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1 - Sachin Kumar Paurush
FEBRUARY 28
Asian School of Business
Authored by: Sachin Kumar Paurush
Economic
Systems
2 - Sachin Kumar Paurush
Economic System
The economic system functions to answer three vital questions:
a] what to produce
b] how to produce and
c] for whom to produce.
The first question 'What to produce' depends on what is wanted. But all wants cannot
be satisfied. This is because a country may not be gifted with all the necessary resources
to produce all the goods. Hence, depending upon the resource endowment a country
would decide what it could produce. Then there is a problem of prioritizing the available
resources among the goods to be produced. Resources should not be used for the
production of unwarranted goods. The production of goods, which are harmful to
human beings, like narcotic drugs, should be prevented. Hence, considering the
availability of resources, the economic system should opt to produce only goods that
would satisfy the wants of human beings and increase social welfare. In this context it
becomes necessary to weigh the individual requirements and the national requirements
for goods.
The second question ‘How to produce’ addresses issues relating to selection of right
strategy, technology and investment. For example, a country like India, with very huge
population cannot prefer capital -intensive technology, as that would lead to more
unemployment of human resources. Similarly, while selecting the technology, a country
should weigh a number of considerations like relevance of technology, cost of
technology, support in case of failures, consequences of the technology used, etc.
Another vital aspect is the investment that a country has to make while selecting the
strategy and the technology and whether the available funds should be invested in
sophisticated research and development or meeting the basic needs of the people.
‘For whom to produce’ implies that based on the resource utilization, the country as a
whole should benefit and not a few segments. This aspect deals with equitable
distribution of the goods and services produced in the economy. The distribution of
national product would differ from country to country depending upon the economic
system in place.
The way in which the above three questions are answered depends on the economic
system which functions in a country. The role of government and private enterprise
3 - Sachin Kumar Paurush
depends on the economic system being followed. There are three main types of
economic systems as discussed in chapter 1. They are capitalism, socialism and mixed
economy. We will discuss the capitalist economic system in this chapter and the other
two will be discussed in the chapters that follow.
Capitalism
Capitalism is an economic system based on the principle of free enterprise. Individual
ownership of resources is an important feature. With control and command over
resources, individuals can conduct any type of business. The object in such a system is to
maximize private gains. Any type of enterprise or production of any commodity or service
is permitted, so long it is wanted by the society. In such a system the market forces
determine the resource allocation and price. That is, the demand and supply forces
together determine what to produce, how to produce and for whom to produce. Price
mechanism is the nucleus of the capitalistic society. The price mechanism clearly reflects
the wants of the people. Once this is known, the producers would allocate the resources
to manufacture and sell the products in great demand. While doing so, there is no control
or regulation over production.
Features of Capitalism
Following are the main features of the capitalist economic system:
i. Profit Motive: All economic activities are guided by the motive of earning profit.
The entrepreneurs choose to produce those goods and services which will yield
greater profit. It is totally profit motive driven and there is no consideration for
social justice.
ii. Right to Private Property: In capitalism individuals are free to own, use and dispose
of productive factors such as land, plant and machinery, capital, etc. Private
property is a legal right and due to this right, property is privately owned by the
people.
4 - Sachin Kumar Paurush
iii. Competition: In capitalism there are a large number of buyers and sellers. Due to
a large number of competing firms, an individual firm cannot control the market.
Profit motive induces new firms to enter the market there by increasing
competition.
iv. Limited Role of Government: There exists a government but it does not interfere
with the day-to-day functioning of the economy. Its main job is to maintain law
and order, ensure the country’s security and enact laws necessary for public
welfare. Pure capitalism rests on laissez-faire policy i.e. no government
intervention at all in business.
v. Role of Price Mechanism: The major role of bringing about equilibrium in the
market is played by the price mechanism. Through this mechanism, the demand
and supply forces interact in the market and an equilibrium is achieved due to
bidding up of prices in case of excess demand and bidding down of prices in case
of excess supply.
vi. Consumer Sovereignty: People are free to spend their incomes as they like. Every
consumer is free to buy from any seller and consume any commodity in any
quality. In fact, the tastes and preferences of consumers direct production in a free
market economy. This is known as the principle of consumer sovereignty.
vii. Freedom of Choice of Occupation: People have the freedom of choice of
occupation as the decision of ‘What to Produce’ and ‘How to Produce’ is taken by
private entrepreneurs and individuals are free to choose their profession.
Variants of Capitalism
There are many variants of capitalism in existence. All
these forms of capitalism are based on production for
profit, at least a moderate degree of market allocation
and capital accumulation. The dominant forms of
capitalism are listed here.
5 - Sachin Kumar Paurush
Laissez-faire/ Pure Capitalism
The phrase laissez-faire is French and literally means "let do", but it broadly implies "let
it be", or "leave it alone." In economics, laissez-faire is an environment in which
transactions between private parties are free from state intervention, including
restrictive regulations, taxes, tariffs and enforced monopolies.
Pure or free market capitalism consists of a free-price system where supply and demand
are allowed to reach their point of equilibrium without intervention by the government.
Productive enterprises are privately owned, and the role of the state is limited to
protecting property rights.
In pure capitalism, prices are determined by supply and demand. Economic intervention
and regulation by the government is limited to tax collection, and enforcement of private
ownership and contracts. Free market differs from situations encountered in state
controlled economies, which can introduce price deviations without any changes to
supply and demand. The means of production is under private, and not state control or
co-operative ownership.
A laissez-faire or pure capitalist system is one within which all markets are unregulated
by any parties other than market participants. In its purest form, the government plays
a neutral role in its administration and legislation of economic activity, neither limiting it
(by regulating industries or protecting them from internal/external market pressures)
nor actively promoting it (by owning economic interests or offering subsidies to
businesses or R&D). Free markets contrast sharply with controlled markets, in which
governments more actively regulate prices and/or supplies, directly or indirectly, which
according to free-market theory causes markets to be less efficient.
