|
|
Economic
Systems
In the Island Case Study, we started with a simple one-person
economy. But, economies are not
usually made up of one person. In
fact, I think that most of us would agree we are not designed as a species to
live on our own. Those of
you who saw the Tom Hanks movie “Castaway” will recall that he was fairly
successful at providing for his material needs.
But he was willing to sacrifice it all to get back “civilization”
with all its traffic jams and annoying cell phones.
Poor Wilson just wasn’t enough. So
why do people need to be around other people?
I’m sure my academic colleagues in biology, anthropology,
psychology and theology would have much to share in answering this question.
But I would contend that people need to be together because they are much
more likely to survive if they can work together...work is an economic activity. So, I’m saying that people are social animals in order to
facilitate our economic lives. Why are we more likely to succeed when we work together?
Because that is the way we can make use of our differences.
One person may be tall, another short, who should pick apples?
Who should collect grubs? One
person has a “green thumb” while the other loves the hunt.
Who should be our gardener? Having different skills and abilities, and
then working in those areas where we are comparatively stronger, creates
benefits economists call gains from specialization. Adam
Smith, the father of modern economics (he’s the one you can blame for this
class), argued in Wealth of Nations that the gains from specialization is
the key that makes mankind materially better off.
He then argued that the economic system that causes society to make the
most of these gains is the market system – but more about this later. The
Three Economic Systems The fact is, because we live in groups, we have to figure out
some sort of organizational scheme that assigns tasks to its members.
Indeed, this scheme must do more than that, it must answer all three
questions of what to produce, how
to produce it and who will consume the
results of our productive efforts. Amazingly,
we can categorize all the variations of human organization into three types.
Now be careful here, no existing economic system is purely one of these
categories. All economies are a
mixture of the three, but usually one of the three schemes is dominant.
What are the three schemes or systems? Traditional.
This kind of organization depends on culture to make the three
decisions. What do I mean by
culture? Culture is a set of
established norms and values of a society.
When you see someone walking down the street with no shirt on you think
it strange (not normal). But if you
lived in Tahiti you would not give that person a second thought.
That is because our society has a different norm than Tahitian society
when it comes to shirts. Values and norms are so part of our society that they are
almost invisible to us. When I say hunter, what gender do you think of?
Where did your answer come from? Do
you think that most people reading this would give the same answer?
Do you think that men are always better hunters than women? If you were organizing the island economy when it had 100
people instead of one, what do you think the hunting band would look like after
all was said and done? Speaking in large general terms (after all this is an economics
class, not an anthropology class), the values and norms of a culture are the
result of past behaviors, or more simply put, traditions.
Let’s say that you are on the island for thirty years.
After a while, you discover that fishing is great in spring and summer
but poor in fall and winter. What
would you produce in the winter? Certainly
not fish, that would be wasting the community’s scarce resources.
After 80 years, when someone said they were going fishing in winter, the
community might chastise or ridicule them for breaking with tradition (There
goes that crazy Bob, fishing in the middle of winter.
Is he stupid or what?). In fact, if it was a deeply enough held
tradition, the community might take even stronger measures, either socially
through things like ostracizing him or politically, like burning him at the
stake for heresy (Bob is making the sea gods angry and will ruin next season’s
catch. We must sacrifice him in
order to appease the gods). Traditions are strong and difficult to change and societies that
use them tend to be very stable. In
part, this is because most traditions have evolved over time and have proven to
be effective. Also, traditions are
so integrated into the members of that society that they see them as just and
right (values). Today we see the
vast differences in wealth in the United States as fair and just.
In many other societies such differences would be seen as unfair and
unjust. Many westerners see the
treatment of women in the Middle East as unjust and unfair.
But many women in this region feel that the treatment of women in the
West is immoral and sinful. What
I’m getting at here is not to says that justice is a relative concept, I’m
saying that people in a traditional society tend to see the existing social
arrangements as just. This means that traditional societies a very reluctant to
change because the existing arrangements are seen as successful and just.
The three economic questions that must be answered are answered
by looking to the past. What
have we produced in the past? Whether
it was wheat or corn, that is what we will produce now.
How did we grow corn in the past? That
is how we will do it now. Who
consumed the corn? Those who
traditionally got the corn will get it again.
