Mixed Economic System

Lecture 7
What is a Mixed Economic System?
• A mixed economic system is a system that combines aspects of both 
capitalismand socialism.
• A mixed economic system protects private property and allows a level of
economic freedom in the use of capital, but also allows for governments
to interfere in economic activities in order to achieve social aims.
• According to neoclassical theory, mixed economies are less efficient
than pure free markets, but proponents of government interventions
argue that the base conditions required for efficiency in free markets,
such as equal information and rational market participants, cannot be
achieved in practical application.
Resource Ownership
• In a command economy, all resources are owned and controlled by
the state.
• In a mixed system, private individuals are allowed to own and control
some (if not most) of the factors of production.
• Free market economies allow private individuals to own and trade,
voluntarily, all economic resources.
State Intervention
• Government intervention and political self-interest play a key role in a
mixed economy.
• This intervention can take many forms, including subsidies, tariffs,
prohibitions, and redistributive policy. 
• Some of the most universally applied mixed economic policies include
legal tender laws, monetary control by a central bank, public road and
infrastructure projects, tariffs on foreign productsin international
trade, and entitlement programs.
Changing Economic Policy
• One important and understated feature of a mixed economy is its
tendency for reactionary and purposeful economic policy changes.
• Unlike in a command economy (where economic policy is very often
directly controlled by the state) or a market economy (market
standards arise only out of spontaneous order), mixed economies can
go through dramatic changes in the "rules of the game," so to speak.
• This is because of the changing political pressures in most mixed
economies. An example of this can be seen in the aftermath of the 
Great Recession when most governments moved to regulate financial
markets tightly, and central banks lowered interest rates.
What Is the Difference Between a Mixed
Economy and Free Markets?
• Mixed economic systems are not laissez-faire systems, because the government is involved in
planning the use of some resources and can exert control over businesses in the private sector.
Governments may seek to redistribute wealth by taxing the private sector, and using funds from
taxes to promote social objectives. Trade protection, subsidies, targeted tax credits, fiscal stimulus,
and public-private partnerships are common examples of government intervention in mixed
economies. These unavoidably generate economic distortions, but are instruments to achieve
specific goals that may succeed despite their distortionary effect.
• Countries often interfere in markets to promote target industries by creating agglomerations and
reducing barriers to entry in an attempt to achieve comparative advantage. This was common
among East Asian countries in the 20th century development strategy known as 
Export Led Growth, and the region has turned into a global manufacturing center for a variety of
industries. Some nations have come to specialize in textiles, while others are known for
machinery, and others are hubs for electronic components. These sectors rose to prominence
after governments protected young companies as they achieved competitive scale and promoted
adjacent services such as shipping.
What Is the Difference Between a Mixed
Economy and Socialism?
• Socialism entails common or centralized ownership of the means of production. Proponents
of socialism believe that central planning can achieve greater good for a larger number of
people. They do not trust that free market outcomes will achieve the efficiency and
optimization posited by classical economists, so socialists advocate nationalization of all
industry and the expropriation of privately owned capital goods, lands, and natural resources.
Mixed economies rarely go to this extreme, instead identifying only select instances in which
intervention could achieve outcomes unlikely to be achieved in free markets.
• Such measures can include price controls, income redistribution, and intense regulation of
production and trade. Virtually universally this also includes the socialization of specific
industries, known as public goods, that are considered essential and that economists believe
the free market might not supply adequately, such as public utilities, military and police
forces, and environmental protection. Unlike pure socialism however, mixed economies
usually otherwise maintain private ownership and control of the means of production.
History and Criticism of the Mixed Economy (1)
• The term mixed economy gained prominence in the United Kingdom after World War
II, even though many of the policies associated with it at the time were first proposed
in the 1930s. Many of the supporters were associated with the British Labour Party.
• Critics argued that there could be no middle ground between economic planning and a
market economy, and many — even today — question its validity when they believe it
to be a combination of socialism and capitalism. Those who believe the two concepts
don’t belong together say either market logic or economic planning must be prevalent
in an economy.
