A Brief History of Economic Systems

Between 9th and 15th centuries, the dominant economic system was Feudalism. This was not just an economic system
but also a social and political system.

There was no concept of nation states instead there were large manors owned by Lords. Lords ruled the manors and
all decision regarding land were made by them. Serfs worked the land and obeyed the rules of manor. Skills were
passed down from generation to generation.

With the passage of time, serfs started revolting and getting their freedom because of harsh working conditions.
Those who succeeded in getting freedom begin to trade and work as middleman between buyer and seller. As trade
activity grew, these merchants starting living together in towns or cities. As a result they gained wealth and power.

Therefore, a new system emerged called Mercantilism. In this new system, the power shifted from manors to towns.

In the time of Feudalism, the Lord supported the king but as power shifted from manors to towns, Merchants
became powerful and the king required their support as well. Merchants supported the king but in return they
expected the king to protect their interests.

They wanted the king to protect their business activities from theft and robbery. They also wanted their business to
be protected from foreign competitors.

Apart from traders, there was another class that constituted workers and craftsmen that held certain occupations.
They include bakers, potters, shoemakers, artists etc. They also began to unite which were called Guilds. The Guilds
also supported and financed the king and expected that their interests be protected.

Thus there arose the conflict of interests between Industrialists and Guilds. Industrialists were developing machines
which were putting workers/craftsmen out of work. Therefore, the workers wanted government to protect their
jobs. On the other side, industrialists wanted government to stay away from economic affairs of people.

At that time, Adam Smith wrote the book “Wealth of Nations” where he described the blessings of Laissez-faire and
free market. Along with others his statement shifted the odds in the favor of industrialists. Economic power was
shifting again and a new economic system was taking the shape.

Once again a new system emerged called Capitalism. Many inventions and discoveries took place that boosted the
process of industrialization that eventually gave rise to industrial revolution. Thus industrialization and capitalism
took place side by side.

The invention of Steam engine made possible the running of large machinery, ships and trains.
The second important invention was Compass that made navigation to remote countries possible.
Third was the discovery of fossil fuels that provided large reserves of fuels for industrialization.

However, this growth period of industrial revolution as a consequence of capitalism had some problems too. Slavery
was the part of early capitalism and there was also exploitation in the form of long working hours, low wage rate,
harsh working conditions and women and child labor etc. capitalism also gave rise to environmental pollution by
emission of carbon, depletion of natural resources, pollution of air, water and soil etc.

Karl Marx said that harsh working conditions and inequality is the result of rising capitalism. Marx predicted that
continued exploitation of workers by capitalists would eventually result in an overthrowing of the capitalist class,
leading to another economic transition from capitalism to socialism.

Socialism did come, but it could not completely replace capitalism. In fact, capitalism has evolved over time.
Thus a new world order emerged, where socialism and capitalism coexist. As a result there remained a long period of
tensions between Capitalistic countries and Socialistic countries known as Cold wars.

In today’s world no economy is purely capitalistic neither is it purely socialistic. Instead, all economies of the world
have some characteristics of socialism and some of capitalism. These are the combination of Capitalism and
Socialism where both private and public sector coexist.

Types or Varieties of Capitalism

Capitalism is an economic system dominated by free markets and private ownership of wealth, assets and business.
There different forms of capitalism. Some of them are given below.

1. Turbo Capitalism
This is also known as predatory capitalism or unrestrained capitalism or free market capitalism.
This refers to an unregulated form of capitalism with financial deregulation, privatization and lower tax on high
earners. Turbo capitalism involves:
 The absence of regulation for banking /finance system. This encourages banks to take risks and pursue profit
through complex financial derivatives rather than basic principles of attracting deposits and lending.
 Less regulation on abuse of monopoly power.
 Lower income tax and lower capital gains tax giving greater rewards to high income earners.
 An unregulated labor market, where it is easy to hire and fire workers, and very limited regulation about working
conditions.
The term ‘turbo capitalism’ was coined in 1989 by Edward Lattwak, in his book “Turbo-Capitalism: Winners and
Losers in the Global Economy”.

2. Responsible Capitalism
Responsible capitalism is essentially a free market economy, but with a degree of government regulation to avoid
the excesses and inequalities of capitalism. Responsible capitalism would involve:
 An extensive welfare state to protect those who are unemployed or on low incomes.
 A progressive tax system with high earners paying a higher % of their income to fund government spending.
 Most industries would be in the private sector, but, the government might take responsibility for areas with
substantial positive externalities and social benefits like health care, education, public transport.
 A willingness to regulate monopolies and protect rights of workers.

