• Chapter 2: economic Systems and Decision Making

    Lesson 1: Economic Systems

    Lesson 1: Vocabulary

    Content Vocabulary
    • traditional economy
    • economic systems
    • command economy
    • socialism
    • market
    • market economy
    • capitalism
    Academic Vocabulary
    • stagnation
    • emphasizing

    Economies Based on Tradition

    How does a traditional economy answer the basic questions of WHAT, HOW, and FOR WHOM to produce?

    Much of what we do springs from habit and custom. Why, for example, does the bride toss the bouquet at a wedding? Why do we greet people by shaking hands rather than by pressing our noses and foreheads against theirs, as the Maori people of New Zealand do? It’s because such practices have become part of our traditional culture.


    In a society with a traditional economy, the use of scarce resources—and nearly all other economic activity—stems from ritual, habit, or custom. Habit and custom also dictate most social behavior. Individuals are generally not free to make decisions on the basis of what they want or would like to have. Instead, their roles are defined by the customs of their elders and ancestors.


    Many societies—such as the central African Mbuti, the Australian Aborigines, and other indigenous peoples around the world—have traditional economies. The Inuit of Northern Canada in the nineteenth century provide an especially interesting case of a traditional economy.


    The main advantage of a traditional economy is that everyone knows which role to play. Little uncertainty exists over WHAT to produce. If you are born into a family of hunters, you hunt. If you are born into a family of farmers, you farm. Likewise, little uncertainty exists over HOW to produce, because you do things much the same way your parents did. Finally, the answer to the FOR WHOM question is determined by the customs and traditions of the society. In some societies, you alone might be responsible for providing for your immediate family. In others, such as the Inuit, you would share the spoils of your hunt with all the families of the village. In other words, tradition dictates how people live their lives.


    The main drawback of a traditional economy is that it tends to discourage new ideas and new ways of doing things. The strict roles in a traditional society have the effect of punishing people who act differently or break the rules. The lack of progress due to the lack of new ideas and new ways of doing things leads to economic stagnation and a lower standard of living than in other economic systems.

    Economies Based on Command

    How does a command economy answer the basic questions of WHAT, HOW, and FOR WHOM to produce?

    In a command economy, a central authority makes the major decisions about WHAT, HOW, and FOR WHOM to produce. A command economy can be headed by a king, a dictator, a president, a tribal leader, or anyone else who makes the major economic decisions.

    A modern, and somewhat more liberal, version of the command economy is socialism. Socialism is an economic and political system in which the government owns some, but not all, of the factors of production. As such, the government plays a major role in answering most of the major WHAT, HOW, and FOR WHOM questions.


    In a pure command economy, the central governing authority makes all of the major economic decisions. This means that the government decides if houses or apartments will be built. It also decides on the best way to build them and on who will receive them.

    Most command economies severely limit private property rights. That means that people are not allowed to own their homes, businesses, and other productive resources, although they may have some personal items like clothing and tools. Because of this, the government owns most of the resources in the economy.

    Socialist economies share many of the same characteristics of pure command economies; only fewer resources are owned or controlled by the central authority. Under socialism, the stated objective of the government is to serve the needs of its people, not just enhance the welfare of its leaders. Most socialist economies tend to be larger than economies directed by pure tradition, which makes it harder for the government to own and direct everything.


    Modern examples of pure command economies are limited to a handful of dictatorships and small tribal economies around the world. North Korea is perhaps the world’s last leading example of a command economy where everything—even the media and tourism—is either owned or controlled by the government.


    1. A major strength of a command system is that it can change direction drastically. The former Soviet Union went from a rural agricultural society in 1910 to an industrial nation in a few decades by emphasizing the growth of heavy industry. During this period, the central planners shifted resources on a massive scale from farming and consumer goods to industrial production.

    2. Another major advantage of a socialist command economy is that it allows most citizens to receive some goods and services that they would otherwise not be able to afford. Cubans, for example, have access to universal health care. Likewise, President Chavez tried to provide basic food, commodities, and electricity at below-market rates to Venezuelan citizens during his time in office.


    1. Leaders of command economies usually provide for themselves at the expense of the general population. The result is that high government officials have nice cars, houses, and plenty of food while the average citizen may be forced to go without.

    2. The loss of the individual freedom to choose. For example, someone who does not want the services of national health ends up paying for it anyway because it has been made available to others. Even the choices of where and how to live can be affected. In Cuba, doctors are required to live in the same buildings where they provide their services, a practice unheard of in the United States.

    3. State-controlled media such as radio and TV are another common feature of most socialist countries, but the programming is usually limited to the propaganda content that the government wants its people to see, not open to what the people would choose to see. 

