement. Whereas other states, including countries in Latin America and Europe, trend more towards the other end, with more government involvement, including higher taxes and more regulation. Sometimes, state involvement really means state coordination. In countries such as Singapore, China, and Vietnam, the state leads the economy including when and where investment takes place. This is often referred to as statism, which is defined as a political economic system where the government often takes on an enterprising role, usually through a state. Statism is also referred to as state capitalism, where the invisible hand is replaced the visible hand in the market (Bremmer, 2012)

    Mercantilism (Economic Nationalism)

    The oldest political economic system is mercantilism. Mercantilism is defined as a political economic system which seeks to maximize a country’s wealth through increasing exports and limiting imports. Use of the mercantilist system was most prevalent between the 16th and 18th centuries, and heavily practiced by the British Empire. Hallmarks of the mercantilist system at this time included the complete control of production and trade by state led companies, high inflation and taxes. Mercantilism also allowed for the expansion of the slave trade, as slaves were seen as necessary to an empire’s economic well-being and power.

    A good example of mercantilism is the British Empire. To achieve imperial economic growth, the empire strongly discouraged its colonies from importing competitive foreign products, encouraging only the importation of British products. This was often accomplished through taxation, as imperial authorities imposed tariffs on sugar and molasses imported from other countries in order to promote its own monopoly on sugar from the West Indies. The British also put forth trade policies that promoted a favorable balance of trade for themselves, again in an effort to maximize its power through wealth creation. Inevitably, this system led to open military conflict as other empires did the same. The Dutch, Spanish and Portuguese empires would try to promote their own economic interests and would try to protect their own colonial markets from British encroachment.

    In theory, mercantilism created a strong relationship between the British empire and its colonies. The empire protected the colonies from the threat of foreign nations, and money from the colonies fueled the imperial engine. In practice however, mercantilism created conflict for the colonies, especially in the Americas, where the cost of imported goods from Britain were substantially higher than imports from other regions. Add to this, the increase in expenses and growing market control, and mercantilism is cited as one of the precipitating factors contributing to the Revolutionary War.

    Although mercantilism is the oldest of the various types of political economic systems, it is by no means a relic of the past. It is very much a present day reality, and is now referred to as economic nationalism. Economic nationalism is defined as attempts by a state to protect or bolster its economy for nationalist goals. Economic nationalism has seen a surge both in the United States and in Western Europe. Economic nationalists tend to favor protectionism. Protectionism is defined as policies protecting a country’s domestic industry through subsidies, favorable tax treatment, or imposing tariffs on foreign competitors. The focus is on savings and exports. Economic nationalists do not want the country to be dependent on other countries for key resources. They prefer policies that lead to diversification of domestic production. This is understandable in key sectors like agriculture. It is more controversial in sectors such as consumer products purchased with disposable income. For economic nationalists, some degree of free trade is fine if it furthers the goal of strengthening the power of the state on the international stage. The focus here is on the state. The common feature of political platforms espousing economic nationalism is the combination of “conservative economic proposals with nationalist stances on international trade and cooperation, as well as on immigration.” (Colantone & Stanig, 2019)

    U.S. president at political rally
    Figure \(\PageIndex{1}\): Former President Trump at a political rally encouraging Americans to “buy American.” (Source: Speeches of Year One by Trump White House Archive, flickr is licensed under Public Domain.)

    While the desire to ‘buy American’ and ‘hire American’ is understandable, it may have unintended consequences. Economic nationalism focuses on the role of growing exports to strengthen the economic position of the state. Nevertheless, if this approach is taken to its logical end, where all countries shun international imports, then there will be a dramatic decline in the ability of exporting companies in the US(and, of course, in other countries) to succeed (and therefore to hire Americans).