Social/ Mixed Capitalism
A social market economy is a nominally free-market system where government
intervention in price formation is kept to a minimum but the state provides significant
social security, unemployment benefits and recognition of labour rights through
national collective bargaining laws. The social market is based on private ownership of
businesses.
6 - Sachin Kumar Paurush
The social market economy seeks a middle path between socialism and laissez-faire
economic liberalism, combining private enterprise with government regulation to
establish fair competition, maintaining a high rate of economic growth, price stability,
low unemployment, good working conditions, social welfare and public services.
State capitalism
The term State capitalism has various meanings, but is usually described as commercial
(profit-seeking) economic activity undertaken by the government with management of
the productive forces in a capitalist manner, even if the state is socialist for namesake.
State capitalism is usually characterized by the dominance or existence of a significant
number of state-owned business enterprises. Examples of state capitalism include
corporatized government agencies (agencies organized along corporate and business
management practices) and states that own controlling shares of publicly-listed
corporations, effectively acting as a large capitalist and shareholder itself.
State capitalism has also come to refer to an economic system where the means of
production are owned privately but the state has considerable control over the
allocation of credit and investment. Alternatively, state capitalism may be used
(sometimes interchangeably with state monopoly capitalism) to describe a system
where the state intervenes in the economy to protect and advance the interests of large-
scale businesses. This practice is often claimed to be in contrast with the ideals of both
socialism and laissez-faire capitalism.
State capitalism can be thought as a social system combining capitalism—the wage
system of producing and appropriating surplus value—with ownership or control by the
government. By that definition, a state capitalist country is one where the government
controls the economy and essentially acts like a single huge corporation, extracting the
surplus value from the workforce in order to invest it in further production. Workers are
exploited in such economies and government operates with the profit motive instead of
social welfare motive.
Corporate Capitalism
Corporate capitalism is a free or mixed market characterized by the dominance of
hierarchical, bureaucratic corporations, which are legally required to pursue profit. State
7 - Sachin Kumar Paurush
monopoly capitalism refers to a form of corporate capitalism where the state is used to
benefit, protect from competition and promote the interests of dominant or established
corporations.
A large proportion of the economy and labour market falls within corporate control. In
the developed world, corporations dominate the market, constititing 50 percent or
more of all businesses. Those businesses which are not corporations contain the same
bureaucratic structure of corporations, but there is usually a sole owner or group of
owners who are liable to bankruptcy and criminal charges relating to their business.
Corporations have limited liability and remain less regulated and accountable than sole
proprietorships.
Corporations are usually called public entities when their shares are listed and traded
on the stock market. This is done as a way of raising capital to finance the investments
of the corporation. The shareholders appoint the executives of the corporation, who are
the ones running the corporation via a hierarchical chain of power, where the major
investor decisions are made at the top, and have effects on those beneath them.
Corporate capitalism has been criticized for the amount of power and influence
corporations and large business interest groups have over government policy, including
the policies of regulatory agencies and influencing political campaigns. Many social
scientists have criticized corporations for failing to act in the interests of the people, and
their existence seems to circumvent the principles of democracy, which assumes equal
power relations between individuals in a society.
Merits of Capitalism
i. Efficient Utilization of Resources
Under capitalism, the scarce resources of the country are used most economically and
with minimum waste. Every business firm wants to minimize costs so that it can compete
in the market. In order to minimize costs producers attempt to utilize factors of
production in the best possible manner.
ii. Rapid Economic Growth
8 - Sachin Kumar Paurush
The capitalism system helps in rapid economic growth due to incentive & initiative.
Countries operating under the capitalist system have achieved a considerable increase
in per capita income. It enables people to enjoy high standard of living. As all the
business firms are running with a profit motive, each of them tries to maximize output
in the given resources and increase in production leads to rise in incomes.
iii. Democratic Nature
Under capitalism, people enjoy full economic freedom. It means that the consumers, the
workers and the entrepreneurs are all free to do the type of work they like or think
appropriate according to their requirements and skills. Everyone has the freedom to
work as per their will to fulfil their needs and wants.
iv. Flexibility and Adaptability
Capitalism has an inherent ability to change according to changing requirements and
circumstances. It is a dynamic system and can be adapted to the changing environment.
Price mechanism serves as an ‘invisible hand’ which automatically brings the required
corrections in the system to bring about equilibrium. This is perhaps the reason why
capitalism, in some form or the other has survived for centuries.
v. Less Corruption
Due to very limited government interference and more dependence on the market
forces, capitalism does not require too many bureaucratic controls. This leads to lesser
corruption which normally breeds in the systems which are too dependent on
bureaucracy.
vi. Higher Efficiency and Productivity
The wages and other factor payments in a capitalist system are linked to productivity.
Those who are more efficient and productive get rewarded and the less efficient ones
have to suffer. This leads to higher efficiency and productivity in the economy as a
whole.
Demerits of Capitalism
i. Lack of Social Benefit
9 - Sachin Kumar Paurush
Maximum social satisfaction can be achieved when goods and services produced are
made available to those consumers who will get the maximum satisfaction from them
which actually mean those consumers who need them the most. But in the capitalist
system goods go in the hands of the people who can offer the best price as the demand
forces in the market are based on the ability to pay and not on need alone.
ii. Social Waste
Cut-throat competition among business firms results in unnecessary expenditure on
advertising and ruthless exploitation of natural and human resources of nation. But, all
this expenditure is guided by profit motive only. The producers produce those goods and
services which rich people can afford to buy rather than those which the society actually
needs.
iii. Social Discrimination
Capitalism leads to the division of the society into two classes: ‘haves’ (rich) and ‘have
nots’ (poor). The rich exploit the poor, the capitalists exploit the labour class and the
society gets bifurcated on the basis of resources one has. Thus, capitalism may benefit
a few at the cost of many.
iv. Loss of Human Values
Capitalism promotes materialistic attitudes in the people. The lust for profits and wealth
gives rise to several social evils. It is alleged that “capitalism has no conscience, its God
is gold. It contains the seeds of its own destruction.” (Karl Marx). Due to discrimination
between rich and poor and most of the opportunities going to the richer sections of the
society, the poorer section turns towards illegal and immoral activities as they feel
deprived and find ‘snatching’ the only way of ‘getting’.
