F.07 – Economic Systems and Theories

Economy is the term used to define the activities that take place within a nation to produce and distribute goods and services for public and private consumption.  An economy is often the synonym for the economic system, which consists of the assumptions, theories, goals, procedures and regulations associated with the production, distribution, trade, and consumption of goods and services.  An economy is evaluated in terms of the wealth it creates for the nation and the wealth and standard of living for its citizens.    Economies are either open and free or closed and subject to governmental  control over the factors of production and how they will be allocated.

What makes countries unique and effective?

When people describe a country, they often refer to its economic approach.  But that is often misleading or incomplete.  America is considered a capitalistic democracy, but it is no longer a pure democracy.  When analyzing a country, you must also consider its form of government, its system of  justice, its commitment to liberty and human rights and its economic philosophy.

The Conflict – The extent to which the economy is open and free or closed and planned

The economies of modern countries are composed of many institutions and businesses.   Some countries believe the best way to serve the people is with strong government planning and controls.  Other countries believe economies are too complex to gather and analyze information fast enough to effectively plan and control it.  Socialism is the economic system that utilizes strong government control.  Capitalism is an economic system that prefers limited government and individual autonomy, and permits the economy to control itself through free market principles.

Capitalism – an economic system based on the private ownership of the means of production and operation for profit. Characteristics central to capitalism include private property, capital accumulation, wage labor, voluntary exchange, a price system and competitive markets.

Socialism – a political and economic theory of social organization where the means of production, distribution, and exchange are owned or regulated by the community as a whole.   Social ownership can be public, collective or cooperative ownership, or citizen ownership of equity.

The two principles that underlie these two economic systems, are “Competition” for Capitalism and “Cooperation” for Socialism.

Where it all began

Evidence shows that trade and barter occurred throughout the world since the beginning of human life.  But modern economic systems did not appear until after the Age of Enlightenment (1685 to 1815) and the Industrial Revolution (19th century).      

The Age of Enlightenment, which started in the late 17th century, began a period of great change and new ideas.  It was an intellectual movement, predominately in England, France, and Germany, in which great thinkers challenged the basic foundations of society.   These philosophers (including Thomas Hobbes, John Locke, Jean-Jacques Rousseau, and Voltaire) offered differing theories on human nature, the role of government, the sources of authority, and concepts of liberty.  These ideas helped guide European societies away from feudalism and absolute monarchies, toward societies based on liberty and equality, along with broader citizen participation. 

The Industrial Revolution of 1760 to 1840 saw new manufacturing processes in Europe and the United States.   This period included the transition from hand production methods to machines, new chemical manufacturing, iron production processes, increased use of steam and water power, the development of machine tools, and the rise of the mechanized factory system.


The core principles of capitalism had many roots, but capitalism as we know it emerged naturally in Northwestern Europe, especially in Great Britain and the Netherlands, in the 16th to 17th centuries.  The original principles of capitalism were espoused by English philosopher John Locke (1632-1704) and Scottish economist Adam Smith (1723-1790).  John Locke’s principles were defined in his book “The Second Treatise of Government.” 

  1. Liberty – All men are naturally in a state of perfect freedom and equality.  This includes a law of nature where no one ought to harm another in his life, health, liberty, or possessions.
  2. Property – Every man has the right to own property, including his own person.  The labor of his body is properly his. 

Adam Smith’s principles for an optimal economy were defined in his book “Wealth of Nations” and earlier in Theory of Moral Sentiment”  illustrated with his Invisible Hand.   They indicated that although individuals act in their own best interests to maximize their capital and labor, in doing so they contribute toward maximizing the optimal output of society.   These principles led to the classical theory of supply and demand, where an uncontrolled free market will balance itself more quickly and effectively than a government system of centralized planning and control.

Capitalism thrived in an American setting, enabling the transition of continental wilderness into a growing and modern economy.  This spurred previously unimaginable advances in transportation, communications, agriculture, medicine, technology and much more.  The standard of living in America quickly became the highest in the world. There were certainly poor working conditions and worker abuse.  But America’s unplanned free market economy was the source of great wealth without precedent.


Socialism refers to both the economic systems and the type of government of authoritarian societies, because they are so intertwined.  

The original principles underlying Socialism were espoused by French philosopher Jean-Jacques Rousseau (1712-1778) and later by German philosophers Karl Marx (1818-1883) and Friedrich Engels (1820-1895).  Jean-Jacques Rousseau’s major works were his books “Discourse on the Origin of Inequality” and “The Social Contract.” 

  1. People should sacrifice their “individual will” in order to realize greater gains for society as expressed in the “general will.”
  2. The fruits of the earth belong to us all. 

