Types of Economies

Every society has to answer three questions

• What goods and services should be produced in the country?
• How should the goods and services be produced? Should producers use more human labour or more capital (machines) for producing things?
• How should goods and services be distributed among people?

One answer to these questions is to depend on the market forces of supply and demand. In a market economy, also called capitalism, only those consumer goods will be produced that are in demand, i.e., goods that can be sold profitably either in the domestic or in foreign markets. If cars are in demand, cars will be produced and if bicycles are in demand, bicycles will be produced. If labor is cheaper than capital, more labor-intensive methods of production will be used and vice-versa. In a capitalist society, the goods produced are distributed among people not on the basis of what people need but on the basis of Purchasing Power—the ability to buy goods and services. That is, one has to have the money in one's pocket to buy it. Low-cost housing for the poor is much needed but will not count as demand in the market sense because the poor do not have the purchasing power to back the demand. As a result, this commodity will not be produced and supplied as per market forces. Such a society did not appeal to Jawaharlal Nehru, our first prime minister, for it meant that the great majority of people of the country would be left behind without the chance to improve their quality of life.

A socialist society answers the three questions in a totally different manner. In a socialist society, the government decides what goods are to be produced in accordance with the needs of society. It is assumed that the government knows what is good for the people of the country and so the desires of individual consumers are not given much importance. The government decides how goods are to be produced and how they should be distributed. In principle, distribution under socialism is supposed to be based on what people need and not on what they can afford to purchase. Unlike capitalism, for example, a socialist nation provides free health care to all its citizens. Strictly, a socialist society has no private property since everything is owned by the state. In Cuba and China, for example, most of the economic activities are governed by socialistic principles.

The United States of America and the United Kingdom are examples of capitalist economies.  They are also examples of developed economies. The erstwhile Soviet Union Cuba and China are both socialist economies.  But while the Soviet Union is developed, China like India is still a developing economy.

Most economies (including ours) are mixed economies, i.e. the government and the market together answer the three questions of what to produce, how to produce, and how to distribute what is produced. In a mixed economy, the market will provide whatever goods and services it can produce well, and the government will provide essential goods and services that the market fails to do.

Another important distinction that is often made is between developed and developing economies.

Developed, Less Developed, and Developing Economies

Countries of the West, which had long been industrialized, and Japan, Korea, and other newly industrialized countries of Asia are developed economies. They are relatively rich countries that have the usual characteristics of a modern industrial society.  The poorer countries have relatively small industrial sectors.  They also have very little access to modern technology whether in industry or agriculture.  The poorest countries are generally described as least developed countries (LDCs). Some of them, however, should be called developing economies because though they have only a small modern industrial sector, they are going through a distinct process of industrialization. In a developing economy the modern industrial sector, though small, keeps increasing in size and the traditional agricultural or rural sector keeps shrinking.

Against them, High-Income economies which comprise only 15 percent of the world population account for 78 percent of world GNP. The situation has worsened during the period 1979-2000 since, in 2000, 14.9 percent of the population of the height income (industrial market) economies accounted for 80 percent of the world GNP. In other words, the bulk of the poor people resides in low-income and middle-income developing countries.

World Bank classifies all its member countries (188 of them) and all economies with a population of 30,000 or more (another 24; altogether 209) by various classifications. One of the most commonly referred to classifications is by Per Capita income.

World Bank Classification

Each year on July 1, The World Bank revises the classification of the world’s economies based on estimates of gross national income (GNI) per capita for the previous year. The updated GNI per capita estimates are also used as input to the Bank’s operational classification of economies, which determines their loan eligibility, e.g. Low-Income countries are eligible for concessional IDA loans.

The classification of countries is determined by two factors:

• A country’s GNI per capita, can change with economic growth, inflation, exchange rates, and population. Revisions to national accounts methods and data can also influence GNI per capita.
• Classification threshold: The thresholds are adjusted for inflation annually using the SDR deflator.

Low and middle-income economies are sometimes referred to as developing economies. The term is used for convenience; it is not intended to imply that all economies in the group are experiencing similar development or that other economies have reached a preferred or final stage of development.

Sectoral Classification of Economy

The sectoral classification of the economy is seen as a continuum of distance from the natural environment. The continuum starts with the primary sector. 

