What's the most common type of economy? People living in the United States might argue that a capitalist or free market economy is superior to others. Scandinavians might vouch for a socialist approach as the most fair and equitable allocation of capital. People in other parts of the world might argue that a communist economy would ensure the greatest satisfaction for the greatest number of individuals.
The truth, however, is that virtually every place on the planet is a mixed economy that combines elements of different types of economies. Read on for more details about mixed economies.
What is a mixed economy?
Americans often like to think of their economic system as part of a free market or capitalist economy, with no government intervention or regulation. Competition exists across the entire economy, with buyers and sellers competing to set prices that are based on supply and demand. In socialist economies, the government controls the means of production and property, as well as price-setting. The primary goal of socialism is to create greater equality; capitalist economies are designed primarily to create wealth.
The problem with these descriptions, however, is that very few economic systems stick to one school of thought. Enter mixed economies, which combine a free market ethos with a socialist-shaped safety net. As a general rule, government intervention in mixed economies is present but falls short of deciding the goods and services that will be produced, how they will be produced, who will produce them, and how much people will pay for them. Instead, the government's primary role is to ensure some degree of social welfare is maintained.
Upsides and downsides of mixed economies
There are advantages and disadvantages to a mixed economy. Among the advantages:
- Resources are allocated more efficiently in a mixed economy, resulting in customer satisfaction. Consider, for example, the former Soviet Union (Union of Soviet Socialist Republics). The country prioritized military spending over consumer goods, eventually leading to unrest that caused its collapse when its leaders attempted to loosen political and economic control of its republics and satellite states.
- Innovation is rewarded, providing producers with greater profits. Consider Apple (AAPL +0.36%), for example, which has been the most valuable company in the world by market capitalization. The company has been valued at more than $3 trillion, largely on the strength of innovations such as the iPhone, iPad, and Apple Watch.
- Governments are able to raise revenues to cover the costs of less-profitable ventures, such as defense, education, and transportation. Although some segments may be wildly profitable, such as military contracting services, it's unlikely that any country could defend itself from external threats with private armies.
Disadvantages of mixed economies include:
- Potential lack of incentives for efficient production if government support is overemphasized. The cost of a college education in the United States has soared over the past decades, in part due to government programs that created a massive student loan market.
- Moral hazards created by large businesses that are aware governments won't let them fail. During the 2007-09 global financial crisis, for example, critics argued that banks weren't concerned about becoming overextended during a housing bubble since they knew the federal government would stage a bailout if necessary.
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Bottom line on mixed economies
No economy is perfectly capitalist or socialist. The Soviet Union, whose economy was ostensibly a purely communist creation, introduced free-market reforms as early as the 1920s to help the country recover from its civil war. The United States, ostensibly home to a free market economy, has imposed wage and price controls at various times, most recently to curb inflation in 1970.
While the definitions of economic systems haven't changed much, the balance between capitalism and socialism in a mixed economy is a constantly moving target. Part of the dynamism is due to political environments; part is because governments will often respond to changing economic environments through monetary policy that involves changing interest rates or through fiscal policy that redirects government spending. Policies in mixed economies are far from static, and wise investors will pay attention to how changes can affect their portfolios.
