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8.1 Different Economic Systems

PLEASE NOTE: This book is currently in draft form; material is not final.

Learning Objectives

  1. Know the difference between capitalism, socialism, communism and fascism.
  2. Understand how market-based and planning-based economies work.

Our basic economic system, as you probably know, is called capitalism. Capitalism means private ownership of productive resources, with a reliance on markets to decide what gets produced and how much it will cost. So, you can start and own a business, and consumers will decide if they want your business around. Markets let consumers and business owners vote with their dollars, euros or yen on what will be for sale, what the price will be, and which firms survive to produce another day. As we’ll see, markets are very good at some things and perhaps not so good at others.

The alternative to market-based economic decision-making is some kind of government-based model. Government would decide, on behalf of people, what will be produced and how much each item will cost. As with market-based systems, government-based systems have their strengths and weaknesses. As a society, in the United States we have largely opted for a market-based approach, but not always.

Take a step back to the isms we talked about in chapter three, and think about them with an eye to how they make economic decisions, and what the advantages and disadvantages of each system is:

  • CapitalismAn economic system that allows private ownership of productive resources, and makes production and pricing decisions via markets.: Private ownership of productive resources, with decisions made largely by consumers and businesses deciding on their own what to produce and what to buy. Remember that capitalism is part of what we call classical liberalismAn economic and political system that relies on democratic participation for political decisions and on markets for economic decisions.—a system that relies on open elections and on markets. Generally speaking, capitalism is more efficient and less equalitarian in terms of who gets what. It produces more wealth, but can distribute it somewhat unevenly.
  • SocialismAn economic system that uses central planning and public ownership of productive resources to decide who will produce what.: Government ownership of productive resources. Public agencies decide what will be produced and what it will cost. These agencies could be subject to political control through elections; they also could simply be imposed on consumers by the state. Socialism doesn’t necessarily imply one kind of political system over another. Socialism is generally less efficient but more equalitarian. Everybody gets something, but everybody may not get as much. To some extent, this is because a socialist system may be more focused on providing jobs for people than it is on providing goods and services.
  • CommunismAn economic and political system that uses socialism to make production decisions and a one-party state to make political decisions.: Government ownership of productive resources, and a one-party state to enforce decisions. The level of public ownership is usually higher than in socialism. It is even less efficient and even more equalitarian (although under communism, some folks appear to be more equal than others. Dictators and high party officials usually appear to live better than do common citizens).
  • FascismAn economic and political system that is not democratic, punishes its enemies and rewards its friends.: Fascism claims to be capitalist, but as the state is not democratic, there’s little popular control over anything. The state (usually, some dictator or group of dictators) tends to reward its friends and punish its enemies, which leads both to oppression and an inefficient economy. (The firm that kicks back the most money to the government is the firm that survives and makes a profit, but it isn’t very often the firm that produces the best products at the lowest price.) Both inefficient and unequal, this seems to represent the worst of all possible worlds.

The world has tended toward capitalism in the last 30 years. With the collapse of the Soviet Union, and the opening of China’s economy, only North Korea and Cuba remain as communist states. And Cuba seems to be slowly edging rightward. That means more economies operated via markets.

Markets vs. Planning

A marketAll the people and businesses involved in the production, distribution and consumption of any good or service. is all the people and businesses involved in the production, distribution and consumption of any good or service. Markets are neither all bad nor all good. When the U.S. economy is doing well, you will hear how wonderful free markets are, like some fairy tale in which everyone really does live happily ever after. Conversely, when the economy is not doing well, you will hear how the market system doesn’t really doesn’t work, and that socialism, after all, is the only answer.

Realistically, neither of these viewpoints is 100 percent true. Every system has its share of strengths and weaknesses, and each represents trade-offs in the creation and distribution of wealth.

As we’ve already noted, market-based systems tend to be more productive—more goods for sale, higher quality and better prices. Planned systems have a hard time anticipating what the public will want, and so tend to produce fewer goods of worse quality, and consequently generate less overall wealth for society. As was noted in the days of the old Soviet Union in the 1970s, it was −60 degrees in Leningrad in February, and you still couldn’t get a cold Coke, because the Soviet-era refrigerators were so bad. That might be a bit of an exaggeration, but in the old communist economies, consumer goods were of poor quality and often in short supply. For example, in Poland in the 1980s, when it was still communist, the price of bread was regulated. Limiting the price of bread meant that even the state-run bakeries couldn’t supply more bread because they couldn’t raise the price to buy more flour. Meanwhile, the price of cake wasn’t regulated, and the bakeries always had lots of cake.