Meaning of Socialism
Socialism refers to an economic system in which the resources are owned by the State
or state owned institutions. Production takes place in the interest of the society and not
for maximizing profits of individuals or organizations. Government decides the type of
productive efforts to be permitted. In other words, in a socialist country, government
can adopt licensing system and other types of regulations to prevent the emergence of
10 - Sachin Kumar Paurush
monopolist and exploitative tendencies. Maximization of community welfare is the
objective rather than profit maximization of individual units.
Socialism is an economic system where the means of production are owned or
controlled by the state or government. In socialism there is no place for private
properties and private enterprise. In this economic system, production is controlled by
the state itself which decides what to produce, how to produce and how to distribute
the product among the population.
According to H.D. Dickinson, “Socialism is an economic organization of society in which
the material means of production are owned by the whole community and operated by
organs representative of and responsible to the community according to a general
economic plan, all members of community being entitled to benefit from the results of
such socialized production on the basis of equal right”. Representative of the community
is usually the government.
Features of Socialism
i. Government Ownership: The major means of production are either owned by the
government or their use is controlled by the government. No private enterprise is
involved in production. All the people work as workers and remuneration is provided
according to work.
ii. Equitable Distribution of Income: Socialist system aims at an equitable
distribution of income. There is no right to private property and hence no one can be
too rich or own much capital and wealth. Government decides the distribution of income
in the economy and tries to provide equitable distribution of income in the society.
iii. Social Welfare: Socialist system has a welfare motive in contrast to the profit
motive of market economy. Community welfare is given priority over individual benefits.
Allocation of resources is done in such a manner so that maximum social welfare can be
achieved with minimum social cost.
iv. Absence of Competition: Since the state owns all the major means of production,
there is no competition between the different production units. There is absence of
11 - Sachin Kumar Paurush
competition in the sense that government owns all the resources and is the sole
producer of all goods and services.
v. Equality of Opportunity: Every member of the society is given equal opportunity
to rise in life in a socialist economic system. Government as a representative of the
community decides about the type of production required in the economy and provides
gainful employment to the people in those areas. Government in socialist economies do
not differentiate among people and provide equal opportunity of education, occupation
and other social benefits to all the members of the society.
vi. Classless Society: Socialism is based on a classless society. As all the members
work to earn their living, there are no such classes as capitalist class and labour class.
Hence this system promotes social equality and class conflicts do not exist in the system.
Variants of Socialism
1. Marxism
The pure socialism is proved to be impractical and it made role of government too
dominant. Most of the governments could not fit in this role effectively. Further,
capitalism with its explicit goals threatened the success of socialism. It was at this
juncture that Karl Marx came up with his ideology, which led to the evolution of Marxian
socialism. Marx propounded through his logical reasoning that economics dominates
every activity of a society. The continued exploitation of labour in the capitalist society
would result in the creation of haves and have-nots. This division of the society would
widen with the continuance of capitalism, which ultimately will result in class struggle.
Marx explained through his theory of value that every product should be valued in
accordance with the value of labour contained in it. But the labourers are rewarded at a
very much lesser rate than what they create. Labourers contribute more by way of their
work to produce the product but they are paid very low wages. The difference or surplus
extracted is the gain realized by the capitalists. The capitalists would accumulate profits
this way at the cost of worsening labour condition. Over a period the divide between the
capitalist class and the labour class would widen to such an extent that there would be
social upheaval. Karl Marx predicted class conflict and argued that unless the capitalist
class realizes this, there would be severe impact on production and economic condition
of a country. His argument came true in the case of France that the French revolution
12 - Sachin Kumar Paurush
broke out in 1789 and problems also came up in other countries like erstwhile USSR and
China. But in China, the Marxism led to the emergence of communism which is discussed
in detail below.
Though Marxism was prevalent in a number of countries for some time, yet it has
inherent defects. Firstly, Marx's view that all activities in all countries are basically
economic in nature is not true. Secondly, his argument that class struggle continuously
takes place in every country did not come true. A number of other reasons of economic,
social and cultural nature led to the struggle and not the way Marx predicted. Thirdly,
the theory of surplus value could not be applied in practice in service industry. Fourthly,
Marx did not consider the possibility that a government could interfere in case of
exploitation of society by the capitalists.
Communism
Communism is Marx's prediction at the fall of capitalism. Marx argued that the widening
inequalities in a society coupled with class struggle should ultimately sound the death
knell of capitalism. He is of the view that when capitalism falls, the communism will
emerge in which, the labourers will lead the country. The government will own all the
resources and determine the needs of the society. It will also decide various other issues
of macro and micro importance. Government will turn out to be the custodian of the
society and in a pure communistic society; people will lead a life where basic necessities
are provided by the government. Unemployment will be very low as everyone is
occupied in some vocation or the other as determined by the needs of the society.
But the way in which communism was practiced in certain countries created an
impression that in communist countries the government was oppressive in its approach
that the people were unable to live a life of freedom and liberty. One has to work in the
vocation available as per the planning of the government to earn his living. Military type
of regimentation was enforced and common people were subjected to absolute control
and regulation by government. The nominated representatives of the Communist party
attended to all the governmental responsibilities. Market mechanism is completely
absent in such a system, as government determines everything on behalf of the country.
13 - Sachin Kumar Paurush
As has been already pointed out depending upon the economic system, the business
environment will change. In a capitalist system, the environment provides opportunities
for everyone who wants to maximize gains. In a socialist system, the government
undertakes the responsibility of providing everything to the citizens. In a Marxist
economy, it is ultimately the labourers who will hold the reins. In a Communist economy,
it is the group of administrators who run the economy in the interest of the economy.
