8.2: Political Economic Systems

Learning Objectives

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

• Compare and contrast the four political economic systems.

Introduction

In some political economy systems, the state supports laissez-faire, which translates from French as ‘let it be’. 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. Some states have command and control, 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. On the other end, some states, including countries in Latin America and Europe, tend to have 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, deciding when and where investment takes place. This statism is also referred to as state capitalism, where the invisible hand is replaced by the visible hand in the market (Bremmer, 2012).

Mercantilism (Economic Nationalism)

Defined as a system that seeks to maximize a country’s wealth through increasing exports and limiting imports, Mercantilism is probably the world's oldest political economic system. From the 16th to 18th centuries, several European nations tried to have complete control of production and trade by state-led companies, which led to high inflation and taxes. Mercantilism also allowed for the expansion of the slave trade.

To achieve imperial economic growth, the British empire strongly discouraged its colonies from importing competitive foreign products. This idea was supported by high 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 economic policies that maximized their 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, while trying 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 North America, where the cost of imported goods from Britain was substantially higher than imports from other regions. Mercantilism is often cited as one of the precipitating factors contributing to the U.S. 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. Economic nationalism is an attempt by a state to protect or bolster its economy for nationalist goals. This newer type of mercantilism has surged in both the United States and Western Europe. It's often associated with Protectionism, which are 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. Agriculture would be one such area. However, controversy exists 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. Indeed, 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)

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 to export goods in the US (and, of course, in other countries) and to succeed (and therefore to hire Americans).

Free Market Capitalism (Economic Liberalism)

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. Key components include 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. Trade imbalances may lead 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. The idea of trade being a zero-sum game is nothing new. Indeed, it contributed to the development of mercantilism, where government policies 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 choices at competitive prices. Meanwhile, businesses 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”. Also, countries benefit from an improved standard of living. Two examples are China and India, which “have experienced growth and development that might not have happened without access to markets.” (Wolla and Esenther, 2017)

Today, capitalism is often referred to by a newer term. Economic liberalism is 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 would be when US president Reagan’s deregulated the phone industry, over 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. Greece was required to sale some state-owned businesses to a private company in order to save its economy in 2012.
• The loosening of government controls, or liberalization, involves reducing the rules related to trade, taxes, etc. Countries that embrace economic liberalism are said to become more capitalist.

Marxism (Economic Structuralism)

Marxism became a critical response to free market capitalism. Developed by Karl Marx, this theory argues that capitalism is destructive, corrupt, and unable to survive as an economic system. Further, capitalist systems would inevitably lead to conflict between the working class (proletariat) and business owners (bourgeoisie). In considering more specifically its economic applications, Marxism is 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.

Communism is where the state, usually dominated by one party, is in complete control of the political economic system, including all property. According to the communist theory, the state itself would wither away and politics would become a relic of the past. In the end, a utopia where everyone has achieved true equality would exist without the need for 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, imposed communist rule through the state party apparatus, and renamed the country the Union of Soviet Socialist Republics (USSR). His successor, Joseph Stalin, 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 demise of communism, Marxist thought still plays a prominent role in today’s economic community through Economic structuralism, where the working class must be protected from exploitation of the capital-owning class, but on an international scale. This system has had a significant role in policy-making in the developing world, particularly in Africa and Latin America. The focus is on workers and owners, as well as inequality, uneven development, property rights and ownership, specialization, and trade.

Economic structuralist theory has been a significant force in Latin America. Often credited to Argentine economist Raul Prebish, underdevelopment is often 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). In Latin American, deficiencies and dysfunctions are both from outside (foreign) and within (domestic).

• 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)
• domestic dysfunction includes “accelerated population growth, premature urbanization…as well as the underdevelopment of agricultural production” among others. (Missio, et al, 2015)

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. These strategies may include 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.

• Direct barriers:
  • 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. 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)
  • Quotas are 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. These goods are typically 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 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.
• Technical barriers typically come in the form of rules or standards imposed by the destination country on the exporting country. For example, the US imposed a requirement that all tractor-trailers coming into the country 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 consists of people producing goods and providing services outside of regular employment, such as selling home-made food products, providing auto repair services and child care. 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, “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)

Broadly speaking, Socialism 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 is Venezuela.

Just like Marxism, modern variants of socialism exist today. The most prominent and relevant is social democracy, which 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. In other words, how can one have true freedom, if they lack the means to survive? Freedom of speech, of the press or to assemble does 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. In theory, the heavy system of regulation protects society from the potential harm that a free market capitalist system could yield. At times, some socially democratic countries will take over the means of production in a particular industry. For example, in Norway, 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.

In Europe, social democracy policies were initially put in place to blunt the ability of communist movements to rally workers to their cause. Since then, these policies have proven to be quite popular. 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. This type of a mixed economy is also often referred to as a social market economy. Over time, the European Union has adopted a number of directives that have aligned with social democracy concepts, including reducing wage inequality, improving incentives to work, and working to sustain domestic demand.

For a full-screen image, please visit Mapped: Economic Freedom Around the World