    Free Market Capitalism (Economic Liberalism)

    A competing approach to mercantilism is capitalism. Capitalism, also referred to as free market capitalism, is a political-economic system where individuals and private entities are able to own land and capital needed to produce goods and services. The forces of supply and demand are determined freely by the market, ideally with little to no interference from the state. In its purest form, capitalism is laissez-faire, which we discussed above. Capitalism centers on self-interest, competition, private property, and the limited role of government control in the market. In economics, self-interest is the means through which individuals can act on their own behalf to make choices that benefit themselves. Within capitalism, the self-interest of uncoordinated individuals is thought to contribute to better outcomes for society at large. Competition occurs when industries, economic firms and individuals vie to obtain goods, products and services at the lowest prices. By allowing competition and self-interest of consumers, market outcomes are thought to be improved for all involved.

    One concern about capitalism is at the international level, particularly when it comes to trade in goods, services, and activities. As mentioned above, trade imbalances may led to the exploitation of poorer countries by richer countries. Rather than a comparative advantage, the country might be at a disadvantage. Think of a poor country that wants to build up its tourism industry. If it follows a wholly capitalist model and allows for trade and foreign investment, it runs the risk of its domestic tourism industry becoming taken over by large corporate hotel chains.

    Still, even with the existence of major trade imbalances, economists have demonstrated that international trade is not a complete ‘zero-sum’ game. A zero-sum game is a situation where one person, or entity, gains at the equal cost of another. Each win must be accompanied by a loss. As Wolla and Esenther explain, the idea of trade being a zero-sum game

    is nothing new; it dominated economic and political thought from the sixteenth to eighteenth centuries. Known then as mercantilism, it led to government policies that encouraged exports and discouraged imports. One of Adam Smith’s purposes in writing The Wealth of Nations…was to dispel the zero-sum game myth behind mercantilism. (Wolla and Esenther, 2017)

    Modern international trade is not a zero-sum game, as there are gains to be made, even small ones. Still, there are other ‘winners’ and ‘losers’ in trade. Winners include consumers who have more choice at competitive prices. Businesses also are winners, as they can sell products to consumers. Specialization through comparative advantage can lead to what is referred to as economies of scale, or the ability to “produce goods at a lower average cost” (Wolla and Esenther, 2017). Also, countries benefit with an improved standard of living. Two examples are China and India. Both “have experienced growth and development that might not have happened without access to markets.” (Wolla and Esenther, 2017)

    Bar chart on the growth of imports and exports
    Figure \(\PageIndex{2}\): The growth of imports and exports since World War II. (Source: Author’s Creation using data from the Federal Reserve Economic Data (FRED) website.)

    The benefits of international trade and free-trade agreements (FTAs) can be seen through data from the US Department of Commerce as described by the US Chamber of Commerce. US FTAs that include 20 countries “represent approximately 6% of the world’s population outside the United States, and yet these markets purchase nearly half of all US exports.” (US Chamber of Commerce.)

    Capitalism is most commonly referred to today as economic liberalism. Economic liberalism is defined as a political economic ideology that promotes free market capitalism through deregulation, privatization and the loosening of government controls. Deregulation involves the removal of government power in a particular industry or economic area. An example includes the US president Reagan’s decision to deregulate the phone industry, which AT&T had monopolistic control, in an effort to create competition, provide more choices and lower prices for consumers. Privatization is the selling of government owned assets. A good example includes the sale of a state-owned airport or harbor to a private company. Greece, a country in the European Union, was forced to do so under a deal to save its economy in 2012. Finally, the loosening of government controls, or liberalization, involves the reduction of rules related to trade, including the reduction of trade regulations, taxes, etc. Countries that embrace economic liberalism are said to become more capitalist.

    Marxism (Economic Structuralism)

    As free market capitalism was a critical response to mercantilism, Marxism became a critical response to free market capitalism. Developed by Karl Marx, who the philosophy is named after, this critique argues that capitalism is destructive, corrupt and unable to survive as an economic system. According to Marx, capitalist systems inevitably lead to conflict between the working class (proletariat) and business owners (bourgeoisie), wherein the workers would eventually rise up against those who own the means of production. In considering more specifically its economic applications, Marxism is defined as a political economic system wherein the means of production are collectively owned by workers, not privately owned by individuals. This system lends itself politically to socialism or communism, both discussed below. In Marx’s mind, eventually social classes, and the subsequent violence that results from class struggle, would no longer exist.