    4. The production of low-quality goods. Workers who are unhappy with where and how they are supposed to work are often given quotas to fill as a way to stimulate production. This sometimes causes the workers to focus on filling their quotas rather than on producing quality goods.

    5. An economy with major elements of command requires a large decision-making bureaucracy

    6. Rewards for individual initiatives are rare in both command and socialist economies.

    7. Planning bureaucracy often lacks the flexibility to promptly deal with major problems, or even minor day-to-day ones. As a result, command economies tend to lurch from one crisis to the next—or collapse completely, as did the former Soviet Union.

    8. Pure command economies tend to stay relatively small because they have such a hard time making all of the decisions necessary for growth and change to take place. 

    Goods and services are never free, even if the country has an economy directed by socialism. This is because the universal problem of TINSTAAFL, or There Is No Such Thing As A Free Lunch, still applies to socialist economies. In more developed European countries such as Denmark, Sweden, and Norway, programs like free education and national health care are funded with high domestic tax rates. As a result, the tax rates in these countries are higher than those in the United States.

    Economies Based on Markets

    How does a market economy answer the basic questions of WHAT, HOW, and FOR WHOM to produce?

    market  is an arrangement where buyers and sellers interact to determine the prices and quantities of goods and services. A market might be in a physical location, such as a farmer's market, or on a Web site, such as eBay. Regardless of its form, a market can exist as long as a mechanism is in place for buyers and sellers to interact. A  market economy is one where the WHAT, HOW, and FOR WHOM questions are primarily answered by people who make supply and demand decisions in their own best interests.


    A market economy is characterized by a great deal of freedom. People can spend their money on the products they want most, which is like casting dollar “votes” for those products. This tells producers which products people want most, thus helping answer the question of WHAT to produce. Businesses are free to find the best production methods when deciding HOW to produce. Finally, the income that consumers earn and spend in the market determines FOR WHOM to produce.

    Market economies also feature the private ownership of resources. A market economy is often described as being based on capitalism—an economic system where private citizens own and use the factors of production for their own profit or gain. The term capitalism draws attention to the private ownership of resources, while the term market economy focuses on where the goods and services are exchanged. As a result, the two terms focus on different features of the same economic system.


    Many of the most prosperous economies in the world, such as Australia, Canada, Great Britain, Japan, Singapore, South Korea, parts of Western Europe, and the United States, are based on markets and capitalism. While there are significant differences among them, these economies share the common elements of markets and the private ownership of productive resources to seek profits.


    1. A market economy has a high degree of individual freedom. People are free to spend their money on almost any good or service they choose. People also are free to decide where and when they want to work, or if they want to invest further in their own education and training. At the same time, producers are free to decide what they want to produce, whom they want to hire, which inputs they want to use, and the way they want to produce.

    2. A market economy adjusts gradually to change over time. Before 2005, for example, gasoline prices were low, so people tended to buy large gas-guzzling SUVs. When the price of gas rose sharply in that year, SUV sales fell, and smaller, more fuel-efficient vehicles became popular. The decision that individuals made themselves—not decisions made by government planners—helped the economy adjust to change.

    3. The relatively small degree of government interference. Except for certain concerns such as justice and national defense, the government normally tries to stay out of the way of buyers and sellers.

    4. Decision making is decentralized. Billions, if not trillions, of individual economic decisions are made daily. Collectively, consumers make the decisions that direct scarce resources into the uses they favor most, so everyone has a voice in the way the economy runs.

    5. The variety of goods and services that are produced. You can find ultrasound devices to keep the neighbor’s dog out of your yard, or download video and street maps to your cell phone, or even use your cell phone as a flashlight. In short, if a product can be imagined, it is likely to be produced in hopes that people will buy it.

    6. The high degree of consumer satisfaction. In a market economy, the choice one group makes does not affect the choices of other groups. If 51 percent of the people want to buy classical music, and 49 percent want to buy rap music, people in both groups can still get what they want.

    7. Goods are usually privately owned, and privately owned goods last longer than goods owned by others. For example, who would take better care of a new car or truck—the person who owns it, or the person who drives one owned by his or her boss? The answer almost always is that the owner is the one who takes better care of his or her property. 


    1. The market economy does not provide for everyone. Some people may be too young, too old, or too sick to earn a living or to care for themselves. These people would have difficulty surviving in a pure market economy without assistance from family, government, or charitable groups.

    2. A market economy also may not provide enough of some basic goods and services. For example, private markets do not adequately supply all of the roads, libraries, universal education, or comprehensive health care people would like to have. This is because private producers concentrate on providing products they can sell for a profit.

    3. A market economy has a high degree of uncertainty. Workers might worry that their company will move to another country in search of lower labor costs. Employers may worry that someone else will produce better or less expensive products, thereby taking their customers.