Hard-core socialist systems don’t always reward hard work and initiative. In the early 1990s, I visited a friend in Bratislava, the capital of Slovakia, which broke away from the Czech Republic after the fall of the Berlin Wall in 1989. His business required him to have a fax machine in his apartment, but he couldn’t get the fax to work. He called the state telephone company, which sent three guys out to look at his fax machine. They told him it was broken, and offered to sell him a new one for about $600 (a lot of money for a fax machine, then and now). The fax machine wasn’t broken; in fact, it worked fine on his neighbor’s phone line. The problem was clearly in his phone line, but the repairmen weren’t motivated to go after that. After the “repairmen” left, my friend turned to me and said, “This is the legacy of 40 years of communism. These people don’t know how to work.” But it was in Bratislava that we stumbled across the monument to the victory of the west in the Cold War: Coming around a corner, we came square upon on a large K-mart, with a Pespi logo painted on its side. “You see,” I told my friend, “there it is. We won.”

It was in part the west’s ability to produce more stuff of higher quality and better cost that enabled it to wade through 50 years of the Cold War and come out ahead. And that ability largely stemmed from its reliance on markets.

Market systems aren’t perfect when it comes to predicting demand, either. But if one firm produces more jeans than consumers want at that time, the firm (and its employees) bear the cost of that decision, as opposed to the whole society. And because most firms know that, they tend to be more careful about how much inventory to produce. Badly run firms go out of business or are acquired; well-run firms prosper and, hopefully, share that success with their employees and customers.

Conversely, however, planned systems can move resources in a way that means there will be less abject poverty. Cuba, for all its problems, has better basic health care, higher literacy rates, and less homelessness than does the United States. On the other hand, it would be much harder for you to go into business for yourself in Havana than it would in Hartford or Hawaii. (Sweden, which has much fewer natural advantages than Cuba, but a market-based economy, has an economy nine times the size of Cuba’s.) So while socialist economies have less disparity of wealth, capitalist societies tend to be richer overall. So socialist economies have a higher floor, and capitalist economies have a higher ceiling.

Capitalist or Socialist?

Finding a balance between the higher floor and the higher ceiling remains the tricky part of economic policy. Increasingly, the world’s nations rely on markets for economic decision making, even a self-proclaimed communist nation such as China. I’ve heard people say of China, “Don’t they know they’re communist?” Having spent some time there, I think they know they’re not. Officially, China’s economic description is described as “Chinese socialism with characteristics of market capitalism,” or, more recently, “market capitalism with characteristics of Chinese socialism.” Perhaps it’s an evolutionary process.

China is still ruled by what I like to call the not-very-Communist Party (or the Kaching! Dynasty), because while they are not very democratic, it is possible to start and own a business. From the time party reformer Deng Xiao Ping (the successor to Chairman Mao) declared “It is glorious to be rich,” China has been grinding its way toward building a market-oriented economy. Many firms are still state-owned, but many are not. That division between the private sector and the state is likely to drive change in China, as private firms will someday increasingly question why they need an overwhelming, unchecked state telling them what to do. So one of China’s great challenges is how to reconcile the unchecked power of the Communist Party with the growing demands of the private sector. The party’s legitimacy increasingly rests on its ability to provide rising standards of living for the nation’s 1.5 billion people. That’s a tough job under the best of circumstances; as every nation realizes at the end of a boom, nothing grows forever (except maybe people’s expectations). While China’s economic growth rates have been strong for more than a decade, when you’re starting from zero, you have nowhere to go but up. That kind of growth simply won’t last forever.

China isn’t really communist, nonetheless, and the United States isn’t 100 percent capitalist. Most nations have what is called a mixed economyAn economic system that features elements of both socialism and capitalism.—a blend of private and public enterprises. Even in the United States, while most businesses are privately owned, we have a number of publicly owned enterprises, from the U.S. Postal Service to public hospitals, water and sewer districts, and public power companies. But most of the economy depends on markets.

Figure 8.1

Chart TK: A diagram placing major nations of the world on the spectrum between socialism and capitalism.

Key Takeaways

  • Capitalism is an economic system that relies on markets.
  • Socialism and communist rely on government planning.
  • Most of the world’s economies are a mix of the two, with some decisions made by private firms and consumers in markets, but some decisions made by government.


  1. Identify some private firms near where you live.
  2. Identify some government-run firms. What would it mean for them to be privatized?
  3. Which countries in the world are still ostensibly communist?