3. Crony Capitalism
A term used to refer to the situation where business success is not based on open market forces instead it is related
to the close link with civil servants, politicians and those in authority. It could be used to refer to situations in early
twentieth century US where business leaders had to buy off politicians in return for favors (e.g. in popular media:
Citizen Kane). Arguably a degree of ‘crony capitalism occurs in countries like China, South Korea and Latin America.
The power of the Mafia in Italy is also an example of ‘crony capitalism’

4. Advanced Capitalism
A term used to refer to societies where capitalism is firmly established. There is widespread acceptance of status quo
and little political activism over fundamental political issues. In advanced capitalism, consumerism is important.
There is likely an established welfare state to overcome the worst of the excesses of capitalism.

5. State Capitalism
State capitalism occurs when state owned industries play a key role within the market economy. Under state
capitalism, the government also plays a key role in planning, for example deciding to invest in transport and
communication. To some extent, China has become a model of state capitalism. Private firms play a key role, but the
government also plays a key role in planning energy, transport and the Chinese government influences monetary
 policy and exchange rate policy. The difference between state capitalism and state socialism is that under state
socialism there is no room for private enterprise and competition.

6. Vulture Capitalism
In this type of capitalism, big firms always keep an eye on smaller firms. As these firms go bankrupt bigger firms
instantly take them into their own possession at very low price.
Another similar type is venture capitalism, where big firms are looking for those firms that have good startups or
they came with some invention but don’t have capital to go on.

7. Popular Capitalism
Popular capitalism is essentially a market economy but with more equal distribution of wealth. This would involve a
degree of redistribution and guarantees of a certain social welfare safety net. Popular capitalism would be willing to
impose greater regulation on the finance sector to prevent excessive risk-taking and growing inequality.

Economic Institutions of Capitalism

Capitalism is an Economic system characterized by a particular combination of institutions. An economic system is a
way of organizing the production and distribution of goods and services in an entire economy. And by institutions,
we mean the different sets of laws and social customs regulating production and distribution in different ways in
families, private businesses, and government bodies.

1. Private Property
The first institution of capitalism is private property. Anything is private property on which you can enjoy your
possessions in a way that you choose to exclude others from their use or if you wish you can dispose of them by gift
or sale to someone else.
In past, the key economic institutions were private property, markets and families. Goods were usually produced by
families rather than firms. But in modern times, firms have replaced the families and most of the goods are produced
by firms.
Over the course of human history, the extent of private property has varied.
In ancient times of hunters and food gatherers, only personal ornaments and clothing was owned by individuals. In
the agriculture stage of historical development, the private property was limited to crop and animals were private
property. In medieval ages, slaves were also considered as private property.
In capitalist economy of today, private property is in the form of equipment, building, durable inputs or capital goods
etc. The scope of ownership has also changed. Private property may be owned by individuals, a family, a business
etc.

2. Market
Another institution of capitalism is the Market. Markets are a way of connecting people who may mutually benefit
by exchanging goods and services through a process of buying and selling.
Market is one of the mechanisms for the transfer of goods and services. Other mechanisms are gift, theft or
government order by which the transfer of goods may take place.
However, there is a difference between market mechanism of transfer of ownership and other mechanisms. Firstly,
these transfers are reciprocated; if you take something, you will have to give something in return.
Secondly, these transfers are voluntary; that is both parties are transferring without any compulsion and they are
fully aware of this transfer.
Thirdly, most of the markets are competitive. No one can charge higher price or sell lower quality goods.

3. Firms
A firm is a way of organizing production with the following characteristics:
 One or more individuals own a set of capital goods that are used in production.
 They pay wages and salaries to employees.
 They direct the employees in the production of goods and services.
 The goods and services are the property of the owners.
 The owners sell the goods and services on markets with the intention of making a profit.
The kinds of firms that make up a capitalist economy include restaurants, banks, large farms that pay others to work
there, industrial establishments, supermarkets, and internet service providers. Other productive organizations that
are not firms and which play a lesser role in a capitalist economy include family businesses, in which most or all of
the people working are family members, non-profit organizations, employee-owned cooperatives, and government-
owned entities (such as railways and power or water companies). These are not firms, either because they do not
make a profit, or because the owners are not private individuals who own the assets of the firm and employ others
to work there.