3 Democratic Socialism
Democratic socialism is the philosophy that both the economy and society should be run
democratically to meet public needs and not to make profits for only a few. To achieve
a more just society, many structures of the government and economy are radically
transformed through greater economic and social democracy so that ordinary citizens
can participate in the many decisions that affect their lives. Democracy and socialism go
hand in hand in this form of socialist system.
Democratic socialism does not create an all-powerful government bureaucracy as in
pure socialism. But on the other hand, it does not allow big corporate bureaucracies to
control the society either as in capitalism. Democratic socialism is a system in which
social and economic decisions can be made by those whom they most affect.
In capitalist system, corporate executives and a few wealthy stockholders make basic
economic decisions affecting millions of people while in pure socialism or communist
system all the decisions rest with the government. Resources are used to make money
for capitalists or satisfy the aspirations of the administrators in the government rather
than to meet human needs. Democratic socialism believes that the workers and
consumers who are affected by economic institutions should own and control them.
Social ownership could take many forms, such as worker-owned cooperatives or publicly
owned enterprises managed by workers and consumer representatives. Democratic
socialists favour as much decentralization as possible. While the large concentrations of
capital in industries such as energy and steel may necessitate some form of state
ownership, many consumer-goods industries might be best run as cooperatives.
14 - Sachin Kumar Paurush
Thus, democratic socialism is a broad political movement propagating the ideals of
socialism within the context of a democratic system. In many cases, its adherents
promote the ideal of socialism as an evolutionary process resulting from legislation
enacted by a parliamentary democracy. Other democratic socialists favour a
revolutionary approach that seeks to establish socialism by creating a non-parliamentary
democratic system, usually based on democracy rooted at the local level as well as at
the national level, including broad based popular associations such as workers' councils,
community groups, and other similar organizations.
Under democratic socialism the whole economy is not necessarily centrally planned.
Apart from major social investments like mass transport, housing and energy, market
mechanisms are needed to determine the demand for many consumer goods.
Democratic socialists have normally defended the role of the public sector, particularly
as regards the provision of key services such as health care, education, utilities, mass
transit, and sometimes also banking, mining, and fuel extraction. For evolutionary
democratic socialists, their economic vision has often included a mixed economy with a
greater emphasis on worker and consumer co-operatives, credit unions, family farms
and small businesses, as compared to authoritarian Marxist-Leninists.
Revolutionary democratic socialists usually distinguish between the role of the public
sector within parliamentary democracies and the role of social ownership in a post-
revolutionary society. They see pre-revolutionary public ownership, not as a means of
achieving socialism, but as a means of ameliorating the worst effects of capitalism until
a revolution is accomplished and the means of production are transferred directly to the
workers and community organizations. With respect to the means of production,
democratic socialism uses the term "social ownership" rather than "nationalization",
because the latter is often associated with state ownership by the bureaucracy of a
parliamentary state. Social ownership in this sense implies a broadly based democratic
control of the means of production at the level of the workers, from which the power in
a democratic republic would flow.
Merits of Socialism
i. Absence of Class Struggle: On account of state ownership of productive resources
and equitable social distribution of income, there is no struggle between haves and
15 - Sachin Kumar Paurush
have-nots. Reduced inequalities of income lead to minimal dissatisfaction and social
discrimination and there are no such classes as capitalists and labourers. This results in
absence of class struggle.
ii. Economic Stability: The problem of overproduction, underproduction, idle
capacity and business cycles are eliminated because the central planning authority takes
all major economic decisions. The government takes the decisions related to allocation
of resources in the economy based on the society needs and availability of resources.
iii. Social Justice: Under socialism, there is a just and equitable distribution of
national income. This creates an environment of equality and justice to all citizens of the
country and social discrimination is avoided. Everyone has equal opportunity for work
and equal facilities are available to all members of the society. There is no exploitation
of the poor by the rich and hence social justice prevails.
iv. Sustainable Economic Growth: Economic planning facilitates optimum utilization
of resources thereby leading to sustainable economic growth. Socialist economies may
not be high growth economies but they use their resources prudently so that a
sustainable development path can be followed. Growth is optimum in the sense that
care is taken not only for the present generation but also for the future generations.
v. Rational Allocation of Resources: The central planning authority which is usually
the government, decides the allocation of resources keeping in view the basic needs and
preferences of people. Wastage of resources in undesirable production is thus
eliminated and community needs take preference over individual profits.
Demerits of Socialism
i. Inefficiency and Low Productivity: Bureaucracy and red tapism in the functioning
of state-owned enterprises lead to low productivity. Payments are not linked to
productivity of the workers and wage increments are more due to social obligations of
the government. Excessive job security in government enterprises also works in negative
as workers remain unconcerned about their contribution to production.
16 - Sachin Kumar Paurush
ii. Lack of Incentive and Initiative: In a socialist economy, people do not have
incentives for hard work and enterprise. All the workers doing the same level of job are
paid equally irrespective of the efforts they are putting and the amount of their
productivity. This works as a disincentive for initiative and efforts to give more output.
iii. Loss of Occupational Freedom: In a socialist economy, people do not enjoy full
freedom to choose occupation and employment of their liking. This again leads to
disinterest in work which becomes a major cause of low productivity and thus lower
production and growth in a socialist economy.
iv. Corruption: There is great possibility of breeding of corruption in a socialist
economy. Bureaucratic controls and procedural bottlenecks lead to mandatory
approvals to be taken from the government which promotes bribery and other forms of
corruption in the government machinery where the bureaucrats try to exploit general
public by taking advantage of their positions.
v. Loss of Consumer Sovereignty: The production in a socialist economy takes place
as per the decisions taken by the government. The wants of consumers are not duly
considered as individual benefits are given a back seat over community needs. This leads
to loss of consumer sovereignty and freedom to consume as per will is absent.
vi. Concentration of Economic Power in the State: Socialism is a totalitarian system
because both economic and political power is concentrated in the hands of the
government. This leads to severe violation of economic and civil rights of the people by
the government if the officials in the government are immersed in greed and individual
gains are prominent for them.