    Chapter 2, Lesson 2: Mixed Economies

    Chapter 2, Lesson 2 Presentation

    Lesson 2: Vocabulary

    Content Vocabulary
    • mixed economies
    • Great Depression
    • communism
    Academic Vocabulary
    • allocation

    Characteristics of a Mixed Economy

    What makes an economy mixed?

    Textbooks like to use neat categories like traditional, market, and command or socialist economies; but the real world is not so orderly.

    Why Mixed Economies Exist

    Mixed economies exist for several reasons. One is that the three major types of economic systems identified by economists--traditional, command, and market--are extreme cases that are useful for classification and descriptive purposes, whereas there is much more diversity in the real world. A second reason for diversity is that a seismic domestic event like a revolution or a period of severe economic decline may invite change. A third reason is that nations tend to evolve over time, shedding some policies that do not work and adding new ones that do.

    Perhaps the most famous example of a revolution affecting economic change took place after Joseph Stalin's rise to power in Russia in 1929. Stalin's iron control of the political apparatus transformed a largely peasant and emerging industrial society into a massive command economy. By the 1950s, the Soviet Union was a major industrial and military superpower. Until its collapse in 1991, the economic success of the Soviet Union's socialist economy was something that many emerging countries copied, even though they may have started with significant components of traditional or market economy structures.

    Meanwhile, well before the Great Depression—the worst period of economic decline in U.S. history, which lasted from approximately 1929 to 1939—the United States had become a powerful industrial economy based on free market principles. Conditions were so harsh in the 1930s that a number of non-free market programs were created, including unemployment insurance, the minimum wage, Social Security, price supports in agriculture, and even bank deposit insurance. This was an example of a predominantly capitalistic market economy evolving into a mixed market economy, an evolution that took place because a democratic political system allowed people to demand changes to the way workers and consumers were treated.

    The WHAT, HOW, and FOR WHOM Decisions

    When we consider political parties and economic systems at the same time, the picture often becomes muddied. For example, the conventional name of North Korea is the Democratic People's Republic of Korea--despite the fact that there is no democracy there at all. The same is true for Laos, or the Lao People's Democratic Republic, which is also not a democracy because it is ruled by the communist Pathet Lao party.

    Shared Characteristics of Mixed Economies

    Because there are so many characteristics that a mixed economy can have, it is difficult to describe them all. However, some of the possible combinations are shown in Figure 2.2.

    Venn Mixed


    Perhaps the most distinguishing feature of a market or capitalist economy is the private ownership of productive resources and the freedom to use them as the owner sees fit. In this system, the allocation of these resources happens entirely in a free market comprised of self-directed individuals.

    Under socialism, private individuals own some of the productive resources, while the government owns and uses the rest. The extent of government-owned resources varies from one socialist country to the next, with most socialist countries being the ones with the most government ownership of resources. For example, in the former Soviet Union, none of the resources were privately owned because the government owned them all.

    Yet another shared characteristic under socialism is that the more socialistic the country, the more likely the political system is to be communist. For example, four of the most socialistic countries today are Cuba, China, Laos, and Vietnam--all of which are communist and have no democracy.

    In a traditional economy, almost all of the major decisions are made according to tradition, making progress and change very difficult. However, when people from a traditional economy come into contact with other cultures, they often adopt technologies and ways of doing things that can benefit them. When the Inuit of Northern Canada saw that rifles were more effective hunting tools than spears, rifles were readily accepted. Likewise, acceptance of markets and limited resource ownership may have been accepted in the same way

    The mixed economies would be represented by the overlapping segments in the center of the diagram in Figure 2.2. Those economies with the most significant components of markets and capitalism are likely to be the most economically developed of the group.

    A nation's involvement in the three major economic decisions can vary considerably. Some countries have governments that intervene only in certain key industries and leave the rest to markets. Other countries have governments that intervene much more. In the case of socialism, the more socialist a country claims to be, the more likely the possibility that its government makes all of the three major economic decisions, often with the claim that they are made for the benefit of its people. When this happens, a mixed socialist economy can turn into a socialist command economy.

    Often the distinguishing characteristics of a socialist economy is that it has one-party rule. The party that rules claims to make its decisions on behalf of all citizens, but it often makes decisions on behalf of the ruling party, which is why many socialist economies are also described as command economies.

    Examples of Mixed Economies

    Why are most economies in the world today considered mixed economies?

    Mixed economies share characteristics with all three economic systems—market, socialist, and traditional. Even so, it is sometimes difficult to describe them as uniquely belonging to one type of economic system or another.

