In this module we will consider major economic systems.

LEAD-IN

An economic system is a set of methods and standards by which a society decides and organizes the ownership and allocation of economic resources. At one extreme, production is carried in a private-enterprise system such that all resources are privately owned. At the other extreme, following Karl Marx and Vladimir Lenin is what is commonly called a command or planned system, such that all resources are publicly owned to minimize inequalities of wealth in the society.

• What is an economic system?

• What kind of economic system do we live in?

• Is enterprise typical only of market economy?

economic system traditional economy

market economy free market enterprise

planned economy mixed economy subsistence

• Look through the words in the Key Vocabulary Section. Translate the sentences given in the right column.

 Key Vocabulary

economic system	экономическая система	Russia was the first country to forge a new economic system under the banner of Marxism.
traditional economy	традиционная экономика	Meanwhile, the traditional economy stagnated.
subsistence	средства к существованию; пропитание	The standard of living today is on the edge of subsistence.
planned economy	плановая экономика	In a planned economy, business activities and the use of resources are decided by the government, and not by market forces. This is a centrally planned economy.
mixed economy	смешанная экономика	A mixed economy is an economic system in which some companies are owned by the state and some are not.
market economy	рыночная экономика	It is probably true that a market economy tends to suppress non-economically useful differences.
free market	свободный рынок	A free market is an economic system in which business organizations decide things such as prices and wages, and are not controlled by the government.
enterprise	предпринимательство	SYN: entrepreneurship Free enterprise is an economic system in which businesses compete for profit without much government control.

READING SKILLS

• Scan the text to find the main features of the market economy.

• List the advantages and disadvantages of the system.

• Sum up the main idea.

• Compare the classification given in the text below and the one above.



There is a connection between political ideology and economic systems. We can identify four broad types of economic systems – a market economy, a command economy, a mixed economy, and a state-directed economy.

Market Economy

In a pure market economy all productive activities are privately owned, as opposed to being owned by the state. The goods and services that a country produces, and the quantity in which they are produced, are not planned by anyone. Rather, production is determined by the interaction of supply and demand and signaled to producers through the price system. If demand for a product exceeds supply, prices will rise, signaling producers to produce more. If supply exceeds demand, prices will fall, signaling producers to produce less. In this system consumers are sovereign. The purchasing patterns of consumers, as signaled to producers through the mechanism of the price system, determine what is produced and in what quantity.

For a market to work in this manner there must be no restrictions on supply. A restriction on supply occurs when a market is monopolized by a single firm. In such circumstances, rather than increase output in response to increased demand, a monopolist might restrict output and let prices rise. This allows the monopolist to take a greater profit margin on each unit it sells. Although this is good for the monopolist, it is bad for the consumer, who has to pay higher prices. Moreover, it is probably bad for the welfare of society. Since, by definition, a monopolist has no competitors, it has no incentive to search for ways of lowering its production costs. Rather, it can simply pass on cost increases to consumers in the form of higher prices. The net result is that the monopolist is likely to become increasingly inefficient, producing high-priced, low-quality goods, while society suffers as a consequence.

Given the dangers inherent in monopoly, the role of government in a market economy is to encourage vigorous competition between private producers. Governments do this by outlawing monopolies and restrictive business practices designed to monopolize a market (antitrust laws serve this function in the United States). Private ownership also encourages vigorous competition and economic efficiency. Private ownership ensures that entrepreneurs have a right to the profits generated by their own efforts. This gives entrepreneurs an incentive to search for better ways of serving consumer needs. That may be through introducing new products, by developing more efficient production processes, by better marketing and after-sale service, or simply through managing their businesses more efficiently than their competitors. In turn, the constant improvement in product and process that results from such an incentive has been argued to have a major positive impact on economic growth and development.

COMPREHENSION

• What economic systems exist? Which classification is the most common?

• What are major features of the market economy?

• Is there any planning in a market economy? Why?

• What kind of market is monopoly?

• What is the role of the government in the market economy?

 Text Vocabulary

output	выпуск (продукции); производство	Government statistics show the largest drop in industrial output for ten years.
profit margin	размер прибыли	A profit margin is the difference between the selling price of a product and the cost of producing and marketing it.
welfare	благосостояние	The price rises will be cushioned by welfare benefits.
competitor	конкурент	SYN: rival A company’s competitors are companies who are trying to sell similar goods or services to the same customers.
incentive	стимул; льгота	SYN: encouragement; stimulus; spur He said the government must introduce tax incentives to encourage investment.
production costs	производственные издержки	In 1989 the price of coffee fell so low that in many countries it did not even cover the production costs. Production costs began to spiral.
goods	мн. товары	Money can be exchanged for goods or services.
antitrust	антимонопольный	In the United States, antitrust laws are intended to stop large firms taking over their competitors, fixing prices with their competitors, or interfering with free competition in any way.
private ownership	частная собственность	Private ownership is guaranteed by the U.S.Constitution.
entrepreneur	предприниматель	An entrepreneur is a person who sets up businesses and business deals.
after-sale service	послепродажное обслуживание	Our company offers after-sale service to all our clients.

Mixed Economy

Between market economies and command economies can be found mixed economies. In a mixed economy, certain sectors of the economy are left to private ownership and free market mechanisms, while other sectors have significant state ownership and government planning. Mixed economies are relatively common in Western Europe; although they are becoming less so. France, Italy, and Sweden can all be classified as mixed economies. In these countries the governments intervene in those sectors where they believe that private ownership is not in the best interests of society. For example, Britain and Sweden both have extensive state-owned health systems that provide free universal health care to all citizens (it is paid for through higher taxes). In both countries it is felt that government has a moral obligation to provide for the health of its citizens. One consequence is that private ownership of health care operations is very restricted in both countries.