This kind of system is not as concerned with getting things done in an
effective or efficient manner as they are making sure things are done in the
“right way” – ways that respect and honor the customs and traditions of
the community. Sometimes traditional systems look like the other systems.
For example, many traditional systems will have a leader, chief or king,
making them look like a command system. Be
careful here. What is the dominant custom of the society?
How did the leader become leader? Is
the leader an absolute ruler? Can
the chief or king do anything they want? Traditional
chiefs, kings and so forth cannot easily change a tradition.
It is unlikely that they would be successful in ordering the community to
fish when the tradition is that of not fishing at this time.
The Czar of Russia (traditional leader) could not change the way the
farmers traditionally carried out their craft, but Stalin (a leader in a command
system) not only could, but did (even though it led to the starvation of
millions of people). The traditional system is by far the most common form of
economic organization used by humans through history.
It can be fairly simple, like the hunting gathering clans of Neolithic
societies or fairly complex like the Feudal societies of 10th century
Europe. As I said earlier,
societies that use just tradition are rare.
Both of these societies had elements of command and markets integrated
into their tradition. Command
is essentially a political system. This
is because all the decisions are made by a central political authority.
While we are in the habit of discounting politics, it is one of the more
essential characteristic of any society. For
me, politics is what happens when a group of people with a common goal or
interest gets together to further that goal or interest through some form of
incentive or coercion. For example,
I may want to live in a quiet place, as do many of my neighbors.
However, one of the neighbors wants to repair motorcycles in his garage.
Those neighbors who want to live a quiet place might get together and
lobby the town to prohibit motorcycle repair in our neighborhood.
We might go even further try to get a law that prevents people from
setting up businesses in our neighborhood.
Ultimately, political systems tend to rely on force and coercion to get
things done. If someone breaks a
law they might have to pay a fine, go to jail or even lose their life. It is often said that the state has a monopoly on the use of
force. The most common command systems of the 20th century
were the communist bloc countries. In
these command systems the communist party tended to make all the decisions
regardless of tradition or efficiency. For
example, the Soviet Union had a five-year plan that stated the production goals
of the society (We will make two million tractors.), thereby answering the
question of what to produce.
Then, they would issue a three-year plan setting out how these goals
would be met (We will have one big factory in Moscow and make all two million
there. It will have 300 workers).
This Answers the how question.
Finally, the central party might then say who has priority in getting the
output (Only party members will get tractors.).
Thus answering the for whom
question. All of these decisions
were made without concern about what the tractors might do to traditional
farming methods or whether or not it was cost effective to replace the
traditional methods with mechanized farming.
The party had decided that it was in the best interest of the state and
so they would be made. Command systems tend to be more concerned with the politics of a
decision rather than the efficiency of a decision. A certain group might get a good (for whom) because they
represent political support (a Navy base in the middle of Texas).
Or some type of good might only go to political supporters (vacation
cottages on the Black Sea went to high Communist Party members).
Command systems are extraordinarily effective when getting
things done. Notice I didn’t say
efficient. Since the central
political authority controls the allocation of resources it doesn’t have to be
concerned with tradition or the institutions of markets to recognize the need
for production. If the central
political authority thinks that it is its best interest to build a road, that
road will be built regardless of the alternative uses of those resources.
Armies get things done ignoring the costs or benefits to the overall
society. A good example of this is
the draft. When the US armed
services need more men during war they don’t engage the market system and
increase soldier’s wages, rather they just took the labor needed through
conscription. They made no attempt
to find those who were most skilled at fighting (had a comparative advantage in
soldiering). As we’ll see, this
is something that the market system does quite well. However, the central political authority in the US wasn’t
concerned about cost effectiveness; they were worried about their continued
viability. The idea here is that
there is not enough time to wait for tradition or markets to recognize the
problem and begin to solve it. The
Market System
is essentially a system based on individual actors following
their self-interest within a system of exchange.
I find it the most difficult system for students to understand, because
we live in it. I know, you think
that would make it easy. But it is
not easy. Most of you think of it
as a natural system...the way things are. In
fact, it is not all that natural; indeed it is the least used system in terms of
human history. One of the reasons
for this is that people worry that without anybody coordinating the allocation
of resources (kings, chiefs, dictators) important things might be overlooked.
Will any fish be caught? Will
only fish be caught and no shelters be built?