    Communist Economies

    The communist philosophy was first laid out by the economic historian and social scientist Karl Marx and his colleague Friedrich Engels in the 1800s. Marx viewed all of history as a class struggle between workers and property owners—a struggle that would lead to alternating periods of depression, such as the one the United States had in the 1930s, and periods of prosperity. Marx thought that the working class would eventually rise up and overthrow the property owners. Society would then eventually reach a theoretical ideal called communism, a state of economic and political affairs where everyone would contribute according to his or her abilities and consume according to his or her needs.

    In this ideal community, no government would be needed and could therefore be eliminated. In order to get there, however, Marx thought that a society would pass through a period of socialism that would require a strong government that served the needs of the people. This is why so many of the so-called communist governments in China, the former Soviet Union, Cuba, and other places around the world frequently described themselves as being socialist, as if they were stepping-stones needed to reach the eventual ideal of communism.

    In a communist system, labor is organized for the common advantage of the community, and everyone consumes according to his or her needs. In practice, however, communist governments have become so involved in dictating the everyday economic decisions of WHAT, HOW, and FOR WHOM that they are frequently called command economies.

    As for a true communist economy, there are none in the world today, and there have never been any in the past. Communism still remains a theoretical ideal in the minds of many revolutionaries, even though in practice it has never been reached.

    Mixed Socialism

    According to Karl Marx, socialism is the stage of economic and political system necessary for a country to reach the ideal of communism. Under socialism, the government owns and controls some, but not all, of the basic productive resources. In most socialist economies, the government provides some of the basic needs of its people, such as education, jobs, transportation, and health care.

    There are a number of mixed socialist economies today. China has a mixture of traditional, command, and market economies. While tradition has a strong influence in rural areas, the government makes many of the major economic decisions and owns the major factors of production.

    Cuba and North Korea are similar to the former Soviet Union, where a socialist government once controlled almost all resources. The Soviet Union’s ownership and control of resources were so extensive that some economists thought of the country as being as much of a command economy as it was a socialistic one.

    Venezuela made a dramatic turn toward socialism when Hugo Chavez became president in 1999. He embarked on a policy of land and wealth redistribution, along with nationalization of domestic and even multinational corporations. Firms that were nationalized included telephone, electric utilities, leading steel companies, food processing plants, and even banks. Most of the nationalization was done by either confiscating or purchasing firms from their former owners. President Chavez died in 2013 before his nationalization was complete, leaving an economy that had a mix of socialism, capitalism, and tradition.

    Mixed Market Economies

    There are many examples of mixed market economies, especially in democratic countries, where people have the ability to influence the makeup of the economy. In Norway, the government owns the basic petroleum industry. It then uses the revenue from selling oil to other nations to keep its domestic gas prices low, finance education, maintain roads, and provide social welfare for its citizens. Because the government controls one major industry, it is a mixed economy based on capitalism and markets with some elements of socialism.

    Sweden was once known as the “socialist state that works” because of its combination of a strong private economy and the broadest range of social programs in the free world. However, the population objected to the high taxes needed to support its social programs, so the country cut back on these expenditures in the 1980s. It is now a mixed market economy because it has not given up all of its socialist programs.

    Because of generous welfare benefits in Denmark, Germany, and France, these countries also qualify as having mixed market economies. In fact, any country that provides significant welfare benefits would qualify, especially if the benefits received by citizens were paid for with taxpayer's money. South Korea, India, and Thailand also have mixed economies that combine traditional economies with elements of command and market economies.

    Finally, the United States also falls into the category of being a mixed market economy. This is because many of our free market features are combined with traditional and socialist elements. As for tradition, many children follow their parents into their parents' occupations. As for elements of socialism, the United States has federal programs that make disability payments to people injured on the job or programs that provide nationwide health and retirement payments for millions of people. Programs like these apply to large groups and are paid for with taxpayer dollars but the programs by themselves do not make the United States a socialist economy.

    Evaluating Mixed Economies

    Which members of society benefit from a mixed economy?

    Mixed economies are a fact of life and can be found all over the globe, and they offer advantages and disadvantages to those who live in them.

    Advantages of Mixed Economies

    Countries that have mixed economies seem to have them because of the benefits the mixed components offer. For example, during the 1970s China's economic growth was poor in comparison with its neighboring countries Japan, South Korea, and Hong Kong. Shortly after Chairman Mao Zedong's death in 1976, China's leaders undertook a modernization of China's economy that involved a heavy dose of capitalism, or "capitalism with Chinese characteristics" as it was often described.

    China became one of the fastest growing economies in the world and the world's second-largest economy. To maintain its growth, China has endorsed various capitalist measures such as markets, competition, profit, and international trade. Still, China is controlled by its communist party, and the government owns all factors of production.

    These changes would not have happened if they did not benefit Chinese authorities, so the fact that they are happening is evidence that they are beneficial to its leadership. Similar changes are also happening all over the world, including the countries of North Korea, Cuba, and even in the former Soviet Union.