    Communism is where the state, usually dominated by one party, is in complete control of the political economic system, including all property. Communist theory suggested that over time, the state itself would wither away and politics would become a relic of the past. A utopia where everyone has achieved true equality would exist without the need of a government. Marx suggested that the communist struggle would begin in industrialized societies that practice capitalism. Yet the first country to embrace communism was Russia, an imperial power that was largely agrarian and still used a serf political economy. In the Russian revolution, communist forces loyal to Vladimir Lenin seized control, imposing communist rule through the state party apparatus, and renamed the country the Union of Soviet Socialist Republics (USSR). Joseph Stalin, the successor to Lenin, forcibly industrialized the country and led it through World War II. Still, the utopia that Marx had predicted never occurred. The USSR eventually collapsed in 1991 and in this wake, most of the country’s allies abandoned communism altogether.

    Despite the death of communism, Marxist thought still plays a prominent role in today’s economic discourse. A good example includes economic structuralism, which is considered by most scholars as a modern extension of Marxism. Economic structuralism is defined as a political economic system wherein the working class must be protected from exploitation of the capital owning class, but on an international scale. Economic Structuralism has played a significant role in policy making in the developing world, particularly in Africa and Latin America. The focus here is on workers and owners. It is also on economic structures such as inequality, uneven development, property rights and ownership, specialization, and trade.

    Economic structuralist theory has been a significant force in Latin America and, in this context, is often credited to Raul Prebish, an Argentine economist who wrote about this theory in 1949. Love (2005) describes that underdevelopment was seen as an “uneasy mix of traditional and modern economies”. In other words, early structuralists focused on industrialization “as the single most important objective in a development program” (Love, 2005). By way of further explanation:

    Structuralist scholars become conceptually known and recognized by their diagnosis in which 'structural deficiencies', 'bottlenecks' or 'inner dysfunctions' are the factors responsible for the developmental divergences in Latin America. (Missio, et al, 2015)

    The deficiencies and dysfunctions are both from outside (foreign) and within (domestic). Examples of foreign dysfunctions include the vulnerabilities developing countries experience in participating in global trade, such as less favorable terms of trade and access to necessary technologies. (UIA) Examples of domestic dysfunction include “accelerated population growth, premature urbanization…as well as the underdevelopment of agricultural production” among others. (Missio, et al, 2015)

    So, having identified these structural challenges and imbalances, the question becomes how should policymakers respond? Common policy responses include import-substitution industrialization strategies. Import-substitution industrialization (ISI) refers to a country's attempt to reduce its dependence on foreign companies through increased domestic production. Grabowski (1994) describes ISI strategies as “utilizing a variety of policy instruments (tariffs, quotas, and subsidies) to protect the domestic market for many types of manufactured goods”. Since industrial development was a major focus of economic structuralism, economists and policy-makers were “generally very optimistic concerning the positive role that trade, in particular export expansion, could play in overall development” (Grabowski, 1994).

    Protectionism is also a major component of ISI strategies. As mentioned above protectionism is designed to protect domestic industries and markets from foreign competition. One category of protectionist policy is the use of direct barriers. The classic - and one of the oldest tools of protectionism - is the use of tariffs. Tariffs are taxes imposed on imported foreign products with the purpose of making those products more expensive and, thus, making the domestically produced products more competitive. However, tariffs can misfire if a domestic company relies on imported components that are more expensive due to the tariff. This added cost is usually passed through to consumers. We saw this happen with the 2018 steel and aluminum tariffs, which resulted in the loss of 75,000 manufacturing jobs. (PBS) Another direct barrier involves the use of quotas or limits on the number of foreign goods coming into a country. The idea is to ensure that domestic companies have a guaranteed share of the market for certain products. This could be televisions, cars or textiles (clothing).

