Who or what decides what you get?
No country in the world today relies on a purely traditional, market, or command economic system. These systems represent theoretical extremes. Nearly all countries have mixed economies that fall somewhere in between these extremes. In a mixed economy, both the government and individuals play important roles with regard to production and consumption. But who decides what varies from one country to another?
Every nation with a mixed economy forges its own balance between market freedom and government involvement. At the minimum, governments are needed to establish the institutions that enable markets to operate. Such institutions include a legal system to enforce laws and a stable system of currency. Most of us never think about these things, but markets cannot function without them.
In many countries, people expect government to go further. They want it to step in when the market operates in ways that society finds unacceptable.
For example, many nations outlaw child labor. Some governments limit the amount of pollution that industries can discharge. In the United States, the government regulates the manufacture of cosmetics, foods, and drugs because consumers want to know that products on the market are safe. Not all governments regulate to the same degree. Each society decides how far it wants its government to go in curtailing the freedom of the market.
Finally, government provides certain goods and services that markets do not always provide or do not provide enough of. Examples include public works, or government-financed projects such as dams, highways, and sewer systems. The market does not provide these goods because, as Adam Smith explained, the cost of providing them “could never repay the expence to any individual or small number of individuals.”
What a government provides varies from country to country. In Canada and much of Europe, health care is provided free to every citizen. Some governments provide free college education or free day care. Governments that provide a high level of goods and services also tax heavily to pay for those goods and services. Again, these are economic choices that every nation makes differently.
How does government participation in the economy change the flow of money and goods? The answer to this can be seen by adding government to the circular flow model. The revised circular flow model in Figure 3.4A shows a mixed economy with three participants: households, firms, and government.
A government enters the flow of money and products through an economy in a number of ways. It purchases land, labor, and capital from households in the factor market. In the United States, the federal government employs almost 2 million people, making it the nation’s largest employer. A government also purchases goods and services from firms in the product market. As the nation’s largest employer, the federal government is also its largest customer, spending hundreds of billions of dollars a year on goods and services.
Governments also combine land, labor, and capital to produce and distribute goods and services. As an example, suppose a town decides it needs a library. The town government buys land and hires architects and builders in the factor market. Later, the town buys books, shelves, computers, and furniture in the product market. Finally, it hires librarians in the factor market. The end result is a public service that the entire community can enjoy.
Now follow the flow of money in a mixed economy. You will see that a government collects taxes from both households and firms. It uses some of this money to pay for the goods and services it buys from firms. It may also transfer some money back to households as payment for government benefits. Social Security checks, welfare payments, and unemployment benefits are examples of government transfer payments.
Although most of today’s economies can be described as mixed, the “mix” of market freedom and government control varies greatly from one nation to the next. In 2013. the Heritage Foundation and the Wall Street Journal published their annual Index of Economic Freedom. This index is a kind of scorecard that ranks the economic freedom of the world’s nations. It is a useful tool for understanding the variety of mixed economies.
Near the top of the rankings is Australia, which was rated the third-mast-free economy. Free markets dominate Australia’s mixed economy. All banks are privately owned. The economy is open to foreign investment and trade. Private property is very secure. Starting a business is easy, taking an average of only two days.
At the very bottom of the list is North Korea. which came in last of the 157 ranked nations. A communist country since 1948. North Korea still has a tightly controlled command economy in which the government directs all industries and businesses. Nearly all foreign trade is forbidden. and private property is severely restricted.
What about countries that fall somewhere in between, such as Japan, South Africa, and France? All three have mixed economies dominated by the market system. All have relatively high levels of economic freedom and secure property rights. But they also have high tax rates, which are used to pay for an array of public services and benefits, such as government-provided health care. In these nations, people have decided that achieving economic equity and security for more members of society is worth giving up some measure of their individual wealth.
Further down in the rankings is China, which is rated “mostly unfree.” China, which has had a communist government since 1949, is in transition from a command economy to a market-oriented system. But its mixed economy is still dominated by an authoritarian government. All Chinese banks are owned by the state. Private property is not secure. Internet use is tightly controlled by the government.
Still, China allows more economic freedom than many countries. Iran, for example, is rated “repressed.” Its economy is dominated by the state. The oil and gas industries are owned by the government, as are almost all banks. As in repressed North Korea, foreign investment in Iran is severely restricted. Iran’s legal system does not uphold property rights or contracts.
Only four countries in the 2013 Index of Economic Freedom, plus Hong Kong, were rated “free.” In addition to Australia, these countries are Singapore, New Zealand, and Switzerland. What do these countries have in common’ All have mixed economies dominated by free markets. Most have democratic forms of government. They are also all among the wealthiest nations in the world. As Adam Smith might have predicted, the societies with the most economic freedom are also among the most prosperous.