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Economic System | Socialism | Capitalism | Mixed Economy |

  • 1. 1 - Sachin Kumar Paurush FEBRUARY 28 Asian School of Business Authored by: Sachin Kumar Paurush Economic Systems
  • 2. 2 - Sachin Kumar Paurush Economic System The economic system functions to answer three vital questions: a] what to produce b] how to produce and c] for whom to produce. The first question 'What to produce' depends on what is wanted. But all wants cannot be satisfied. This is because a country may not be gifted with all the necessary resources to produce all the goods. Hence, depending upon the resource endowment a country would decide what it could produce. Then there is a problem of prioritizing the available resources among the goods to be produced. Resources should not be used for the production of unwarranted goods. The production of goods, which are harmful to human beings, like narcotic drugs, should be prevented. Hence, considering the availability of resources, the economic system should opt to produce only goods that would satisfy the wants of human beings and increase social welfare. In this context it becomes necessary to weigh the individual requirements and the national requirements for goods. The second question ‘How to produce’ addresses issues relating to selection of right strategy, technology and investment. For example, a country like India, with very huge population cannot prefer capital -intensive technology, as that would lead to more unemployment of human resources. Similarly, while selecting the technology, a country should weigh a number of considerations like relevance of technology, cost of technology, support in case of failures, consequences of the technology used, etc. Another vital aspect is the investment that a country has to make while selecting the strategy and the technology and whether the available funds should be invested in sophisticated research and development or meeting the basic needs of the people. ‘For whom to produce’ implies that based on the resource utilization, the country as a whole should benefit and not a few segments. This aspect deals with equitable distribution of the goods and services produced in the economy. The distribution of national product would differ from country to country depending upon the economic system in place. The way in which the above three questions are answered depends on the economic system which functions in a country. The role of government and private enterprise
  • 3. 3 - Sachin Kumar Paurush depends on the economic system being followed. There are three main types of economic systems as discussed in chapter 1. They are capitalism, socialism and mixed economy. We will discuss the capitalist economic system in this chapter and the other two will be discussed in the chapters that follow. Capitalism Capitalism is an economic system based on the principle of free enterprise. Individual ownership of resources is an important feature. With control and command over resources, individuals can conduct any type of business. The object in such a system is to maximize private gains. Any type of enterprise or production of any commodity or service is permitted, so long it is wanted by the society. In such a system the market forces determine the resource allocation and price. That is, the demand and supply forces together determine what to produce, how to produce and for whom to produce. Price mechanism is the nucleus of the capitalistic society. The price mechanism clearly reflects the wants of the people. Once this is known, the producers would allocate the resources to manufacture and sell the products in great demand. While doing so, there is no control or regulation over production. Features of Capitalism Following are the main features of the capitalist economic system: i. Profit Motive: All economic activities are guided by the motive of earning profit. The entrepreneurs choose to produce those goods and services which will yield greater profit. It is totally profit motive driven and there is no consideration for social justice. ii. Right to Private Property: In capitalism individuals are free to own, use and dispose of productive factors such as land, plant and machinery, capital, etc. Private property is a legal right and due to this right, property is privately owned by the people.
  • 4. 4 - Sachin Kumar Paurush iii. Competition: In capitalism there are a large number of buyers and sellers. Due to a large number of competing firms, an individual firm cannot control the market. Profit motive induces new firms to enter the market there by increasing competition. iv. Limited Role of Government: There exists a government but it does not interfere with the day-to-day functioning of the economy. Its main job is to maintain law and order, ensure the country’s security and enact laws necessary for public welfare. Pure capitalism rests on laissez-faire policy i.e. no government intervention at all in business. v. Role of Price Mechanism: The major role of bringing about equilibrium in the market is played by the price mechanism. Through this mechanism, the demand and supply forces interact in the market and an equilibrium is achieved due to bidding up of prices in case of excess demand and bidding down of prices in case of excess supply. vi. Consumer Sovereignty: People are free to spend their incomes as they like. Every consumer is free to buy from any seller and consume any commodity in any quality. In fact, the tastes and preferences of consumers direct production in a free market economy. This is known as the principle of consumer sovereignty. vii. Freedom of Choice of Occupation: People have the freedom of choice of occupation as the decision of ‘What to Produce’ and ‘How to Produce’ is taken by private entrepreneurs and individuals are free to choose their profession. Variants of Capitalism There are many variants of capitalism in existence. All these forms of capitalism are based on production for profit, at least a moderate degree of market allocation and capital accumulation. The dominant forms of capitalism are listed here.
  • 5. 5 - Sachin Kumar Paurush Laissez-faire/ Pure Capitalism The phrase laissez-faire is French and literally means "let do", but it broadly implies "let it be", or "leave it alone." In economics, laissez-faire is an environment in which transactions between private parties are free from state intervention, including restrictive regulations, taxes, tariffs and enforced monopolies. Pure or free market capitalism consists of a free-price system where supply and demand are allowed to reach their point of equilibrium without intervention by the government. Productive enterprises are privately owned, and the role of the state is limited to protecting property rights. In pure capitalism, prices are determined by supply and demand. Economic intervention and regulation by the government is limited to tax collection, and enforcement of private ownership and contracts. Free market differs from situations encountered in state controlled economies, which can introduce price deviations without any changes to supply and demand. The means of production is under private, and not state control or co-operative ownership. A laissez-faire or pure capitalist system is one within which all markets are unregulated by any parties other than market participants. In its purest form, the government plays a neutral role in its administration and legislation of economic activity, neither limiting it (by regulating industries or protecting them from internal/external market pressures) nor actively promoting it (by owning economic interests or offering subsidies to businesses or R&D). Free markets contrast sharply with controlled markets, in which governments more actively regulate prices and/or supplies, directly or indirectly, which according to free-market theory causes markets to be less efficient. Social/ Mixed Capitalism A social market economy is a nominally free-market system where government intervention in price formation is kept to a minimum but the state provides significant social security, unemployment benefits and recognition of labour rights through national collective bargaining laws. The social market is based on private ownership of businesses.
