This overview of economics has implicitly assumed a market economy with private ownership and government regulation, a pretty common model. We have avoided labels, but of course countries differ in their economic and political systems. One often hears people talk of “capitalism versus socialism” or “capitalism versus communism”. If we treat communism as a form of socialism, we can clarify this labelling dichotomy.
Capitalism and socialism are usually defined in terms of ownership of the “means of production”. In a capitalist country, industry and trade are controlled by private owners for profit.
In a purely socialist country, industry and natural resources are owned in common, and decisions on what to produce are planned.
The extremes of each system are laissez-faire free market capitalism on the one hand, and a totally planned socialist economy on the other. Neither extreme exists in the world today, and for good reason[1]. Central planning has given way to markets everywhere in the world, regardless of who owns the means of production. The “invisible hand of the market” is simply the best way to balance supply and demand and to drive innovation and productivity increases. As we will see in Part II, the remarkable rise of China, still an ostensibly “socialist” country, has been driven by its switch to market incentives and a mixed ownership economy. Even state-owned enterprises in China now are organized as profit seeking corporations with their own boards of directors and executives[2]. In addition, nearly half of China’s GDP now derives from its vibrant, rapidly growing, “capitalist” private sector.
US Corporations probably come to mind as exemplars of “capitalism”, but paradoxically they illustrate that the profit motive works even when ownership is widely distributed. US publicly traded companies are owned by their stockholders, and anyone with money in a retirement fund holds such stock. If everyone in the US held equal amounts of stock in say Facebook or Ford, these would be truly “socialist” entities on an ownership basis. Everyone wants to see the value of their shares go up, and the managers of these enterprises are highly incentivized, including financially, to grow their companies and increase profits.
In short, market economies are almost universal in the world today, and private ownership of much or almost all the productive capacity, capitalism, is equally widespread. When people talk about “socialism”, especially in the US, they are usually talking about government measures designed to address the various issues we identified above with laissez-faire free market capitalism, such as externalities and monopolies and crashes. They are also often talking about any programs that redistribute income, such as Social Security and Medicare. Such redistributive programs don’t directly affect the economic engine of market capitalism, but by influencing demand, they do influence what is produced. Medicare recipients, for example, will cause an increase in demand for doctor’s services over the no Medicare alternative. Such programs are not “socialism” in an economic sense, and they often end up benefiting the economy. Public education, for example, has a positive effect on productivity, which makes us all richer in the end.
This is a book on economics, not politics, but it is important to clarify that capitalism and socialism are economic systems that are compatible with a variety of political systems. Singapore was mentioned earlier. It is a democracy rated as one of the least corrupt in the world and has an extensive state-owned sector producing one third of GDP and a per capita income higher than in the US. Nazi Germany, a mixed economy, had a corporate capitalist sector that benefited greatly from slave labor and government contracts. It was of course a dictatorship. Russia is also a mixed economy and dictatorship with much of the capital owned by a small group of oligarchs. Corruption is rampant. The US, Western Europe, and most other “advanced economies” are democracies and fully capitalist, but with varying levels of social programs and regulation. China has a complex one-party political structure and a hybrid economy with the party still “guiding” the economy through planning and industrial policy.
Labels such as “socialist” or “capitalist” are way too simple to characterize a country economically, and even less useful when characterizing a country’s overall political and economic structure. These terms imply a simple dichotomy when the reality is that countries must be characterized along many interrelated dimensions[3].
[1] We’ve discussed the problems with laissez-faire capitalism at length.
[2] Guluzade, Amir. 2019. “Explained, the Role of China’s State-Owned Companies.” World Economic Forum. May 7, 2019. https://www.weforum.org/agenda/2019/05/why-chinas-state-owned-companies-still-have-a-key-role-to-play/.
[3] For a overview of the different types of capitalism, see https://www.imf.org/en/Publications/fandd/issues/Series/Back-to-Basics/Capitalism