    The advantages of mixed economies are not restricted to communist-controlled command economies. In the democratic countries of northern Europe, countries like Sweden, Denmark, Germany, and Norway have maintained extensive socialistic programs that offer generous education, employment, and health benefits even though their economies are based on capitalism and free markets. In the United States, socialist-sounding programs like widespread health insurance exist side-by-side with competitive markets and the ownership of private property.

    Disadvantages of Mixed Economies

    Mixed economies with a strong component of socialism tend to provide more services to consumers than do traditional command economies. For example, Germany and the Scandinavian countries offer a wide range of social benefits that includes medical coverage, free education, and even generous vacation time. The problem is that these programs are not free, so the countries must find a way to pay for them.

    One way to cover the costs of these programs is through taxation. As a result, personal income taxes are higher in almost all major European countries than they are in the United States. The other way to cover these costs is to produce less of something else. So, the cost of generous welfare programs can be absorbed by shifting resources away from other projects.

    Chapter 2, Lesson 3: The Global Transition to Capitalism                                 Chapter 2, Lesson 3 Presentation

    Lesson 3: Vocabulary

    Content Vocabulary
    • GDP per capita
    • privatization
    • vouchers
    • Five-Year Plan
    • Gosplan
    • collectivization
    • perestroika
    • Great Leap Forward
    • nationalization
    • Solidarity
    • European Union (EU)
    • black market
    • capital-intensive
    • keiretsu
    • population density
    Academic Vocabulary
    • undertaking
    • isolationism


    How does an economic system help a society deal with the fundamental problem of scarcity?

    Suppose you run a company that makes and sells smart phones. If the stores in which your phones are sold cannot stock enough phones to meet customer demand, what would you do? Would you produce more phones or fewer phones? Would you change the price of your phones? Explain your decisions.

    The dominant economic trend of our lifetime has been the transition of communist and socialist economic systems to capitalism. It has been a transition of epic proportions, and it shows few signs of slowing down. As countries make the transition, the final form of capitalism they adopt will reflect many of their own cultural and social values. That is one reason why so many different faces of capitalism exist in the world today.

    Some of the former transitioning countries, such as Chile, Russia, and the former Soviet bloc countries of Eastern Europe, have almost completed their transition to capitalism. Because of their previous history as command or socialist countries, however, the GDP per capita, or GDP per person, in those countries is still lower than those in other capitalist countries.


    Problems of Transition

    In what ways does the mind-set of a country’s citizens have to change in order to transition to capitalism?

    When an economy becomes large and complex, a capitalist market-based system is the most efficient way to organize production and provide the necessary economic incentives. Even so, economies that are not capitalist often find that the transition to capitalism is difficult.

    Why Capitalism?

    Simply put, capitalism is the most powerful engine for generating wealth the world has ever seen. Because of capitalism, countries or regions as culturally diverse as Germany, Japan, Singapore, South Korea, Sweden, the United States, and the special administrative region of Hong Kong have greatly increased their productivity and have experienced exceptional economic growth.

    This growth has improved nearly everyone’s standard of living, the quality of life based on the ownership of necessities and luxuries that make life easier. In a world that is becoming increasingly connected by the media, people everywhere are aware of—and even begin to want—some of the wealth that capitalism in other countries can generate.

    In contrast, the collapse of the Soviet Union indicates that communism as an economic system has reached an evolutionary dead end. Pure capitalism can be harsh and may not be attractive to everyone, but in democratic nations, people can modify capitalism to meet more of their economic and social goals. However, there is no guarantee that countries attempting a transition to capitalism will be able to do it smoothly, or that they can do it at all. This is because there are so many hurdles to negotiate.

    Privatization of State-Owned Property

    A key feature of capitalism is the ownership of private property. In order for the transition to capitalism to take place, privatization, or the conversion of state-owned factories and other property to private ownership, must be accomplished. Privatization is important because entrepreneurs want to be rewarded for undertaking business ventures involving risk. Private property is also important because people take better care of property they actually own.

    In Poland, Hungary, and the Czech Republic, this transition was accomplished by using vouchers. Vouchers were certificates that could be used to purchase government-owned property. In practice, vouchers were either given to the citizens of a country or sold at very low prices. State-owned companies could then be converted to corporations, and the corporate stock could be auctioned for vouchers. As vouchers were exchanged for certificates of ownership, the ownership of state-owned enterprises was transferred to private hands.

    Loss of Political Power

    Under communism, the Communist Party was the ruling class. When countries transitioned to capitalism, the party feared that it would lose much of its political power as a new class of entrepreneurs and capitalists took over.

