What Is the Economic System in the United States?
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Summary:
The U.S. economy is defined as a mixed economy, which features characteristics of both socialism, a command economy, and capitalism (aka a market economy). Mixed economies combine aspects of both these economic systems. They allow consumers and businesses freedom of choice, but they limit this freedom through specific regulations on businesses and other forms of government intervention. For instance, the government may manipulate the American economy via taxation, regulations, and social programs.
The United States’ economy is one of the world’s largest. Though it’s common to hear that the U.S. has a “free market economy,” that’s not entirely true. Instead, the U.S. economy combines features of both socialist central planning and the free market to produce a mixed economy. Supporters of the mixed economic model believe that it retains the free market’s ability to produce great wealth and innovation while empowering the government to protect consumers from exploitative practices and ensure citizens’ health and safety.
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What is an economic system?
Economic systems describe how societies, countries, or governments organize, allocate, and distribute:
- Raw or natural resources
- Manufactured goods and products
- Services
In short, an economic system defines how each type of good or service is produced or exchanged.
In a socialist system, government central planners may regulate access and means of production — like land, capital, and labor — in an attempt, say, to keep the population fed. In a free market system, farmers and ranchers who sense a demand for certain foods rather than others will shift production toward those in-demand foods to maximize their profit so they can buy more of the things they desire. In a mixed economy, either might happen in any given industry, depending on whether and to what extent government officials have decided that the free market can or cannot be trusted.
Each type of economic system requires many agencies and decision-making processes to function. These entities may include:
- Private businesses and other voluntary associations. The closer the economy is to a free market or capitalist system, the more these dominate.
- Government-ordained bodies in both public and private sectors. The more mixed or socialist the economy becomes, the more prevalent these bodies will be.
For an economic structure to count as successful, it must meet the needs of the population, meaning it must be suitably adapted to the patterns of consumption in a given nation.
Whatever your economic system, thriving in it will require sound money management
While the economic systems of whole nations or societies vary, certain aspects of individuals’ lives are pretty constant. Whether your system allows you to freely do business with whomever you want and keep all you earn or limits your employment options and takes half what you earn in taxes, managing the money you keep wisely will mean a better future than not doing so. One way to improve your money management is to use the right tools.
Types of economic systems
An economic system is defined by how a society’s resources, goods, and services get distributed. In some economies, this means spontaneous processes resulting from the interactions of private individuals and organizations pursuing their own objectives. In others, it means the methods a national government uses to distribute resources, goods, and services in accord with the wishes of government officials, the voting public, or both. The four basic types of economies include:
- Traditional
- Command
- Market
- Mixed
While they all share some basic features, each also comes with its own distinguishing characteristics, strengths, and weaknesses.
Caveat: strengths and weaknesses according to whom?
The strengths and weaknesses of economic systems are often matters of debate. For instance, contemporary advocates of the free market reject many claims about capitalism’s (that is, the market economy’s) shortcomings. To avoid bias, when this article provides lists of pros and cons for each economic system, it will list the pros as seen by supporters of the system and the cons as seen by opponents. Any of these pros or cons may be a matter of opinion and open to debate, and it is not the intention of this article to endorse any of them.
Preexisting biases play a big role: People who advocate for one or another economic system most often do so because of deeply held convictions that guide how they interpret economic history and data. Most people will display one of two biases.Advocates of the free market — called classical liberals, libertarians, or, sometimes, anarcho-capitalists — maintain that the free market is a self-organizing system that grows organically out of the free choices of countless individuals and the institutions they cooperatively form. In their view, attempts to plan, direct, or manipulate an economy from above, as in a mixed or socialist system, are fundamentally misguided and doomed to fail.
Advocates of mixed or command economies either reject the idea that the market or society can self-organize entirely or hold that such self-organization cannot be trusted to produce desirable results. In their view, human planners acting with authority must oversee the market and society, improving upon unsatisfactory spontaneous developments, correcting defects introduced by individual and corporate greed, compensating for insufficient charitable impulses among the populace, and moving society in a direction the planners deem desirable and properly progressive.