It’s hard to accept that all this will happen without someone in
charge. But somehow a market system gets things done without someone in
charge. How do things get done? Adam
Smith called this phenomenon “the invisible hand.” Go back to your island.
Don’t put anyone in charge of the 100 people. Assume that people want equal amounts of vegetables and fish.
Let’s also say that fishing looks like the more attractive thing to do
(lying on the beach with a fishing pole sounds better than toiling away in the
hot fields), so seventy people go out fishing.
At the end of the day these fishing-people come to the community
gathering place and begin to trade their fish for vegetables.
What do you think the terms of trade will be?
There will be a tendency for the price of fish to be low, while the price
of veggies will tend to be high. Now
what do you expect some of those fisher-people to do?
Following their own self-interest, they will go to the fields, where they
may end up getting more fish than when they went fishing. Sometimes the market system is called the price system because consumers and producers use prices to guide their decisions. High prices of send a signal to producers that society wants more of these goods and low prices serve as a signal to producers that society wants less of those goods. Prices determine the answer to the “what to produce” question. They also tell consumers what is relatively scarce or relatively abundant. A high price tells the consumer that this is a rare good that uses a lot of resource to produce so it should be conserved. On the other hand, a low price tells the consumer that it is abundant and can be used without much care. Prices also answer the question of how to produce as well.
Suppose we have an abundance of one resource, let’s say rocks, and a
relative scarcity of another resource, iron.
In a market system rock prices will be low and iron prices will be high.
So when it comes to deciding which to use in making tools, the rocks have it.
The only way a society would use iron to make a tool would be if the
price of the good made by the tool was so high that it “covered the cost” of
the more expensive iron. This high price of iron would also lead people to make more
iron, thus lowering its price and making it more practical for making iron tools
over time. This is one of the
beauties of the market system, it makes sure scarce resources go to those
activities where they are needed the most, and at the same time it provides
incentives to solve problems of scarcity.
So it the long run iron would replace rocks. This is one of the reasons
why the market system is considered the more effective in using scarce resources
to meet society’s needs (efficient) of the three economic systems. Imagine the same rock-iron problem in a traditional system.
At first rocks would be used to make tools.
This would become the tradition. People
would hesitate to use iron to make tools since it goes against tradition. They
would also be discouraged in finding ways of making iron more cheaply since
there is no need for it. A great
example of this is introduction of the horse collar in medieval in Europe.
Even though horses are stronger and faster than oxen when it comes to
plowing if they use a horse collar, it took 300 years for this technological
innovation to take hold. Now imagine that same problem in a command system.
First the central political authority might not even consider using iron
for tools but might use them for weapons. Why?
The overriding concern of command systems is to secure their authority.
This is done with force. They
must have a police force and army to insure their survival.
However, if they do order tools be made from iron, it will be done.
This reveals one of the strengths of the command system…the dynamic
ability to change as the central authority sees fit.
One day weapons the next day tools.
A potential problem is how that the underlying scarcity of iron may or
may not be addressed. Getting back to the market system, the for whom question is also answered based on individuals acting as
there own interest. Individuals
consume according to how much money they have, this is based on the price of the
resources they own. An important
benefit of this arrangement is that they will make sure these resources go to
the highest bidder and not lay idle. So,
the more you produce in those areas society values the most (as signaled through
a high price), the more you can consume. A possible drawback is that not everyone has the same resources,
indeed markets are notoriously uneven.
In terms of consumption, prices also serve as a rationing
device. When there is not enough of
a good to go around the price is bid up. This
causes those people who don’t value the good as highly or can’t afford the
good to not get. This exclusion
will continue until there is a match between how many goods there are and the
number of people who get the good. This
of course brings up the equity question. Is it fair that some people are excluded from consuming a
good because they are poor? The
person with Downs Syndrome will never command a wage as high as the merit
scholar. So he or she will always
be excluded from consuming goods that are relatively scarce.
However, income is a reward for putting forth the effort of getting
resources to the market, so this is not an easy call. For now, let’s let the answer be: sometimes it is fair and
sometimes it is not. The core thing
we will have to decide is how we define fair.
But whether it is fair or not, it is always the case in a market
system that there will be unevenness in levels of income.
If I had each of you start at zero wealth today and gave you $10,000,
this time next year some of you would have more and others would have less.