    In countries such as Czechoslovakia, Hungary, and Poland, the Communist Party leaders who were ousted from office lost their power before their country’s industry was privatized. In these countries, the voucher system worked reasonably well to redistribute wealth to new leaders.

    In other countries, Communist leaders grabbed a large share of vouchers and thus a large portion of ownership in many privatized companies. In the most blatant cases, some of which occurred in Russia after the collapse of the Soviet Union, the ownership of companies was directly transferred to politicians who were influential during the transition period.

    As a result, former political leaders traded their political power for economic power in the form of resource ownership, and so the old ruling group simply became the new ruling group. In the case of Russia, the members of the old ruling party had a difficult time actually giving up their power.

    Responding to New Incentives

    People in countries that transition to capitalism have to adjust to a whole new set of incentives. They have to learn how to make decisions on their own, take initiative, interpret prices, and fend for themselves in free markets. Many of these adjustments are enormous, often even prohibitive.

    For example, workers used to getting the same salary regardless of how hard or how often they come to work have to learn that they will get fired if they do a poor job. Factory managers have to learn to pay back loans they took out from banks, and they have to learn to pay their bills on time.

    Underestimating the Costs

    Too many countries that want the advantages of capitalism focus on its benefits, but they don’t fully consider its costs. Yet the costs can hinder or even prevent a country’s successful transition.

    The costs of capitalism during the Great Depression, for example, included instability, unemployment, and social unrest. At that time, the United States did not have the economic policies and social welfare programs needed to lessen the devastation. Now that such assistance exists in the United States, most economists agree that another Great Depression will not occur here.

    The same cannot be said for the countries in transition. They have not yet developed the automatic stabilizers and the social welfare nets that cushion the instabilities of capitalism. During transition, nations will experience the instabilities of early capitalism long before they experience the benefits.



    Countries and Regions in Transition

    What are the common features of the transition to capitalism?

    Despite the transitional problems, most nations and regions all over the globe are moving toward capitalism. Some have a little further to go than others, but may eventually get there; others appear to have gone about as far as they ever will go.


    To see why the transition to capitalism has been so difficult for Russia, it helps to understand how the economy was managed during the Soviet era. During that period, the government controlled economic activity with Five-Year Plans. The first Five-Year Plan—a comprehensive, centralized economic plan designed to achieve rapid industrialization—was introduced by Joseph Stalin in 1927.

    The Gosplan was the central authority that devised the plans and directed overall economic activity. It tried to manage the economy by assigning production quotas to all Soviet industries. Central planning also extended to agriculture with the introduction of collectivization—the forced common ownership of all agricultural and industrial enterprises. Planners then sought to ensure the growth of the economy simply by increasing the quotas given to the farms and factories.

    Despite its efforts, central planning eventually failed. The Soviet economy had become too complex and large to be managed by a single planning bureaucracy. Shortages appeared everywhere, workers were often unpaid, and many people lacked the incentives to work.

    After Mikhail Gorbachev assumed power in 1985, he introduced perestroika, the restructuring of the Soviet economy. Under the restructuring, plant managers had more freedom to pursue profits, and small business was encouraged.

    Gorbachev’s successor, Russian president Boris Yeltsin, accelerated privatization after the fall of the Soviet Union. The government distributed vouchers to citizens so that they could purchase ownership shares in companies being privatized. Eventually Russia opened a stock market, which made the ownership of capital by private individuals a reality in a country that once preached the evils of private property.

    Under the first regime of President Vladimir Putin, privatization began to slow. Under the guise of fighting corruption, Putin used his power to regain centralized control of key energy and mineral industries. The period of transition to capitalism is now over for Russia. Under the second presidency of Putin, the country can be described as having a market-based economy with the exception of energy, natural resource, and defense-related industries, which the government controls.


    The People’s Republic of China became a communist economy in 1949. That year the Chinese Communist Party, under the leadership of Mao Zedong, gained control of the country. Over the next few decades, China modeled itself after the Soviet Union, adopting a series of Five-Year Plans to manage its growth.

    In 1958 Chinese leaders instituted the Great Leap Forward, an attempt to revolutionize industrial and agricultural production almost overnight. This ambitious and radical Five-Year Plan forced farmers off their land to live and work on large, state-owned communal farms.

    The Great Leap Forward was a disaster. The agricultural experiment failed, and the economy never came close to achieving the planned degree of industrialization. Other plans followed, but by the late 1970s China finally decided to abandon the Soviet model.

    By the early 1980s, the influence of other successful market economies in Asia—especially in Hong Kong—was too much for China to ignore. Guangdong Province, one of China’s provinces just north of Hong Kong, copied many of the free market practices of the region and was even allowed to officially experiment with capitalism.

    Today China is privatizing some industries, introducing market reforms, and otherwise acting in a capitalistic manner. The progress made so far is remarkable as it now is the world’s second-largest economy. China’s transition was made possible because of its willingness to replace communist ideology and control with capitalistic practices.