The Role of Price Mechanism in a Free Market Economy

The prices play most important role in a free market economy. All economic decisions are made based on the prices
of goods and services. Prices give signal to producers and consumers and on the basis of that they make their
production and consumption decisions.

1. What and How much to produce

Since the resources are scarce, the society has to decide that what goods to be produced and how much are to be
produced. This decision depends on the priorities of the society. If the society gives priority to the production of
more consumer goods now, it will have less in the future. A higher priority on capital goods implies less consumer
goods now and more in the future. The priorities of the societies are reflected in prices of goods. Anything with
higher prices will be produced more as compared to lower price goods. This can be shown by the diagram given
below.

Explanation: In the above diagram, production of capital goods is shown on vertical axis, while the production of
consumer goods is shown on horizontal axis. Society can choose any combination of both goods at production
possibility curve. Any point beyond PP is desirable but not achievable such is K. Any point inside PP is achievable but
not desirable because it is inefficient such is R. However all the points at PP are desirable as well as achievable such
as B, C, and D. Society can produce any combination that is at PP. The decision that which point society will choose
depends on the priorities of the society.

2. How to Produce
The next task of prices is to determine the techniques to be used for the production of articles. Prices of factors are
the rewards received by them. Wage is the price for the service of labor, rent is the price for the service of land,
interest for the service of capital and profit for the service of entrepreneur. Thus wages, rent, interest and profit are
the prices paid by the entrepreneur for the services of the factors of production which make up the costs of
production.
Every producer aims at using the most efficient productive process. An economically efficient production process is
one which produces goods with the minimum of costs. The choice of a production process will depend upon the
relative prices of the factor services and the quantities of goods to be produced.
A producer uses expensive factor services in smaller quantities relative to cheap resources. In order to reduce costs
of production, he substitutes cheaper resources for the dearer. If capital is relatively cheaper than labor, the
producer will use a capital-intensive production “process. Contrariwise, if labor is relatively cheaper than capital,
labor-intensive production processes will be used.

3. To determine the income distribution

The price mechanism also determines how income is distributed in a capitalist economy. In such an economy,
consumers and producers are largely the same people. Producers “sell goods at given prices to consumers for
money, and consumers receive “incomes from producers in
exchange for their services. The owners of factors of production
who are all consumers sell their services at given prices for
money to producers, and then spend that money to buy goods
produced by producers. In fact, the price mechanism is a system
of real flows from producers to consumers and from consumers
to producers.

Explanation: This figure shows the price mechanism in the form

of a circular flow. The upper portion determines the prices on
the goods market when the demand for goods by consumers
equals the supply of goods by producers. It is this which decides
what to produce. The decision as to how to produce is entirely
taken by the producers. The lower portion of the figure shows
that consumers or households are the controllers of the factors
of production—land, labor, capital and entrepreneurial talent. It
is they who supply their services to producers who demand them and in return the households receive money. This
is how prices are determined on the factor market.

4. To provide an incentive to growth

Prices are important means to economic growth. The inputs for improvement, innovation and development come
through price mechanism. Higher prices and profits encourage producers to spend money on research and bring
innovation. New and better techniques are developed which lead to more production. Thus price mechanism
ultimately leads to Growth.

Arguments for and against capitalism

Arguments for Capitalism

Most of the advocates of capitalism belong to classical school or neo classical school of thought.

1. According to the advocates of capitalism, it is an efficient system which leads to productive and allocative
efficiency. In this system, capitalist produces those things that the consumer wants. Moreover, prices are at
lowest level. And there is an efficient use of resources; they are devoted to the production of those goods
that consumers desire. There is an invisible hand that ensures efficiency without government intervention.
2. Capitalism is also dynamically efficient and leads to rapid growth. The reason behind dynamic efficiency is
that the competition among capitalists forces them to invest in research and development. Thus each
capitalist competes to lower his or her costs, to sell more goods, and to get a large share of consumer
demand, growth will be automatically stimulated.
3. It is also argued that capitalism is best foundation for democracy. Everyone is free to go to any business.
There is no restriction regarding the nature or type of business. In capitalism there is no control of the
government over what is produced or how it is produced. Similarly there is a freedom of speech which is also
an inherent feature of democracy. Moreover, everyone is free to choose the occupation of his own free will
 and change whenever he desires. Due to various similarities these two systems are complementary to each
other.