Primary Sector

There are many activities that are undertaken by directly using natural resources and the output is natural too. Production of crops using soil rain etc. Similarly, minerals and ores are also natural products. When we produce a good by exploiting natural resources, it is an activity of the primary sector

Secondary Sector

The secondary sector covers activities in which natural products are changed into other forms through manufacturing that we associate with industrial activity. It is the next step after primary

Tertiary Sector

Third category of activities that falls under tertiary sector, help in the development of the primary and secondary sectors. These activities, by themselves, do not produce a good but they are an aid or a support for the production process. For example, goods that are produced in the primary or secondary sector need transportation service to be sold in shops. Some essential services may not directly help in the production of goods.

Quaternary Sector

This sector is an extension of three sector hypothesis. It comprises intellectual services e.g. informing generation, information sharing, consultation. Some expert argue that intellectual services are distinct enough to warrants a separate sector

Quinary Sector

This sector is also known as golden collar sector consists of highest level of decision makers in any sector or department be it government, businesses and media. Sometimes it considered to comprise of health, education, police, fire services and other govt industries not intended to make a profit etc.

Division of sectors as organised and unorganised

Organised sector covers those enterprises or places of work where the terms of employment are regular and therefore, people have assured work. They are expected to work only a fixed number of hours. They are registered by the government and have to follow its rules and regulations which are given in various laws such as the Factories Act, Minimum Wages Act, Payment of Gratuity Act, Shops and Establishments Act etc. It is calledorganised because it has some formal processes and procedures

Unorganized sector is characterized by small and scattered units which are largely outside the control of the government. There are rules and regulations but these are not followed. Jobs here are low-paid and often not regular. There is no provision --overtime, paid leave, holidays, leave due to sickness etc. Employment is not secure. People can be asked to leave without any reason.

Other Ways of Classifying Indian Economy

Indian economy can be understood in terms of a number of dichotomies. These dichotomies are the result of nature of Indian economy, geographical factors, historical developments, Government policy.

• One-way is suggested by the definition of the mixed economy itself. The division into the Public and the Private Sectors based on ownership of the enterprise.
• Again, it is sometimes useful to describe a developing economy by dividing it into two broad sectors according to habitation in towns and villages, viz. the Urban and Rural Sectors. The Tertiary Sector produces not goods but services.  Trade, communication, administration, transport, banking and other services belong to this sector.

Apart from the divisions into sectors along the lines of ownership of the enterprise, the type of the activity and urban-rural habitation, and federal structure of the Indian economy indicates the importance of its division in another way: division into regions or the states. 

Role of Government in Economy

The various economic problems of recent years have stimulated serious debate about the proper role of government in economic planning.  Parties on the political left in Europe have advocated more controls and more planning (i.e. socialist pattern). In the 1980s a different solution was offered by the Conservative Party government of Prime Minister Margaret Thatcher in Great Britain and by the Republican administration of President Ronald Reagan in the U.S.  In both countries, attempts were made to diminish taxation and government regulation on private enterprise and thus, by enlarging the potential profits of central elements of supply-side economics, the guiding doctrine of the two leaders (i.e. capitalist pattern).

It can be said that the role of government in any economy depends on the nature of the state.

In a capitalist state the government plays a minimalist role or the role of a facilitator i.e. it allows the free market forces of demand and supply to allocate all resources in the economy. In such an economy the access to resources is governed by one’s purchasing power and the government can do little to change it.

In contrast to this, in a socialist state the government is the owner as well as manager of almost all forces of production and the allocation of resources is governed by the principles of Justice and Equity irrespective of one’s purchasing power. It plays the role of a regulator. The government resorts to tools like progressive taxation (rate of taxation rises with absolute income) to equitably distribute the rewards of growth in the economy.

Such role by government is seen as Interference in the free market forces and is often seen as counter-productive for the economy at large as there is no incentive or disincentive to be efficient and productive.

But today the governments across the world adopt a rational synthesis of the two approaches. While they refrain from any direct interference in the free market forces of demand and supply, they do adopt the policy of what has been termed as the Welfare State i.e. ensuring that every individual gets a minimum standard of goods and services so as to enjoy a minimum standard of living. For this they resort to certain degree of taxation that is seen as just by society as it gets returned as basic services and utilities for all.