Traditional economies
A traditional economy is the oldest, simplest, and most sustainable economic structure. Generally, it’s based on agriculture, mineral extraction, or other simple processes and a somewhat-specialized division of labor. In other words, each member of a community produces or barters goods that contribute to the community’s progress.
Because traditional economies often occur in areas with limited or restricted resources, they rarely generate a surplus of goods. But due to their lowered output, traditional communities don’t produce the same level of wastage seen in more advanced economies.
While highly sustainable in the sense that it does not place excessive demand on natural resources, a traditional economy is, in another sense, unsustainable on a large scale. As a society advances through innovation and industrialization, moving away from an agrarian order with limited specialization toward an increasingly urban one with greater specialization, traditional economies naturally give way to more advanced systems.
Examples of traditional economies
While less common today, some rural settings or communities still live off traditional income-producing activities. For instance, any nation’s economy that relies primarily on farming or bartering (instead of currency) may count as traditional. You can find pockets of such communities in South America, Asia, and Africa.
Command economies
A command economy is an economy characterized by substantial government ownership or control over the means of production. Also known as planned economies, they rely on a central authority (the government) to:
- Regulate the economic structure
- Allocate resources
- Control the means of production
- Dictate the prices of goods and services
Theoretically, command economies work as long as the government acts in accordance with the people’s best interests. This requires, of course, that the government know what the people’s best interests are, something not everyone believes government officials can do successfully or consistently. Still, on paper, a command economy provides enough jobs, goods, services, and medical care to keep people affordably fed and housed.
Command economies: theory vs. reality
However, economies with sufficient centralized authority to earn the “command economy” label typically exert more control over citizens’ lives than other systems. They may restrict personal freedom, dictate the labor force, or control their population’s movements. And because they’re slow to change, they’re more vulnerable to economic or natural disasters, poverty, and famine.
Additionally, such a system often becomes less efficient than market-driven economies. For instance, in capitalism, demand determines the flow of goods and services. But in command economies, the government allocates goods to the people. Often, this means that resources concentrate in the hands of the powerful, and black markets serve the overlooked in society.
Examples of command economies
You can find command structures in authoritarian, communist, and socialist economies, and in nations with a surplus of coveted goods, like gold or oil. Some command examples include the Soviet Union (no longer extant), North Korea, and Saudi Arabia. While China is historically a command economy, and though its government still possesses the power to intervene in all aspects of Chinese life, it has significantly reshaped its economy on the basis of capitalist theory.
[W]e take the end of 1976 as the start of post-Mao reform and argue that China basically became a market economy by the end of the 90s before it joined the World Trade Organization in 2001.” — Cato Institute
Pro tip: Some democratic states adopt the practices of a command economy during times of war, such as the United States in World War II. During that time, the government took over the means of production to supply the war effort and rationed necessary supplies.
Market economies
Market economies are based on the concept of “laissez-faire” structures. Such a system holds that the less governments interfere with the economy, the better off private enterprise, and society as a whole, will be.
The French phrase laissez faire literally means ‘allow to do,’ with the idea being ‘let people do as they choose.’ The origins of laissez-faire are associated with the Physiocrats, a group of 18th-century French economists who believed that government policy should not interfere with the operation of natural economic laws.” — Merriam-Webster
In theory, keeping government and markets separate helps to limit state power while aligning government interests with the economic interests of a nation’s people. Therefore, a crucial aim of market economies is to limit government’s authority and curb excessive government power. In turn, privately-owned businesses prosper and pass wealth to individuals, thereby fostering rapid growth.
That means that in free markets, private ownership thrives due to the lack of government intervention. Meanwhile, individuals have the personal freedom to spend their capital however they wish, without restriction or compulsion by government bodies.