  • 6. 6 - Sachin Kumar Paurush The social market economy seeks a middle path between socialism and laissez-faire economic liberalism, combining private enterprise with government regulation to establish fair competition, maintaining a high rate of economic growth, price stability, low unemployment, good working conditions, social welfare and public services. State capitalism The term State capitalism has various meanings, but is usually described as commercial (profit-seeking) economic activity undertaken by the government with management of the productive forces in a capitalist manner, even if the state is socialist for namesake. State capitalism is usually characterized by the dominance or existence of a significant number of state-owned business enterprises. Examples of state capitalism include corporatized government agencies (agencies organized along corporate and business management practices) and states that own controlling shares of publicly-listed corporations, effectively acting as a large capitalist and shareholder itself. State capitalism has also come to refer to an economic system where the means of production are owned privately but the state has considerable control over the allocation of credit and investment. Alternatively, state capitalism may be used (sometimes interchangeably with state monopoly capitalism) to describe a system where the state intervenes in the economy to protect and advance the interests of large- scale businesses. This practice is often claimed to be in contrast with the ideals of both socialism and laissez-faire capitalism. State capitalism can be thought as a social system combining capitalism—the wage system of producing and appropriating surplus value—with ownership or control by the government. By that definition, a state capitalist country is one where the government controls the economy and essentially acts like a single huge corporation, extracting the surplus value from the workforce in order to invest it in further production. Workers are exploited in such economies and government operates with the profit motive instead of social welfare motive. Corporate Capitalism Corporate capitalism is a free or mixed market characterized by the dominance of hierarchical, bureaucratic corporations, which are legally required to pursue profit. State
  • 7. 7 - Sachin Kumar Paurush monopoly capitalism refers to a form of corporate capitalism where the state is used to benefit, protect from competition and promote the interests of dominant or established corporations. A large proportion of the economy and labour market falls within corporate control. In the developed world, corporations dominate the market, constititing 50 percent or more of all businesses. Those businesses which are not corporations contain the same bureaucratic structure of corporations, but there is usually a sole owner or group of owners who are liable to bankruptcy and criminal charges relating to their business. Corporations have limited liability and remain less regulated and accountable than sole proprietorships. Corporations are usually called public entities when their shares are listed and traded on the stock market. This is done as a way of raising capital to finance the investments of the corporation. The shareholders appoint the executives of the corporation, who are the ones running the corporation via a hierarchical chain of power, where the major investor decisions are made at the top, and have effects on those beneath them. Corporate capitalism has been criticized for the amount of power and influence corporations and large business interest groups have over government policy, including the policies of regulatory agencies and influencing political campaigns. Many social scientists have criticized corporations for failing to act in the interests of the people, and their existence seems to circumvent the principles of democracy, which assumes equal power relations between individuals in a society. Merits of Capitalism i. Efficient Utilization of Resources Under capitalism, the scarce resources of the country are used most economically and with minimum waste. Every business firm wants to minimize costs so that it can compete in the market. In order to minimize costs producers attempt to utilize factors of production in the best possible manner. ii. Rapid Economic Growth
  • 8. 8 - Sachin Kumar Paurush The capitalism system helps in rapid economic growth due to incentive & initiative. Countries operating under the capitalist system have achieved a considerable increase in per capita income. It enables people to enjoy high standard of living. As all the business firms are running with a profit motive, each of them tries to maximize output in the given resources and increase in production leads to rise in incomes. iii. Democratic Nature Under capitalism, people enjoy full economic freedom. It means that the consumers, the workers and the entrepreneurs are all free to do the type of work they like or think appropriate according to their requirements and skills. Everyone has the freedom to work as per their will to fulfil their needs and wants. iv. Flexibility and Adaptability Capitalism has an inherent ability to change according to changing requirements and circumstances. It is a dynamic system and can be adapted to the changing environment. Price mechanism serves as an ‘invisible hand’ which automatically brings the required corrections in the system to bring about equilibrium. This is perhaps the reason why capitalism, in some form or the other has survived for centuries. v. Less Corruption Due to very limited government interference and more dependence on the market forces, capitalism does not require too many bureaucratic controls. This leads to lesser corruption which normally breeds in the systems which are too dependent on bureaucracy. vi. Higher Efficiency and Productivity The wages and other factor payments in a capitalist system are linked to productivity. Those who are more efficient and productive get rewarded and the less efficient ones have to suffer. This leads to higher efficiency and productivity in the economy as a whole. Demerits of Capitalism i. Lack of Social Benefit
  • 9. 9 - Sachin Kumar Paurush Maximum social satisfaction can be achieved when goods and services produced are made available to those consumers who will get the maximum satisfaction from them which actually mean those consumers who need them the most. But in the capitalist system goods go in the hands of the people who can offer the best price as the demand forces in the market are based on the ability to pay and not on need alone. ii. Social Waste Cut-throat competition among business firms results in unnecessary expenditure on advertising and ruthless exploitation of natural and human resources of nation. But, all this expenditure is guided by profit motive only. The producers produce those goods and services which rich people can afford to buy rather than those which the society actually needs. iii. Social Discrimination Capitalism leads to the division of the society into two classes: ‘haves’ (rich) and ‘have nots’ (poor). The rich exploit the poor, the capitalists exploit the labour class and the society gets bifurcated on the basis of resources one has. Thus, capitalism may benefit a few at the cost of many. iv. Loss of Human Values Capitalism promotes materialistic attitudes in the people. The lust for profits and wealth gives rise to several social evils. It is alleged that “capitalism has no conscience, its God is gold. It contains the seeds of its own destruction.” (Karl Marx). Due to discrimination between rich and poor and most of the opportunities going to the richer sections of the society, the poorer section turns towards illegal and immoral activities as they feel deprived and find ‘snatching’ the only way of ‘getting’. Meaning of Socialism Socialism refers to an economic system in which the resources are owned by the State or state owned institutions. Production takes place in the interest of the society and not for maximizing profits of individuals or organizations. Government decides the type of productive efforts to be permitted. In other words, in a socialist country, government can adopt licensing system and other types of regulations to prevent the emergence of
