Economic systems and their types

Economic systems are the methods and mechanisms societies use to organize economic activities and allocate limited resources to meet the needs of individuals and groups.
An economic system includes the rules and procedures that determine how goods and services are produced and distributed among different groups in society. Economic systems are influenced by the culture, history, politics, and natural resources of a country.

Economic Systems

An economic system is defined as the set of economic, social, and legal relationships that govern the course of economic life in a given society at a given time.
In other words, an economic system is defined as a system for the production, allocation of resources, and exchange and distribution of goods and services in a society, whereby economic resources, whether limited or unlimited, are used efficiently to satisfy the various needs of the individual and achieve well-being.

There are several key objectives within the macroeconomic framework of economic systems, which generally include economic growth, full employment, economic efficiency (maximizing output using available resources), price stability, and a balanced trade balance.
Some economists add economic freedom as a key objective: this refers to the individual’s right to freely choose employment, consumption, and investment according to their interests and desires.

For example, there is a group of societies on which governments or political systems depend to manage and operate available resources, and to monitor the quality of these services.

Other societies rely on the free market, entrepreneurs, and various business owners to invest these resources, while political systems and governments monitor economic activity to ensure that various laws are not violated.

Economic system objectives

The economic system aims to address the fundamental economic problem of scarce resources and multiple human needs. It seeks to strike a balance between limited resources and the ever-increasing human desire for satisfaction.
This system is closely linked to the nature of the economic problem facing each society, as the nature of economic challenges varies depending on the environment, social conditions, and available resources.

The economic system relies on the optimal management and exploitation of available resources, ensuring maximum efficiency and productivity.
From this perspective, various economic system types have emerged, such as capitalism, socialism, mixed systems, and others. Each system expresses a different vision for how resources are distributed and economic activity is organized.

Every society faces a set of challenges that determine the features of its economic system, the most prominent of which are:

• Diversity of economic resources and their different nature between agriculture, industry, and services.
• The scarcity or abundance of some resources imposes on society a special method of management and distribution.
• Social customs and traditions that influence individuals’ economic behavior and attitudes toward saving or consumption.
• The size of the population determines the demand for goods and services, and thus directs economic policies.

These factors combined drive each society to choose a specific economic system that is consistent with its reality and potential.
The resource factor is the most important in shaping this system, as it represents the fundamental foundation of any economic structure. It determines the nature of production, methods of distribution, and the path of development within society.

Types of economic systems

There are several ways to classify different economic systems, but they often differ in their terminology. For example, some refer to a market economy as a capitalist economy.

But there are four basic types of economic systems, and we will learn about them in detail:

1. Traditional Economy

A traditional economy is defined as one that relies on the customs and traditions of a specific community, or one that is closely tied to its geographic location.
The traditional economy is the first and oldest economic system known to humanity, and it is often based on agriculture, hunting, taxes, and fees.
All of these factors governing the traditional economy are related to land and geographic location, which is why we find this economy widespread in African countries, South America, and Asia.

The traditional economy still maintains its position in the modern era due to its many advantages. Among the most prominent of these advantages is the simplicity of its laws, as there are no complexities in calculating fees or taxes, and the production and distribution processes are simple.
The traditional system is also characterized by equality among individuals, as there are no significant differences between them, as resources, work methods, and profits are clear and defined for everyone.

Every individual in this system, whether a farmer, fisherman, or supervisor, clearly knows their rights and responsibilities. In the event of a malfunction, it’s easy to identify the cause, as it clearly shows who is negligent in performing their duties.
In addition, the traditional economy is characterized by its stability and sustainability compared to other economic systems, as it relies on fixed and stable resources, unlike systems that are affected by market fluctuations or rely on advanced technology.

The traditional economy faces challenges such as the potential loss of some resources due to climate impacts. Rising temperatures or reduced rainfall in some areas can disrupt production and lead to a shortage of a particular resource.
This system is also vulnerable to control by political leadership, especially if it relies heavily on laws and regulatory systems to regulate markets and trade.
In addition, the traditional economy can be exploited by other economic systems, such as capitalist systems, which may exploit natural resources in an unsustainable manner.

The shortcomings of the traditional economy can be overcome through several measures, including diversifying sources of income by integrating elements of other economic systems.
Also, a system can be built to store vital resources to avoid any shortages that may occur due to climate or economic changes.
Finally, efforts must be made to establish associations of craftsmen and professionals to combat any corruption or negligence and ensure the continuity of production fairly and sustainably.