    China’s transition to capitalism is not yet complete; it has implemented the reforms on a gradual basis and still has a long way to go. Many prices are still regulated and many industries are state owned, although many state-owned firms have been given more autonomy.

    At the same time, China is faced with some problems that may slow its growth. The population is aging, which will eventually leave the country with a shortage of younger workers. Pollution of the air and water is another major problem, and was so severe that China had to take drastic steps to reduce air pollution during the Beijing Olympic Games in 2008. To reduce air pollution, approximately 300,000 heavy trucks were banned during the Olympics, while half of the city’s 3.5 million vehicles were only allowed to drive every other day. Plus, in 2013, over 13,000 dead and decaying pigs were discovered floating down a major river that flowed into Shanghai. Even though the river supplies the city with about one-fifth of its water supply, government officials described the water quality as being “normal.”


    Latin America

    In the past, many Latin American countries followed a path of economic development that combined socialism and isolationism.Chile, however, took major steps to foster the growth of capitalism when it privatized airlines, telephone services, and utilities. The country even used the billions deposited in its pension funds to supply capital to new entrepreneurs. As a result, many industries prospered, and Chile now exports copper, paper and pulp, fruit, and chemicals.

    Today Chile has one of the strongest market-oriented economies in the region.  It is extensively engaged in foreign trade and has some of the strongest financial institutions in the region. The conversion to a free market economy is now complete and has been a resounding success.

    Argentina has similarly embarked on a program to remove government from the everyday business of running the economy. The country is rich in natural resources, and it has a highly literate population and a diversified industrial base. At first the government sold state-owned oil fields, petrochemical plants, and a number of other businesses to private companies. Since 2000 it experienced both high rates of growth and a major crisis in its banking sector. Instability in the political sector, however, along with nationalization, the conversion of private property to government ownership, of several major energy companies has halted the full transition to capitalism.

    Finally, one country clearly resisting the transition to capitalism is Venezuela. Under President Hugo Chavez, who ruled as president until his death in March 2013, the economy was being transformed into a socialist state. However, the transition to socialism was not smooth, because of a housing crisis, rapidly rising prices, and electricity and food shortages. President Chavez’s successor promised to continue the socialist policies, but the private sector is in turmoil and it remains to be seen if the trend toward socialist policies will continue.

    Eastern Europe

    The nations of Eastern Europe, especially those that were unwilling members of the former Soviet bloc, were eager to shed communism and embrace capitalism.

    The struggle for freedom began in Poland with Solidarity, the independent and sometimes illegal labor union established in 1980. Solidarity was influential in securing a number of political freedoms in Poland. Eventually, the Communist Party lost power, and interest in capitalism grew. In 2004 Poland joined the European Union (EU), the association of European nations created in 1993 to develop a single market with full economic and political cooperation.

    Hungary also made a successful transition to a market economy. It was considered the most “Western” Communist bloc country with a thriving black market—a market in which entrepreneurs and merchants sell goods illegally. Hungary’s experience with these markets helped ease the transition to capitalism. It too became a full member of the European Union in 2004.

    Finally, the Czech and Slovak Republics, along with Estonia, Latvia, Lithuania, and Slovenia, were all granted admission to the EU in 2004. These countries, along with Bulgaria and Romania, which joined in 2007, made great strides toward capitalism after the collapse of the Soviet Union. All of these countries thus completed one of the more remarkable transitions of economic systems in history—going from communism to capitalism in a relatively short period of time.

    Other Faces of Capitalism

    Why is capitalism different in different countries?

    Some former socialist or communist countries are still making the transition to capitalism. Many other countries have had successful capitalist economic societies for some time. This is one reason that so many other countries are trying to make the transition. As Figure 2.3shows, capitalist countries have much higher per capita incomes than other countries.


    Japan, like the United States, has a capitalist economy based on markets, prices, and the private ownership of capital. There are several reasons for Japan’s success. One is that Japan has a loyal and dedicated workforce. At many companies, employees even arrive early for work to take part in group calisthenics and meditation with the intent on making their day more productive.

    Another reason is the ability and willingness of the Japanese to develop new technologies. Because of its small and aging population, Japan has worked to boost productivity by developing techniques that are capital-intensive—methods of production that use large amounts of capital for every person employed—rather than labor-intensive. As a result, Japan is recognized as the world leader in the area of industrial robots.

    The feature that really sets Japan apart from the United States is the degree to which Japan’s government is involved in the day-to-day activities of the private sector. The country’s Ministry of International Trade and Industry (MITI), for example, is a government body that identifies promising export markets for Japanese firms. The ministry then provides subsidies to industries to make them competitive in those areas.