In other words, there’s no government body regulating private ownership or free enterprise. Instead, the consumer economy controls prices, innovation, and economic powers by influencing supply and demand through purchasing decisions.
Examples of market economies
Historically, Hong Kong was considered a free market economy. And the United States has had a considerably freer market in past, particularly in the 1800s, than it has today. Pure free markets, however, only exist in theory.
For that matter, systems without free market activity also only exist in theory. There has never been a command economy without a black market of free exchange. Regulated and outlawed sectors of mixed economies also have underground free markets in operation most of the time. And free and voluntary exchange of goods also exists in traditional economies, which are really precursors to, not competitors with, more advanced economies like market economies.
Pro tip: While some nations — such as America — have courted freer versions of capitalism in the past, advocates of the mixed economy have blamed such practices for mass worker exploitation and government corruption. Though advocates of the free market argue against these claims, most “market economies” today regulate business, trade, and other matters deemed of national interest.
Fun fact: Because human labor is a valued good in the free market — the most central and important part of the market, in fact — consistent advocates of the free market oppose most or all immigration controls. Restrictions on immigration are characteristic of mixed and command economies.
Mixed economies
A mixed economy, or dual system, combines characteristics of command or socialist economies and market economies. The goal is to form an economic system where the market is freer than a command structure but more tightly regulated than a free market economy.
For instance, in a mixed economy, many industries are operated by private enterprises. Additionally, individuals and businesses may both practice private ownership. However, services like transportation, utilities, and health care may be wholly owned by the government or subject to government control through regulation.
The central authority may also intervene by:
- Regulating corporations to protect consumer interests
- Issuing licenses to perform certain activities
- Placing restrictions on voluntary transactions in the private sector
- Banning certain transactions or activities in some or all circumstances
- Purchasing public property or providing public services
- Using tax revenues to regulate economic stability
Additionally, in a mixed economy, the government may own or subsidize critical sectors like agriculture, national defense, and transportation.
Examples of mixed economies
In an increasingly developed world, mixed economies are more common than ever. In fact, most major countries in the Western Hemisphere run on various forms of mixed economies. Some examples include India, France, Britain, and Spain.
Something to think about: Since neither command economies nor market economies exist in pure form, you might want to think of these two economic systems as limiting concepts only. That is, they are the never-reached extremes on the spectrum of real-world economies that are all mixed. More socialistic, communistic, or authoritarian economies fall closer to the command end. Economies with less government intervention fall closer to the market end. For those who value freedom but see a need for government regulations and a social safety net, the challenge is to prevent the mixed economy they favor from moving too far toward the command end of the spectrum.
Learn more about world economic systems
Reading an article like this is a great help if you want to understand various economic systems and how they compare to the one you know best here in America. But you could learn even more by visiting a few countries with other systems. Though saving up to pay for travel expenses is never a bad idea, a case could also be made for considering a loan to fund your travels.
What is the economic system in the United States?
The United States is a prime example of a mixed economy, featuring characteristics of both capitalism and socialism. The government protects a degree of free enterprise, but it also regulates private industry. While private businesses produce most of the nominal GDP, or gross domestic product, the government shapes the economy through fiscal policy and, via the Federal Reserve, monetary policy.
GDP measures a nation’s total economic output according to the market value of final goods and services.
How the U.S. government Influences the economy
Support for U.S. government manipulation of the nation’s market forces dates back to America’s founding, when people like Alexander Hamilton advocated for a national bank similar to today’s Federal Reserve. But the U.S. economy qualified as primarily a market economy until the early 20th century, at which time its transition to a more obviously mixed system accelerated significantly.
Today, there can be no doubt that the U.S. economy is mostly mixed, with government intervention playing at least some role in most economic activity. For instance, the government imposes regulations in almost all sectors. Supporters of these regulations argue that they promote the public good, protect consumer rights, or prevent future ecological disasters.