    Other forms of protectionism are sometimes referred to as non tariff regulatory barriers, or restrictions on trade not involving a tariff or a quota. These are not as direct or focused but can still have a significant impact on trade. There are three broad categories: financial, physical, and technical. Non tariff financial barriers include government subsidies and tax breaks for specific domestic industries. Thus, instead of taxing imports, the government makes domestic products more competitive (less expensive) by giving businesses cash, forgivable loans, below market loans, or tax breaks to businesses in the sectors the government wants to protect. This financial assistance is a cost borne by all the taxpayers rather than consumers of specific goods. Subsidies are common in agriculture because the ability of a country to provide food for its people generally is considered a matter of national importance and security. Physical barriers can be both natural and human-made. Steep, treacherous mountain passes or dangerous water crossings can make trade more expensive. Similarly, countries can intentionally make border crossings more difficult with structures such as walls and gates. Finally, there are technical barriers. Typically, these come in the form of rules or standards imposed by the destination country on the exporting country. One example comes from trade between the US and Mexico. The US imposed a requirement that all tractor-trailers coming into the US must comply with certain safety standards. (Aguilar, 2011) This requirement meant that, until Mexico could upgrade its fleet of tractor-trailers, Mexican trucking companies had to bring their goods to the border, off load the cargo into a US-compliant truck, and then continue to their destination. This added time, and therefore costs, to the goods coming from Mexico.

    The informal sector, also known as the informal economy, is that part of the economy consisting of people producing goods and providing services outside of regular employment. This includes people selling home-made food products, providing auto repair services and child care. The concern for economists is that productivity in the informal sector is low, meaning that these small enterprises are not very efficient and therefore do not contribute to increased standards of living. According to the International Monetary Fund, “today, the informal sector still accounts for about a third of low- and middle-income countries’ economic activity—15 percent in advanced economies.

    Socialism (Social Democracy)

    A final political economic system to consider is socialism. Socialism, broadly speaking, is both a political and economic system in which property, as well as the means of production, are collectively owned. In most cases, production is owned and controlled by the state. Socialist theory does allow for individual ownership of property, such as one’s house. The emphasis of a socialist system is to secure more equal outcomes and distribution of wealth through the collective ownership of resources and the means of production by the state. Few socialist countries exist today. The closest example we have is Venezuela. Venezuelan leadership, first under Hugo Chavez and then Nicolas Maduro, have nationalized or

    Just like Marxism, modern variants of socialism exist today. The most prominent and relevant is social democracy, which is defined as a political and economic system that favors heavy market regulation to achieve a more equal society. This approach argues that capitalism can lead to disproportionate distribution of wealth, which is viewed as inconsistent with democratic principles. The argument goes, how can one have true freedom, if they lack the means to survive? Freedom of speech, of the press or to assemble do not mean much if one goes hungry. Another term for this is democratic socialism, an ideology that seeks democracy not just in the political sphere but in the economic sphere as well.

    In social democracies, governments levy high taxes on corporations and wealthy individuals and redistribute the collected funds to poorer members of society through social welfare programs. While social democracies have a capitalist system as their base, it is overlaid with a heavy system of regulation to protect society from the potential harm that a free market capitalist system could yield. At times, some social democratic countries will take over the means of production in a particular industry. A good example is Norway where the oil company is state-owned and the revenues from the sale of oil go to pay for social expenditures, such as education and health.

    Social democracy became popular in Europe, where such policies were initially put in place to blunt the ability of communist movements to rally workers to their cause. These policies proved to be quite popular, and have become an important feature in social democracies. Sweden is a great example. The country has developed a political economy where its citizens enjoy quite a few benefits, including access to free health care, free education and generous pensions. These benefits are paid for through higher taxes and societal expectations of corporate behavior. A country, such as Sweden, that has this type of a mixed economy is also often referred to as a social market economy. A social market economy is defined as a socioeconomic system that combines principles of capitalism with domestic social welfare considerations. Over time, the European Union has adopted a number of directives that have aligned with social democracy concepts. These include reducing wage inequality, improving incentives to work and working to sustain domestic demand.