    Despite Japan’s successes, it experienced economic stagnation that began in the 1990s. Part of the reason is that most large Japanese firms belong to a keiretsu (kay • reht • soo), a tightly knit group of firms governed by an external board of directors. The role of the keiretsu is to ensure that competition does not threaten individual firms. A similar agreement in the United States among competing firms would be illegal under our antitrust laws.

    Modest economic growth returned in 2003 and continued until 2008, when Japan entered the global economic slump of 2008–2009. Before it could fully recover, in 2011 a massive tsunami hit Japan and destroyed a major nuclear reactor and caused the loss of nearly 20,000 lives. Since then, public opinion turned against nuclear power, and almost all of its 50 nuclear reactors were shut down two years later.

    All of this, with the possible exception of the 2011 tsunami, is an ironic turn of events because the world looked to Japan as the very model of growth in the 1980s.

    South Korea

    One of the most successful nations in Asia is South Korea. In the mid-1950s, after it became divided from North Korea, South Korea was one of the poorest countries in Asia. It needed to rebuild an economy torn up by war. The country also had the highest population density—number of people per square mile of land area—in the world.

    The South Korean government began by opening its markets to world trade. At first, the government focused on only a few industries. This allowed its people to gain experience producing and exporting for world markets. Businesses in the South Korean economy began to produce inexpensive toys and consumer goods. As they became skilled in production and exports, businesses next moved into textiles such as shirts, dresses, and sweaters. They then invested in heavy industry, such as shipbuilding and steel manufacturing.

    Today, South Korea is a major producer of consumer and electronic goods such as home appliances and televisions. The country also has become a leading producer of automobiles. The South Korean experience shows that capitalism can change a badly war-damaged economy into a well-developed, highly industrial one in just a few generations.

    South Korea, like other nations of the capitalist world, recovered slowly from the worldwide slump in 2008–2009, but it shows no signs of retreating from its commitment to capitalism. Its major industries are in the export sector, and so its recovery and future economic growth are closely tied to the continued recovery of other capitalist systems in the world.


    Singapore is a small island nation about 3.5 times larger than Washington, D.C. Despite its small size, its GDP ranks about 40th in the world, and it has a per capita income almost 20 percent higher than that of the United States. The lure of generous tax breaks, government subsidies, and government-sponsored training of employees has attracted thousands of multinational firms to Singapore. Efforts to develop its own technologies through spending on research and development accounted for a significant part of its strong economic growth.

    The government of Singapore has focused on a few select industries, including telecommunications services, software, and biotechnology. The government has spent millions on laboratories, attracting top scientists from all over the world. Pharmaceuticals and medical technology are now leading industries, and Singapore is Southeast Asia’s leading financial and high-tech hub.

    The high rates of recent economic growth, its corruption-free environment, and its sound capitalist structure are all reasons for Singapore’s remarkable performance.


    Taiwan, formerly known as Formosa, is located off the coast of the much larger People’s Republic of China. The population of Taiwan is about 23 million, and the per capita income is almost 80 percent of that of the United States.

    Planning has always been a feature of the Taiwanese economy, with the government trying to identify those industries most likely to grow in the future. Most of these plans target high-tech industries such as telecommunications, consumer electronics, semiconductors, precision machinery, aerospace, and pharmaceuticals. Government guidance of investment and foreign trade is decreasing, and the country has signed a number of international trade agreements with capitalist nations, which should help boost growth.

    Taiwan was one of the early economic powers in Asia, but some experts have warned that the centralized planning process will hamper future economic growth. Another concern is the looming presence of the People’s Republic of China, which regards Taiwan as a “renegade province” and vows eventual unification. Despite its early start, the per capita GDP in Taiwan has fallen behind those of Hong Kong and Singapore.


    Sweden is now a mature industrial nation even though it was once known for its broad range of social welfare programs. The Swedish economy—with its generous maternity, education, disability, and old-age benefits—was thought to be the model of European socialism.

    Social benefits were expensive, however, and to pay for them, the highest tax brackets reached 80 percent. This meant that a person who earned an additional $100 would keep only $20. Many athletes and celebrities even left the country to avoid high taxes.

    Eventually the heavy tax burden, the high costs of the welfare state, and massive government deficits cut into Sweden’s economic growth and led to the defeat of the Socialist Party. After a new government committed to a free market economy, it reduced the role of the public sector, lowered taxes, and privatized many government-owned businesses.

    Today Sweden features a mix of high-tech capitalism and liberal welfare benefits. The welfare system attracts other residents of the EU because of the liberal benefits they can collect, something that contributes to a relatively high unemployment rate. Despite the taxes required to support the welfare system, Sweden generates a GDP per capita about three-quarters the size of that in the United States.