Arguments against Capitalism

Most of the critics of Capitalism are Marxists. Similarly, environmentalists and institutionalists (followers of Thorstein
Veblen) are also critical to capitalism.

1. The first argument that is often advanced against capitalism is that it is a system that is exploitive to workers.
The workers are the one, who actually create surplus value, but they do not get their share in this surplus
instead all the surplus goes into the pockets of the capitalists in the form of profit and the worker gets only a
meager wage.
2. Capitalism leads to wider fluctuations in output, with a few years of boom times followed by a few years of
recession or depression. Due to unplanned nature of Capitalism, businesses often engage in overproduction,
as a result prices fall and businesses have to decrease their output and lay off workers. Thus capitalism leads
to some unemployment most of the time and heavy unemployment periodically.
3. Prices under this system reflect only private costs. Negative externalities created as result of production or
consumption activity under capitalism are not taken into account. So the market fails to achieve productive
and allocative efficiency. Firms produce at inefficient output level which leads to environmental degradation.
Moreover, due to free rider problem, there are various goods that will not be produced if left to market.
4. Capitalism is based on competition. Increase in competition leads to the elimination of the weak firms and
gives rise to the establishment of monopoly power of large corporations. These corporations charge higher
prices, pay less attention to consumers, does not attempt to lower costs, and do not invest in research and
development.
5. Capitalist economic power means they have the resources to control politicians, journalists and media etc.
They also have the means to buy voters and political power. As a result they influence people through these
unfair means and promote their self interests. Even if these methods fail to work, the economic structure
would still cause politicians to bow to capitalist.

Difference between Government owned property and private property

Government property consists of land or assets owned by federal, state, or local governments and institutions such
as parks, libraries, roads etc.

Key features
 It refers to land or other assets that are legally owned by the government.
 Government-owned property may be titled at the federal, state or local level and may or may not allow
unrestricted public access.
 Some government-owned properties constitute public goods such as parks, libraries and roads etc.
Government owned property is often considered ‘public’ property, although that does not mean that all such
property is freely accessible to all citizens. For instance, an army base or laboratory may be government owned, but
with highly restricted access. A public playground, on the other hand, may be owned by a local government and free
to anybody to enjoy.
Property rights define the theoretical ownership and legal ownership of resources.
Government property can include residential, commercial and industrial land as well as other physical assets such as
machinery.
The property may become government-owned property through normal purchases, through foreclosure. By
foreclosure, it means that the property taken into government ownership due to non payment of taxes or debts.
Government owned property vs private property
There is difference between government owned property and private property which is owned by individuals or
corporations. An 18th century philosopher John Locke’s homesteading theory describes that how people took private
property into their ownership.

Human beings gain ownership of a natural resource through an act of original cultivation or appropriation. For
example, if a man discovered an unknown island and began to clear the land and build a shelter, he is considered the
rightful owner of that land. Since most resources have already been claimed at some point in history, the modern
acquisition of private property takes place through following ways.
Through voluntary trade
Through inheritance
Through gifts
Through collateral on loan
Private property has most important role in capitalism.

Capitalism and Environment

Although environmentalists and ecologists believe that overpopulation results in exploitation of natural resources
therefore, they regard overpopulation as a basic cause of environmental degradation. However, it is the capitalism
that is the real culprit. Capitalism along with overpopulation leads to environmental disasters such as global
warming, climate change, acid deposition, soil degradation, air and water pollution.

Capitalism is an economic system in which the private profit-maximization motive leads to an impressive
productivity and growth. The profit-maximization logic induces the producers to specialize in what they are best at
producing and invest in the latest technologies to increase productivity and efficiency.
Due to competition, firms invest in cost cutting technologies in order to decrease their costs and prices. This
altogether leads to a virtuous cycle of efficiency, productivity, and optimized profit.

Examples of success in terms of growth rates are numerous in the modern history of capitalism. The massive
industrial development of England in the 18th and 19th centuries, the United States as early capitalist developers
prior to the two devastating World Wars, the remarkable growth of rates western Europe (i.e. Germany, France,
Italy,) in the post-war era followed by Japan in the last half a century, the rise of the East Asian Tigers and, of course
more recently, the Chinese leviathan are the conspicuous examples of stunning economic development in
contemporary capitalism.

But this enormous growth happens at the cost of environment.