One of you might use it to buy lottery tickets and win, another may do
the same thing and loose. One of
you might speculate in the stock market while another may use it to get a degree
in finance. The individual in the
stock market would be wealthier after one year, but after ten years I have no
idea who would be wealthier. It
would depend on the value of the stock market and the value of people trained in
finance. But it’s highly unlikely
that the wealth of the two individuals would be the same.
That is the nature of a market system. Let’s see if we can summarize this all up.
For the most part, we will be studying the market system and how
it works. At first we will focus on
how it works in the ideal paying particular attention to its strengths.
Then we will focus on how markets can and do fail.
To do this we have to develop several intellectual tools that economists
use to analyze markets. These tools
are called models, which is the topic for the next reading.
But first a short note on social institutions. Economic
Institutions Each economic system rests on social pillars called
institutions. By institution I mean
more than physical institutions like prisons, schools, hospitals and the like.
In this context an institution is any social construct that facilitates
human interaction. They are complex
and are the result of dynamic interactions among the forces of culture, history,
psychology, economics, and so on. For example, the institution of marriage can
be seen as being created by several forces.
Note that it is a social construct; people in a society made it what it
is. Indeed, marriage does not
exist except within some social context. It
allows for people to more easily engage in the economic effort of meeting the
material needs of a family. It
serves as a psychological need for stability in our personal life.
It serves as a social signal to others that these people are removing
themselves as potential mates. It
serves a biological function in that children will be cared for by more than one
adult within the society. While
marriage is a fairly common social institution the details vary from society to
society. Some marriages may be ended by divorce, others may not.
Some marriages are essentially patriarchal with the male having the last
say, while others assume equality between the sexes.
Some marriages allow polygamy while others are strictly monogamous. These
details are the result of different circumstances, geography, cultures,
religions, or in a word: histories. Marriage is also a good example of how social institutions are
constantly evolving. Not only is
marriage different between societies but it can be different within the same
society over time. What Americans
thought of marriage in the 19th century is very different from how it
is practiced today. Divorce is a
good example of this evolution. People
rarely divorced in the 19th century but by the end of the 20th
it was fairly common. One of the
more interesting evolutions this institution now taking place is the status of
same sex marriages within our society. This illustrates a final point I would like to make about
institutions. Institutions often
cross lines between culture (informal) and the rules enforced by government
(formal). Marriage is not only a
social institution, but it has formal legal standing.
When one enters into a marriage they have entered into a social agreement
that has formal procedures just like a contract.
Here, we are most concerned with those institutions that
facilitate economic interaction within the market system.
They have all the characteristics set above, they are both formal and
informal, they are different depending on time and place, and above all they are
constantly evolving. The three most important institutions of a market
system are markets, money and property rights.
System
Subcategories One more word about economic systems, while there are only three
basic categories of economic systems there are a large variety of subcategories
of these systems. Subcategories of
traditional systems include tribalism (pre-Columbian Native American society)
and feudalism (medieval Europe). Subcategories
of the command system include communism (pre-1989 Russia) and imperial empires
(the Egyptian pharaoh empire). Subcategories of the market system include
Capitalism (the modern United States) and Plantation Economies (pre-civil war
south). There are even blends of
systems such as fascism and mercantilism that combine systems like market and
command. What distinguishes
these systems from one another is the institutional make-up of each subcategory. You might note that many of the subsystems have the suffix ism.
This is because there is more than bit of an institutional ideology
associated with each. Feudalism had
early Catholic Christianity as its ideological core.
Communism had the Marxist ideals cooperation and community at its
ideological core. Capitalism has
Smith’s invisible hand and the material well being of the individual at its
core. Each of these ideologies
justifies and declares just the social outcomes of the economic system.
The sacrifice of the individual for the group is an accepted value within
communism. The extraordinary wealth
of an individual is taken as a signal of that person’s social contribution
within a capitalist nation. Capitalism has the three core market institutions of markets, money and
property rights, but there are several institutions that are unique to it.
To list a few:
With the collapse of communism, the market subsystem of
capitalism has come to dominate global economic activity.
Why? In part, it is because
it is the most dynamic and materially successful economic system ever developed
by using markets to organize production. How
do markets cause this? Let’s see
if we can’t begin to answer this question.
|