The government also partially or fully controls many goods and services like:
- Education
- The legal system
- Medical care
- National defense
- Postal delivery
When it comes to business, the U.S. government requires private companies to register with the proper agency. Many professionals and businesses, including those in mining, health care, and even hair styling must have a government license to work. And many government agencies and policies exist to regulate economic exchanges and labor force rights, including the:
- Food and Drug Administration (FDA)
- Department of Labor (DOL)
- Fair Labor Standards Act (FLSA)
- Employee Retirement Income Security Act (ERISA)
Additionally, the U.S. government bans, regulates, or taxes some goods to criminalize or discourage their use, including cocaine, flavored smokable products, alcohol, and even raw milk. And, when officials deem necessary, the government may address problems by creating agencies, raising the minimum wage, or restricting transactions.
Financial policies in the United States
The federal government influences the U.S. economy via financial policies that affect inflation, supply and demand, and tax revenue.
The Federal Reserve and monetary policy
The Federal Reserve System is the nation’s central bank. It’s responsible for controlling monetary policy, regulating the nation’s banks, maintaining economic stability, and preventing economic upheaval.
For instance, when the Fed believes that inflation is a problem, it employs contractionary policies like interest rate hikes. Contractionary policies are designed to encourage saving, reduce demand and spending, and burst asset bubbles.
By contrast, if the Fed is worried about a recession, it uses expansionary tactics instead. These may include decreasing interest rates or buying investments on the open market to influence long-term interest rates. Expansionary policies encourage spending heavily, increase liquidity, and stimulate lending.
The federal government and fiscal policy
The federal government — such as Congress — institutes fiscal policies such as altering spending patterns or tax revenues. Both can affect the total money supply flowing through an economy.
For instance, during recessions, the government may increase spending, reduce tax revenues, or both. Such policies put more money in the wallets of consumers and businesses, which encourages economic expansion. By contrast, during periods of inflation, the government may decrease spending or increase tax rates to reduce consumer and business spending. In turn, prices may drop, which reduces inflation.
A minority report in economics deems attempts to guide the economy through fiscal and, especially, monetary policy misguided. In fact, this viewpoint, supported by such individuals as Dr. Richard M. Ebeling, blames many of the problems governments in mixed economies claim to solve on those governments themselves. Concerning the Great Depression, for instance, Ebeling offers the following explanation:
The attempt to ‘stabilize’ the general price level though central bank monetary manipulation, especially by the American Federal Reserve in the 1920s, created the appearance of a healthy, well-balanced, growing economy. In fact, beneath the surface of that relatively ‘stable’ price level, central bank policy had generated unbalanced and distorted patterns of investment activities and resource uses that meant that the ‘good times’ were coming to an end.”
FAQs
What types of economy are there?
The four primary types of economy are traditional, command, market, and mixed. Each involves varying levels of private ownership and government intervention.
How strong is the U.S. economy today?
Currently, the U.S. economy is one of the richest in the world, with a gross domestic product of $23 trillion. While many relied on unemployment benefits during the pandemic, employment numbers are up 90% from the spring of 2020. However, economic forces like inflation have also caused prices to rise, leading to the Federal Reserve hiking interest rates.
What impact does the U.S. economy have globally?
By some estimates, the United States accounts for 20–30% of global output and a third of stock market capitalization. That means the U.S. has an important influence on global economics, including trading activities, tariffs, and even product innovation.
Key takeaways
- Economic systems are typically classified as traditional, command, market, or mixed economies.
- Each system interacts with or controls the flow of goods, services, the labor force, and supply and demand.
- The U.S. is a mixed economy, meaning it borrows characteristics from both command and free market economies.
- The U.S. federal government controls the economy with regulatory oversight, licensing requirements, and laws that ban or restrict the sale of some goods.
- Mixed economies use tax revenues, government spending, and central bank policies to promote financial goals or serve the public.
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