2. Command Economy

A command economy relies on the presence of a central authority, such as a government, that manages all resources, makes economic decisions, and determines plans.
This central authority controls many aspects, including setting both short- and long-term economic plans and allocating resources to implement these plans comprehensively.
It also defines the roles of individuals and companies based on available resources, seeking to utilize everyone’s capabilities in the best possible way.

The central power sets all laws and systems of reward and punishment, and it is the political engine of society, including its dealings with external organizations and forces.
It also identifies and prioritizes the needs of individuals in a way that ensures that urgent problems are prioritized, while ensuring that everyone has their basic needs met.

The central power monopolizes key sectors such as transportation, land, energy, mining, and other vital sectors, including businesses and factories, thus remaining the sole controller of these areas without competition.
This system is a product of communist political thought, the most prominent examples of which are China and Russia. Although these two countries have attempted to partially liberalize their economies over the past twenty years and transform them into a mixed economic system, the central foundations remain largely present.

The advantages of a command economy are limited and are primarily represented by the ability to expand rapidly and launch projects in a very short time, given the absence of any obstacles or multiplicity of decision-making. A single entity controls everything, eliminating red tape and delays.
This system also features the cooperation and unity of all sectors to achieve specific goals that contribute to quickly meeting societal needs. Strict laws also facilitate oversight across various economic sectors.
The strength of this system lies in its implementation. If a good plan is developed and implemented effectively, a country can achieve tremendous progress, as is the case with China, which has witnessed a rapid rise in many economic areas, despite challenges related to equitable wealth distribution.

As for the drawbacks of a command economy, it has proven throughout history to be fraught with challenges. Most notably, poor planning can lead to disasters, as the system relies entirely on the established plan, making addressing problems extremely difficult.
Corruption also spreads due to the absence of an effective system of government oversight, as the government controls resources and is the decision-maker in enacting laws.

Many individuals resort to violating strict laws due to the lack of an open market that allows for a variety of products, leading to the spread of illegal trade, also known as the black market.
The system also lacks creativity, as institutions and companies are restricted by predetermined plans.
Moreover, large sectors suffer from inadequately meeting their needs, as priorities depend solely on government decisions.
As a result of this slow pace of innovation and development, countries that rely on this system have been forced to adopt diverse economic policies to improve performance.

3. Market Economy

A market economy is based on supply and demand. The production process depends on available resources and the services and products people and society need.
This economy is also called a capitalist economy, which is generally based on interest. All parties seek to obtain the maximum benefit at the lowest cost. For example, business owners want to obtain the most skilled labor and production resources at the lowest cost, and they also want to sell their services at the highest possible price. Buyers want to obtain the best products at the lowest possible cost, and skilled workers want to sell their skills to companies that will pay them the highest possible wages.

Amidst all these desires, the role of governments emerges in monitoring and protecting, ensuring that every element of this economy has the opportunity to compete fairly and that everything it needs is available in the market. This unleashes companies and businesspeople to be creative and compete with absolute freedom, and also allows them to work in any field they desire.

A market economy is characterized by an abundance of products needed by society, based on the law of supply and demand. This results in the availability of high-quality goods to meet consumer needs and satisfy them.
The market economy also creates an environment that encourages competition, stimulating innovation and the continuous development of companies. It contributes to the emergence of new technologies and innovative ideas that benefit people in their daily lives.
It also encourages investors to invest capital, which leads to the creation of new job opportunities and better investment of available resources in society.

Despite these advantages, the market economy faces some drawbacks that negatively impact individuals and society.
For example, not all individuals can compete and develop themselves due to disabilities or illness, leaving them marginalized in this system.
Many workers are forced to work beyond their capacity to meet their needs and excessively reduce their expenses, leading to negative outcomes.
In addition, large corporations may monopolize the market in the absence of effective government oversight, exacerbating corruption and collusion between large corporations and regulatory bodies.

One of the worst consequences of the market economy is child labor, which has become rampant in capitalist systems where money becomes the primary goal, disregarding human rights.
The market economy also widens the gap between the rich and the poor, with the wealth of the rich increasing significantly at the expense of the working and poor classes, due to the absence of a fair system for wealth distribution.

Therefore, studying the history of capitalism or reading any book about it will reveal that it is replete with protests by workers and oppressed groups due to the absence of any social justice and the lack of laws protecting them from the injustice of employers.
Any business owner can fire a worker at any time or reduce wages without accountability or oversight. This has driven countries, driven by political activism represented by labor unions, to resort to a different type of economy.

4. Mixed Economy

A mixed economy is defined as a combination of the three previous types: the market economy, the command economy, and the traditional economy. This is done in an attempt to overcome the shortcomings of each system, while at the same time benefiting from its advantages.