The first community known for adopting socialistic principles was New Harmony, Indiana, founded in 1825 by Robert Owen (1771-1858), a wealthy Scottish social reformer.  In February of 1826, his town adopted a new constitution entitled “The New Harmony Community of Equality”.  The goal was to achieve happiness based on equal rights and equality of duties. The followers of Robert Owen coined the term Socialism.  But because of constant quarrels, the community was divided into smaller communities, and in 1828 Socialism was replaced by more Individualist principles. 

Karl Marx is considered the father of Socialism, but his ultimate goal was Communism.   In 1848, Marx and fellow German Friedrich Engels published “The Communist Manifesto,” which introduced the principles that led to Marxism.  Marxism is a social, political, and economic theory, which focuses on the struggle between capitalists and the working class.  Marx wrote that power relationships between capitalists and workers were inherently exploitative and would inevitably lead to class conflict.

Marx suggested that all societies naturally evolve through a series of stages from Primitive Communism, to Slavery, to Feudalism, to Capitalism, to Socialism and eventually to Communism. He believed that communism engenders utopian society where class and government fade away.  In a Marxist utopia, everyone would happily share property and wealth, free from the conflicts that class-based systems bring.  But in order to achieve this stage, society had to experience a revolution. 

  • Stage 1: A revolution must occur in order to overthrow the existing government.  Marx emphasized the nee­d for total destruction of the existing system in order to move on to Stage 2.
  • Stage 2: A dictator or elite leader (or leaders) must gain absolute control over the proletariat. During this phase, the new government controls the common citizen’s personal choices — including his or her education, religion, employment and even marriage.   Collectivization of property and wealth must also take place.
  • Stage 3: Achievement of utopia. This phase has never been attained because it requires that all non-communists be destroyed in order to achieve perfect equality.

In the last third of the 19th century, social democratic parties arose in Europe, based on ideas from Marxism.     The philosophy of Karl Marx influenced the following socialist movements:

  • Social-Democrat Worker’s Party in Russia (1898)
  • Adolph Hitler’s National Socialist Workers Party of Germany (1920)
  • Joseph Stalin’s Union of Soviet Socialist Republics (1922)
  • Mao Zedong’s Socialist Education Movement and Communist Party of China (1943)

The major flaw of Socialism is that it places too much power in the hands of a few and lacks the checks and balances to control and limit that power.  It is sold as a fairer, more equal, and more efficient, classless utopia.  But power corrupts and utopia quickly turns into dystopia, which is nearly impossible to reverse.  Instead of a fairer classless society it inevitably becomes a two-tier system with the ruling class and supporters living in luxury and common people struggling to survive.  Instead of encouraging individuals to achieve their God-given potential and make an independent living, it subsumes all to accomplish central planning objectives.  The result is an inefficient economy that does not grow and creates to a lower standard of living for all. 

The attraction of a utopian society is overwhelming, and followers feel they can achieve it, avoiding the failures of the past.  And some aspire to joining the ruling class.

The Road to Serfdom was written between 1940 and 1943 by Austrian-British economist and philosopher Friedrich Hayek.  In it he warns of the risks of Socialism and Communism and describes what he calls “The Middle Way.”   The middle way is an incremental step away from Capitalism and toward Socialism, hoping to find that ideal balance.  But these incremental steps don’t accomplish their objectives and more incremental steps lead closer and closer to Socialism.  This is the theory behind “New Democratic Socialism” and other, similar movements.  

Since the end of World War II, many countries experimented with Socialism.   Some of these such as Argentina, Cuba, and Venezuela had been successful and prosperous societies, then experienced significant deterioration. Others that implemented milder hybrid forms of Socialism such as France, England, and Canada are still prosperous, but arguably not as prosperous as they could be.  Countries such as Cambodia, North Korea, Vietnam, and Ethiopia are still experiencing substandard living conditions. 

The flaws in the philosophy of Socialism and Communism:

  • Socialism has never succeeded
  • Socialism denies some essential traits of human nature
  • Socialism pays lip service to the will of the people, but requires a dictator to implement
  • Socialism inevitability becomes totalitarian, a pseudo-scientific tyranny


Earlier in this paper, we provided a diagram showing the various elements of government.  Each of these have a number of components that identify where a country is on a spectrum from Collectivism on the left to Individualism on the right.  Where is America today?

Form of Government – America was founded as a “Representative Republic” but as a result of our two-party system, lifelong politicians have gained firm control over the levers of power.  The people of America are losing their voice and power, and America has become closer to an “Oligarchy.”   The majority of the policies currently being implemented by these politicians are based on socialistic principles, are unconstitutional, and are not in the best interest of the people or the health of America.