Mass production requires mass consumption at the same time. Higher consumption, the higher production, the
higher production, the higher sales, and with higher sales, higher profits are generated, which are largely re-invested
in the sustainability of the firm or the business-unit. Therefore, capitalism requires an endless growth of
consumption and production in order to remain stable, raise the standards of living, and produce ample employment
for the young and increasing world population.

Since we live in a world where resources are finite, we cannot afford to use them extravagantly. Soon there will be
not enough resources to sustain life on earth. Reasons of environmental degradation due to large scale production
are following:
1. Negative externalities are not being taken into account. When a firm produces something, it also pollutes
the environment and its cost is zero. Therefore, it pollutes the environment endlessly.
2. The prices of non-renewable resources are usually low in the short run. Due to which their use is very high
leading to the emissions of greenhouse gases and carbon at very high rate.

Due to this, the producers tend to overproduce and buyers tend to over consume these resources.
What can be done?
Market structure under capitalism does not provide any mechanisms to counter the environmental hazards that the
large-scale production and consumption processes inflict on the environment. Hence, there have to be non-market
interventions to contain or reduce environmental damages. This non-market intervention can be either state or
social forces.

But the problem is that states in democratic and non-democratic countries alike often overlook this, or deliberately
neglect it due to the pressure that comes from the influential business groups. In most countries, the state is
subservient to the bindings of the influential business groups. The state needs to provide incentives for business
groups to ensure that they remain as dynamic as possible to ensure economic growth and ample employment
opportunities. So the state on its own would be reluctant to take measures that might reduce the profit rates of
business-groups for the sake of the environment.

There remains another form of non-market intervention, which is social forces. In democratic states people enjoy a
certain level of freedom for social activism. Thus, in democratic states, environmental activists can form disruptive
movements that seriously demand far more stringent regulations to save the environment. In some cases, they may
be able to compel the state to impose restrictions on the firms and inspect them regularly.

International cooperation is also a key for effective abatement. But achieving meaningful international cooperation
has proven to be a hard task. Even though nations have a common interest in preventing climate change, many are
reluctant to reduce carbon emissions voluntarily.

In short, the market mechanisms under capitalism do not provide incentives for preserving the environment. Firms
are constantly threatened by market competition to cut costs and optimize profit. The environment thus falls prey to
the compulsive market behavior of the capitalist mode of production. Without the intervention of non-market
entities such as the state, international organizations and social forces, capitalism as an economic system simply will
not safeguard our planet.

The Role of Self Interest and Invisible Hand in a free market economy or
capitalism
A market economy is an economic system in which individuals own most of the resources -land, labor, and capital -
and control their use through voluntary decisions made in the marketplace. It is a system in which the government
plays a small role. In this type of economy, two forces - self-interest and competition - play a very important role.
The role of self-interest and competition was described by economist Adam Smith over 200 years ago and still serves
as foundational to our understanding of how market economies function.

1. Self Interest is the Motivator of Economic Activity

Everyone in an economy works for his own self-interest. No one has any concern about others instead they work to
make living for themselves. In fact, most of the economic activity we see around us is the result of self-interested
behavior. The miracle of a market system is that self-interest produces behavior that benefits others. While working
for self-interest, individuals provide valuable good or service to society.

2. Competition is the regulator of economic activity

Due to self-interest, individuals may be induced to price gouging, behaving rudely or sell/producing inferior
products. But this type of behavior is checked by the competition which regulates the economy. Due to competition
there is large number of sellers and buyers therefore a single seller or buyer cannot influence prices by his own
action. When someone tries to sell goods at higher price, individuals can simply go to his competitors.

Moreover, if competition does not exist in the market, it automatically emerges when individual see opportunities.
When there is a single seller in the market, he charges high prices and people see it as an opportunity and they enter
into the market so the competition emerges and economic activity gets regulated.
Invisible hand
According to Adam Smith, invisible hand is equal to self-interest and competition. This invisible hand ensures that
the producers and consumers are working in the best interests of the whole society. When everyone in the society
works for his own interest, they also end up working for the interest of the society. There is no government that
makes decision of what, how, and for whom to produce. Instead invisible hand ensures that the resources are
allocated in such a way that those goods are to be produced that the society wants. Moreover, the goods are
produced at minimum costs and their prices are as low as possible.

Regulation
Despite of invisible hand, everything cannot be left on markets. Often times, markets get failed to generate efficient
outcomes. It is called market failure. It happens due to free rider problem or negative externality. Therefore, it is
argued that government intervention is necessary when market fails to generate efficient outcomes.