• Classical and Marxist theorists say that either the law of value or the accumulation of
capital is what drives the economy, or that non-monetary forms of valuation (i.e. 
transactions without cash) are what ultimately propel the economy. These theorists
believe that Western economies are still primarily based on capitalism because of the
continued cycle of accumulation of capital.
History and Criticism of the Mixed Economy (2)
• Austrian economists starting with Ludwig von Mises have argued that a mixed economy is not
sustainable because the unintended consequences of government intervention into the
economy, such as the shortages that routinely result from price controls, will consistently lead to
further calls for ever increasing intervention to offset their effects. This suggests that the mixed
economy is inherently unstable and will always tend toward a more socialistic state over time.
• Beginning in the mid 20th century, economists of the Public Choice school have described how
the interaction of government policy makers, economic interest groups, and markets can guide
policy in a mixed economy away from the public interest. Economic policy in the mixed economy
unavoidably diverts the flow of economic activity, trade, and income away from some
individuals, firms, industries, and regions and toward others. Not only can this create harmful
distortions in the economy by itself, but it always creates winners and losers. This sets up
powerful incentives for interested parties to take some resources away from productive activities
to use instead for the purpose of lobbying or otherwise seeking to influence economic policy in
their own favor. This non-productive activity is known as rent-seeking.
Advantages of a Mixed Economic System (1)
• Allows capitalism and socialism to coexist: A mixed economic system
allows capitalism and socialism to coexist and function by segregating
the roles of the government and the private sector.
• Capitalism sets prices through an equilibrium between supply and
demand on private goods, while socialism sets prices through
planning where the private sector fails or does not want to produce
certain goods, such as public transportation, universal health care,
and education.
• The government plays a crucial role in promulgating and enforcing
laws and ensuring fair competition and business practices.
Advantages of a Mixed Economic System (2)
• Allows government to internalize positive and negative
externalities: The production of certain goods and use of resources by
the private sector can come at a cost of their underproduction or
overuse.
• For example, paper mills and mining companies are known for using too
much water or polluting it during the production process, generating a
negative externality for the general population who drinks this water.
• A mixed economic system ensures the government can step in and
correct for the negative effect of the externality by either prohibiting
harmful activity or heavily taxing it.
Advantages of a Mixed Economic System (3)
• Allows for correction of income inequality: Capitalism is known for
generating income inequality through a concentration of capital.
• A mixed economic system can correct such a phenomenon by taxing
and redistributing wealth to the households located at the bottom of
the income distribution.
Disadvantages of a Mixed Economic System (1)
• Spontaneous order and the price system: The concept of spontaneous 
market order grew out of Adam Smith's insight about the "invisible hand." This
theory argues market information is imperfect and costly, and the future is
uncertain and unpredictable. Since information is imperfect, some system of
information coordination is necessary to facilitate trade and voluntary
cooperation. For Ludwig von Mises and F.A. Hayek, by far the most successful
information signals are market prices. Their term for this process is "catallaxy,"
which Hayek defines as "the order brought about by the mutual adjustment of
many individual economies in a market."
• Whenever government interferes in market prices, catallaxy is distorted,
causing misallocations of resources and deadweight losses. Despite their best
intentions, mixed economies are a burden on the price mechanism.
Disadvantages of a Mixed Economic System (2)
• Government market failure: Public choice theory applies the principles of
economic analysis to the government. The chief proponents of public choice
theory argue governments necessarily create more market failures than they
prevent and mixed economies rationally produce inefficient outcomes. American
economist James Buchanan showed special interest groups rationally dominate
in democratic societies because government activities tend to offer benefits
directly to a concentrated, organized group at the expense of a poorly informed,
disorganized tax base.
• Milton Friedman showed that government-caused market failures tended to lead
to increasing failures. For example, poor public schools create low-productivity
workers, who are then priced out of the market by minimum wage laws (or other
artificial workplace expenses) and must then turn to welfare or crime to survive.
Disadvantages of a Mixed Economic System (3)
• Regime uncertainty: Economic historian Robert Higgs noted that
mixed economies tend to have continuously changing regulations, or
rules of trade. This is especially true in Western democracies with
opposing political parties.