  • 10. 10 - Sachin Kumar Paurush monopolist and exploitative tendencies. Maximization of community welfare is the objective rather than profit maximization of individual units. Socialism is an economic system where the means of production are owned or controlled by the state or government. In socialism there is no place for private properties and private enterprise. In this economic system, production is controlled by the state itself which decides what to produce, how to produce and how to distribute the product among the population. According to H.D. Dickinson, “Socialism is an economic organization of society in which the material means of production are owned by the whole community and operated by organs representative of and responsible to the community according to a general economic plan, all members of community being entitled to benefit from the results of such socialized production on the basis of equal right”. Representative of the community is usually the government. Features of Socialism i. Government Ownership: The major means of production are either owned by the government or their use is controlled by the government. No private enterprise is involved in production. All the people work as workers and remuneration is provided according to work. ii. Equitable Distribution of Income: Socialist system aims at an equitable distribution of income. There is no right to private property and hence no one can be too rich or own much capital and wealth. Government decides the distribution of income in the economy and tries to provide equitable distribution of income in the society. iii. Social Welfare: Socialist system has a welfare motive in contrast to the profit motive of market economy. Community welfare is given priority over individual benefits. Allocation of resources is done in such a manner so that maximum social welfare can be achieved with minimum social cost. iv. Absence of Competition: Since the state owns all the major means of production, there is no competition between the different production units. There is absence of
  • 11. 11 - Sachin Kumar Paurush competition in the sense that government owns all the resources and is the sole producer of all goods and services. v. Equality of Opportunity: Every member of the society is given equal opportunity to rise in life in a socialist economic system. Government as a representative of the community decides about the type of production required in the economy and provides gainful employment to the people in those areas. Government in socialist economies do not differentiate among people and provide equal opportunity of education, occupation and other social benefits to all the members of the society. vi. Classless Society: Socialism is based on a classless society. As all the members work to earn their living, there are no such classes as capitalist class and labour class. Hence this system promotes social equality and class conflicts do not exist in the system. Variants of Socialism 1. Marxism The pure socialism is proved to be impractical and it made role of government too dominant. Most of the governments could not fit in this role effectively. Further, capitalism with its explicit goals threatened the success of socialism. It was at this juncture that Karl Marx came up with his ideology, which led to the evolution of Marxian socialism. Marx propounded through his logical reasoning that economics dominates every activity of a society. The continued exploitation of labour in the capitalist society would result in the creation of haves and have-nots. This division of the society would widen with the continuance of capitalism, which ultimately will result in class struggle. Marx explained through his theory of value that every product should be valued in accordance with the value of labour contained in it. But the labourers are rewarded at a very much lesser rate than what they create. Labourers contribute more by way of their work to produce the product but they are paid very low wages. The difference or surplus extracted is the gain realized by the capitalists. The capitalists would accumulate profits this way at the cost of worsening labour condition. Over a period the divide between the capitalist class and the labour class would widen to such an extent that there would be social upheaval. Karl Marx predicted class conflict and argued that unless the capitalist class realizes this, there would be severe impact on production and economic condition of a country. His argument came true in the case of France that the French revolution
  • 12. 12 - Sachin Kumar Paurush broke out in 1789 and problems also came up in other countries like erstwhile USSR and China. But in China, the Marxism led to the emergence of communism which is discussed in detail below. Though Marxism was prevalent in a number of countries for some time, yet it has inherent defects. Firstly, Marx's view that all activities in all countries are basically economic in nature is not true. Secondly, his argument that class struggle continuously takes place in every country did not come true. A number of other reasons of economic, social and cultural nature led to the struggle and not the way Marx predicted. Thirdly, the theory of surplus value could not be applied in practice in service industry. Fourthly, Marx did not consider the possibility that a government could interfere in case of exploitation of society by the capitalists. Communism Communism is Marx's prediction at the fall of capitalism. Marx argued that the widening inequalities in a society coupled with class struggle should ultimately sound the death knell of capitalism. He is of the view that when capitalism falls, the communism will emerge in which, the labourers will lead the country. The government will own all the resources and determine the needs of the society. It will also decide various other issues of macro and micro importance. Government will turn out to be the custodian of the society and in a pure communistic society; people will lead a life where basic necessities are provided by the government. Unemployment will be very low as everyone is occupied in some vocation or the other as determined by the needs of the society. But the way in which communism was practiced in certain countries created an impression that in communist countries the government was oppressive in its approach that the people were unable to live a life of freedom and liberty. One has to work in the vocation available as per the planning of the government to earn his living. Military type of regimentation was enforced and common people were subjected to absolute control and regulation by government. The nominated representatives of the Communist party attended to all the governmental responsibilities. Market mechanism is completely absent in such a system, as government determines everything on behalf of the country.