Therefore, in a mixed economy, governments manage resources based on natural resources and the customs and traditions of society.
They also establish laws, monitor the market, and provide guarantees for all members of society to preserve their rights to care, education, and health, and to protect them in the event of any disasters in society.
In addition, they rely on a free market system and apply the principles of supply and demand to allow various companies to develop and compete freely.

The mixed system is now widespread throughout the world, especially in developed countries. There is no flaw in this system, except that it relies heavily on governments.
There are still governments that favor a command economy, such as China, while others, such as the United States, are more inclined toward a market economy and capitalism.
In this case, the flaws of the dominant economic system become apparent. The only guarantee is the people’s culture and their resistance to governments, as Hong Kong is currently attempting to do with the Chinese government to which it belongs.

The difference between economic systems

Balancing element	Capitalist system	Socialist system	Mixed system	Traditional system	Islamic economic system
Intellectual basis	It is based on individualism and absolute economic freedom; the market determines prices and production without state intervention.	It is based on collective ownership of the means of production and full state intervention in managing the economy to achieve equality.	Combines individual freedom and government planning; the state intervenes to correct market failures.	It relies on inherited customs and traditions in production and consumption without scientific economic principles.	It is based on the objectives of Islamic Sharia in achieving justice, succession and moderation between the individual and society.
Ownership	Completely private, it is a sacred right that may not be touched.	Completely public and private ownership of the means of production is abolished.	Shared between the state and individuals, depending on the type of economic activity.	Collective or familial, often agricultural.	Dual and balanced ownership: It recognizes private, public, and state ownership within legal controls.
Economic freedom	Absolute freedom in investment, production, and consumption.	Almost no freedom, the state determines everything.	Relative freedom; the market operates under state control.	Bound by customs and beliefs.	Economic freedom is governed by Islamic law (prohibiting usury, fraud, and monopoly).
Social justice	It is achieved through competition, but results in a great disparity in wealth.	It is achieved through imposed equality, but it weakens the incentive to work.	It seeks to achieve a balance between efficiency and equality.	It is achieved in a traditional, limited way within the group.	It is achieved through zakat, endowment, spending, and prohibiting usury, to achieve a balance between the rich and the poor.
Income distribution mechanism	The market determines it according to supply and demand.	The state determines it by central planning.	A mixture of market and state intervention.	Determined by tradition and social status.	It is determined according to work, effort, risk, and Sharia controls, along with Takaful tools such as Zakat.
The role of the state	Very limited (guardian state).	Comprehensive and central.	Organized and directed when needed.	Almost absent, except through leaders or clan.	A supervisory, regulatory, and judicial role; it intervenes to achieve the objectives of Sharia without infringing on freedom.
Attitude towards morality and religion	Separates economics from religion and morality.	It links economics to political ideology, not religion.	Tolerates religious values ​​but does not adopt them.	Related to customs rather than organized religious values.	It links economics with ethics and faith; economic behavior is an act of worship and a responsibility before God.
Economic stability	It is subject to cycles of recession, depression and recovery due to speculation.	Suffering from stagnation and poor productivity.	Relatively more stable than the previous two systems.	Stable but unproductive.	It is stable by nature because it is based on a balance in production, spending, and ethical financing.
The position on interest (usury)	Acceptable and legitimate.	Initially rejected, but replaced with symbolic interest rates within the country.	Acceptable within regulatory limits.	There are no sophisticated financial systems.	It is completely forbidden and is replaced by Islamic financing such as Musharaka and Murabaha.

Controversy over economic systems

Some researchers oppose the concept of market efficiency and the idea that free markets are a mechanism for allocating resources, especially when theories of equitable income distribution see it necessary to distribute equal shares among participants in an economy and not compensate for the productivity of a firm or individual.

The differences between these economies are important, as they arise from differences in human capital, personal preferences, differentiation, luck, and market power.
Generally, economists who are more committed to the idea of ​​​​free market (laissez-faire) oppose differentiation because it hinders the efficient functioning of the economy. In this context, the Gini ratio is a common measure of economic difference, as it measures the differences in income distribution within an economy in particular.

There is still academic interest in command economies and communist economies, as well as growing interest in mixed economies.
However, most economic theories focus on market systems characterized by private ownership, where maximizing profit and personal happiness are the primary motivations for economic activity among participants in an economy.

FAQ about economic systems

Conclusion

We learned about economic systems, as well as the types of economic systems, and we delved into explaining each one of them.

Sources:

• Macroeconomics (Investopedia)
• Understanding the Mixed Economic System (Investopedia)
• What Is a Market Economy (Investopedia)
• Command Economy Explained (Investopedia)