Liberty and Human Rights –  The U.S. Constitution supports individual liberty and autonomy.  In the late 1940s the United Nations began promoting socialistic principles espoused by global progressives.  This gave legitimacy to an American movement toward collectivism and equality, and away from the U.S. Constitution and its values and principles.         

Justice System – America’s Justice system was built upon British Common Law to support individual liberty and autonomy.  In America today, there is more emphasis on Social Justice than Justice.  As a result, our Justice System has become overly complex and is dangerously less effective.  

Economic Philosophy – America’s effort to satisfy Social Justice objectives has required heavy government taxes, ownership, control and regulation into our economic system.  As a result, we have evolved away from a pure free market, into crony capitalism, and an extensive welfare system. Because of the governments heavy influence in segments of our economy we are now a hybrid Capitalism/Socialism combination.

Schools of Economic Thought – Classical vs. Keynesian

No discussion about economic systems would be complete without at least mentioning the two economic schools of thought.

Classical economics flourished, primarily in Britain, in the late 18th and early-to-mid 19th century. Its main thinkers were Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Robert Malthus, and John Stuart Mill.  This school of thought held that government influence in the economy should be resisted.  They promote a “laissez-faire” approach which allows the free-market economy to manage itself.

Keynesian economics was named after the British economist John Maynard Keynes during the great depression in the 1930s.   This school of thought posited that consumer demand is the primary driving force in an economy and supports expansionary fiscal policy.  Its main tools are government spending on infrastructure, unemployment benefits, and education.  In America, this belief has been used to justify excessive borrow and spend policies, while ignoring the long-term risks as well as the short-term corruption and disincentives to work.

American Evaluation Metrics

America’s economic system has been evolving in a different direction than the intent of the U.S. Constitution.  This evolution has been driven by the assumptions, theories, principles and goals of the Global Left and socialism.  But would we have been a healthier country that did a better job of supporting our people if we had not strayed from Capitalism?  To answer this question, we would have to define a set of metrics to evaluate our economy against.  Then we should compare the principles of capitalism and socialism and make smarter policy decisions.  Below is a list of economic principles we could consider.  

  • The growth of the economy and the wealth of the country
  • The ability to provide jobs for the people
  • The wealth disparity and distribution
  • Ability to accumulate wealth
  • The standard of living for the people
  • The stress of the people
  • Fairness
  • Equality
  • Amount of corruption
  • Happiness and a sense of accomplishment
  • Innovation


The problems associated with the American economy are constantly on the minds of Americans.  But what are these problems and are they real or imagined?  Are they the result of too much greed and autonomy, or too much government ineffectiveness and corruption?  The solution people favor depends on what they think the cause is.   If you think the cause is too much corporate greed, you will support more Socialism and government control.  If you think the cause is too much government corruption, you will support more free market Capitalism.  Either way, the problems associated with the current situation are because America has been involved in a constant tug-of-war, being pulled in one direction then the other.  America needs a better way of analyzing challenges and setting policy.

Learning Circle Discussion

Problem Statement – After World War II, America began adopting and implementing principles associated with Collectivism and Socialism.   This resulted in an extensive increase in the size and scope of American government.   In spite of this growth, the problems this bigger government was designed to resolve still exist and in many cases have gotten worse.  For example, policies were enacted to win the war on poverty, but poverty still exists.  Under America’s two-party political system, policy decisions are not based on effective problem-solving techniques, but ideological differences. 

So, what is America today and what do we want America to be?   Would America be better off if it was more like China, Russia, Venezuela, or Cuba?   Would America’s problems be resolved under economic systems like England, Germany, France, Canada or Norway?   Or should America build upon the experience and strengths of the U.S. Constitution, setting its own course and leading the world in a better direction?

Questions to Consider

  • How would you describe America’s current economic system?  Is this system the optimal system for the American people and the health of America? 
  • What are the theories, principles, and goals underlying America’s economic system and how should they be modified or enhanced?
  • What should be the role of the American government in controlling or influencing the American economy? 
  • What steps should the American government take to create a fairer and more equal society?
  • What should be America’s approach to deficit spending, borrowing and taxing?
  • How should America achieve objectives like modernizing infrastructure?
  • What should be America’s policy for taxing business and people?
  • How serious are concerns about corporate greed?  About government corruption?  How can these concerns be mitigated?
  • What are the metrics that should be used to evaluating the effectiveness of the American economy?
  • What should be the relationship between the federal government and state governments concerning the economy?
  • What are the sectors of the economy that definitely should be controlled by the government? That definitely should not be controlled by the government?