  • 13. 13 - Sachin Kumar Paurush As has been already pointed out depending upon the economic system, the business environment will change. In a capitalist system, the environment provides opportunities for everyone who wants to maximize gains. In a socialist system, the government undertakes the responsibility of providing everything to the citizens. In a Marxist economy, it is ultimately the labourers who will hold the reins. In a Communist economy, it is the group of administrators who run the economy in the interest of the economy. 3 Democratic Socialism Democratic socialism is the philosophy that both the economy and society should be run democratically to meet public needs and not to make profits for only a few. To achieve a more just society, many structures of the government and economy are radically transformed through greater economic and social democracy so that ordinary citizens can participate in the many decisions that affect their lives. Democracy and socialism go hand in hand in this form of socialist system. Democratic socialism does not create an all-powerful government bureaucracy as in pure socialism. But on the other hand, it does not allow big corporate bureaucracies to control the society either as in capitalism. Democratic socialism is a system in which social and economic decisions can be made by those whom they most affect. In capitalist system, corporate executives and a few wealthy stockholders make basic economic decisions affecting millions of people while in pure socialism or communist system all the decisions rest with the government. Resources are used to make money for capitalists or satisfy the aspirations of the administrators in the government rather than to meet human needs. Democratic socialism believes that the workers and consumers who are affected by economic institutions should own and control them. Social ownership could take many forms, such as worker-owned cooperatives or publicly owned enterprises managed by workers and consumer representatives. Democratic socialists favour as much decentralization as possible. While the large concentrations of capital in industries such as energy and steel may necessitate some form of state ownership, many consumer-goods industries might be best run as cooperatives.
  • 14. 14 - Sachin Kumar Paurush Thus, democratic socialism is a broad political movement propagating the ideals of socialism within the context of a democratic system. In many cases, its adherents promote the ideal of socialism as an evolutionary process resulting from legislation enacted by a parliamentary democracy. Other democratic socialists favour a revolutionary approach that seeks to establish socialism by creating a non-parliamentary democratic system, usually based on democracy rooted at the local level as well as at the national level, including broad based popular associations such as workers' councils, community groups, and other similar organizations. Under democratic socialism the whole economy is not necessarily centrally planned. Apart from major social investments like mass transport, housing and energy, market mechanisms are needed to determine the demand for many consumer goods. Democratic socialists have normally defended the role of the public sector, particularly as regards the provision of key services such as health care, education, utilities, mass transit, and sometimes also banking, mining, and fuel extraction. For evolutionary democratic socialists, their economic vision has often included a mixed economy with a greater emphasis on worker and consumer co-operatives, credit unions, family farms and small businesses, as compared to authoritarian Marxist-Leninists. Revolutionary democratic socialists usually distinguish between the role of the public sector within parliamentary democracies and the role of social ownership in a post- revolutionary society. They see pre-revolutionary public ownership, not as a means of achieving socialism, but as a means of ameliorating the worst effects of capitalism until a revolution is accomplished and the means of production are transferred directly to the workers and community organizations. With respect to the means of production, democratic socialism uses the term "social ownership" rather than "nationalization", because the latter is often associated with state ownership by the bureaucracy of a parliamentary state. Social ownership in this sense implies a broadly based democratic control of the means of production at the level of the workers, from which the power in a democratic republic would flow. Merits of Socialism i. Absence of Class Struggle: On account of state ownership of productive resources and equitable social distribution of income, there is no struggle between haves and
  • 15. 15 - Sachin Kumar Paurush have-nots. Reduced inequalities of income lead to minimal dissatisfaction and social discrimination and there are no such classes as capitalists and labourers. This results in absence of class struggle. ii. Economic Stability: The problem of overproduction, underproduction, idle capacity and business cycles are eliminated because the central planning authority takes all major economic decisions. The government takes the decisions related to allocation of resources in the economy based on the society needs and availability of resources. iii. Social Justice: Under socialism, there is a just and equitable distribution of national income. This creates an environment of equality and justice to all citizens of the country and social discrimination is avoided. Everyone has equal opportunity for work and equal facilities are available to all members of the society. There is no exploitation of the poor by the rich and hence social justice prevails. iv. Sustainable Economic Growth: Economic planning facilitates optimum utilization of resources thereby leading to sustainable economic growth. Socialist economies may not be high growth economies but they use their resources prudently so that a sustainable development path can be followed. Growth is optimum in the sense that care is taken not only for the present generation but also for the future generations. v. Rational Allocation of Resources: The central planning authority which is usually the government, decides the allocation of resources keeping in view the basic needs and preferences of people. Wastage of resources in undesirable production is thus eliminated and community needs take preference over individual profits. Demerits of Socialism i. Inefficiency and Low Productivity: Bureaucracy and red tapism in the functioning of state-owned enterprises lead to low productivity. Payments are not linked to productivity of the workers and wage increments are more due to social obligations of the government. Excessive job security in government enterprises also works in negative as workers remain unconcerned about their contribution to production.
  • 16. 16 - Sachin Kumar Paurush ii. Lack of Incentive and Initiative: In a socialist economy, people do not have incentives for hard work and enterprise. All the workers doing the same level of job are paid equally irrespective of the efforts they are putting and the amount of their productivity. This works as a disincentive for initiative and efforts to give more output. iii. Loss of Occupational Freedom: In a socialist economy, people do not enjoy full freedom to choose occupation and employment of their liking. This again leads to disinterest in work which becomes a major cause of low productivity and thus lower production and growth in a socialist economy. iv. Corruption: There is great possibility of breeding of corruption in a socialist economy. Bureaucratic controls and procedural bottlenecks lead to mandatory approvals to be taken from the government which promotes bribery and other forms of corruption in the government machinery where the bureaucrats try to exploit general public by taking advantage of their positions. v. Loss of Consumer Sovereignty: The production in a socialist economy takes place as per the decisions taken by the government. The wants of consumers are not duly considered as individual benefits are given a back seat over community needs. This leads to loss of consumer sovereignty and freedom to consume as per will is absent. vi. Concentration of Economic Power in the State: Socialism is a totalitarian system because both economic and political power is concentrated in the hands of the government. This leads to severe violation of economic and civil rights of the people by the government if the officials in the government are immersed in greed and individual gains are prominent for them.