In mixed economies, governments also tend to take into state ownership troubled firms whose continued operation is thought to be vital to national interests. The French automobile company Renault was state owned until recently. The government took over the company when it ran into serious financial problems. The French government reasoned that the social costs of the unemployment that might result if Renault collapsed were unacceptable, so it nationalized the company to save it from bankruptcy. Renault's competitors weren't thrilled by this move, since they had to compete with a company whose costs were subsidized by the state.

Command Economy

In a pure command economy, the goods and services that a country produces, the quantity in which they are produced, and the prices at which they are sold are all planned by the government. Consistent with the collectivist ideology, the objective of a command economy is for government to allocate resources for "the good of society." In addition, in a pure command economy, all businesses are state owned, the rationale being that the government can then direct them to make investments that are in the best interests of the nation as a whole, rather than in the interests of private individuals.

Historically, command economies were found in communist countries where collectivist goals were given priority over individual goals. Since the demise of communism in the late 1980s, the number of command economies has fallen dramatically. Some elements of a command economy were also evident in a number of democratic nations led by socialist-inclined governments. France and India both experimented with extensive government planning and state ownership, although government planning has fallen into disfavor in both countries.

While the objective of a command economy is to mobilize economic resources for the public good, just the opposite seems to have occurred. In a command economy, state-owned enterprises have little incentive to control costs and be efficient, because they cannot go out of business. Moreover, the abolition of private ownership means there is no incentive for individuals to look for better ways to serve consumer needs; hence, dynamism and innovation are absent from command economies. Instead of growing and becoming more prosperous, such economies tend to be characterized by stagnation.

State-Directed Economy

A state-directed economy is one in which the state plays a significant role in directing the investment activities of private enterprise through "industrial policy" and in otherwise regulating business activity in accordance with national goals. Japan and South Korea are frequently cited as examples of state-directed economies. A state-directed economy differs from a mixed economy in so far as the state does not routinely take private enterprises into public ownership. Instead, it nurtures private enterprise but proactively directs investments made by private firms in accordance with the goals of its industrial policy. For example, in the early 1970s, the Japanese Ministry of International Trade and Industry (MITI) targeted the semiconductor industry as one in which it would like to see Japanese firms have a major presence. Industrial policy often takes the form of state subsidies to private enterprises to encourage them to build significant sales in industries deemed to be of strategic value for the nation's economic development. Thus, the Japanese government subsidized research and development (R&D) investments made by Japanese semiconductor companies. It also used direct administrative pressure to persuade several companies to enter the industry. To help targeted industries develop, the state may also protect them from foreign competition by erecting barriers to imports and foreign direct investment. Accordingly, Japanese semiconductor companies were protected from foreign competition by barriers to imports and restrictions on the ability of foreigners to establish operations in Japan.

The intellectual foundation for a state-directed economy is based on the so-called infant industry argument. This argument suggests that in some industries, economies of scale are so large firms from developed nations have such an advantage that it is difficult for new firms from developing nations to establish themselves. Industrial policy is seen as a means of overcoming this economic disadvantage. Moreover, it is argued that state-directed industrial policy may allow a country to establish a leading position in an emerging industry where scale economies will ultimately be of great importance.

One criticism of state-directed economies is that government bureaucrats don't necessarily make better decisions about the allocation of investment capital than the market mechanism would. For a long time, the economic success of countries such as Japan and South Korea allowed advocates of state involvement to dismiss such criticisms. However, a decade of stagnant growth in Japan coupled with the 1997 implosion of the South Korean economy have added legitimacy to these criticisms. The South Korean collapse, in particular, has been widely attributed to uneconomic investments by Korean companies in industries that the government deemed to be of national importance, such as semiconductors.

COMPREHENSION

• What is the mixed economy?

• What role does the government play the mixed economy?

• Define the command economy.

• Compare the mixed and the state-directed economies. What do they have in common? List the main differences.

 Text Vocabulary

to intervene	вмешиваться ( о государстве)	The Government is doing nothing to intervene in the crisis.
bankruptcy	банкротство	SYN: bust; insolvency The number of corporate bankruptcies climbed in August.
to allocate	распределять; ассигновать	It helps them to decide policies, allocate resources and plan services.
rationale	логическое обоснование; причина	The preamble constitutes a review of the rationale for greater cooperation between the organization and the Russian Federation.
priority	приоритет	The government’s priority is to build more power plants.
demise	гибель; падение (строя)	After the demise of communism Russia began its market reforms.
dramatically	существенно	SYN: considerably The prices have considerably increased.
public good	общественное благо	Politicians are happier to dress up their ruthless ambition as a necessary pursuit of the public good.
state-owned enterprise	государственное предприятие	In China state-owned enterprises manufacture the bulk of exports.
prosperous	преуспевающий; благополучный	The division between the prosperous west and the impoverished east remains.
public ownership	государственная собственность	SYN: state ownership Public ownership was common in socialist countries.
state subsidy	государственная субсидия	State subsidies keep retail prices artificially low.
R&D	сокр. от research and development – проектно-конструкторскя работы; НИОКР	Businesses need to train their workers better, and spend more on R&D.
to erect barrier (to)	создавать барьеры (чему-л.)	By erecting non-tariff barriers the new cabinet tried to protect their infant industries.
foreign direct investment	прямые зарубежные инвестиции	ABBR: FDI The EU is Mercosur’s largest trading partner and largest source of foreign direct investment.
infant industry	новая отрасль	Developing countries have to impose duties to protect their infant industries.
economies of scale	экономия на масштабах (производства); эффект масштаба	Building many units at once produces economies of scale that can be passed through to purchasers.
stagnant	вялый; низкий	A poorly managed, stagnant economy offers private investors fewer opportunities.

EXERCISES