Traditional Economy With Its Characteristics, Pros, Cons, and Examples

The Five Traits of a Traditional Economy

© The Balance 2018

BY KIMBERLY AMADEO 
Updated May 03, 2019
A traditional economy is a system that relies on customs, history, and time-honored beliefs. Tradition guides economic
decisions such as production and distribution. Traditional economies depend on agriculture, fishing, hunting, gathering, or
some combination of the above. They use barter instead of money. 
Most traditional economies operate in emerging markets and developing countries. They are often in Africa, Asia, Latin
America, and the Middle East. But you can find pockets of
traditional economies scattered throughout the world.
Economists and anthropologists believe all other
economies got their start as traditional economies. Thus,
they expect remaining traditional economies to evolve
into market, command, or mixed economies over time.

Five Characteristics of a Traditional Economy

 © The Balance, 2018

First, traditional economies center around a family or tribe.

They use traditions gained from the elders' experiences to
guide day-to-day life and economic decisions.

Second, a traditional economy exists in a hunter-gatherer

and nomadic society. These societies cover vast areas to
find enough food to support them. They follow the herds of animals that sustain them, migrating with the seasons. These
nomadic hunter-gatherers compete with other groups for scarce natural resources. There is little need for trade since they
all consume and produce the same things. 

Third, most traditional economies produce only what they need. There is rarely surplus or leftovers. That makes it
unnecessary to trade or create money.

Fourth, when traditional economies do trade, they rely on barter. It can only occur between groups that don't compete. For
example, a tribe that relies on hunting exchanges food with a group that relies on fishing. Because they just trade meat for
fish, there is no need for cumbersome currency.

Fifth, traditional economies start to evolve once they start farming and settle down. They are more likely to have a
surplus, such as a bumper crop, that they use for trade. When that happens, the groups create some form of money.
That facilitates trading over long distances. 

Traditional Mixed Economies

When traditional economies interact with market or command economies, things change. Cash takes on a more important
role. It enables those in the traditional economy to buy better equipment. That makes their farming, hunting, or fishing
more profitable. When that happens, they become a traditional mixed economy. 
Traditional economies can have elements of capitalism, socialism, and communism. It depends on how they are set
up. Agricultural societies that allow private ownership of farmland incorporate capitalism. Nomadic communities
practice socialism if they distribute production to whoever best earned it. In socialism, that's called "to each according to
his contribution."

That would be the case if the best hunter, or the chief, received the choicest cut of meat or the best grains. If they
feed children and the elderly first, they're adopting communism.
There are several pros and cons of a traditional economy, as discussed below.
Advantages
 Little or no friction between members
 Everyone understands their role and contribution
 More sustainable than a technology-based economy
Disadvantages
 Exposed to changes in nature and weather patterns
 Vulnerable to market or command economies that use up their natural resources

Advantages
There is little friction between members. Custom and tradition dictate the distribution of resources. Everyone knows their
contribution toward production, whether it's as a farmer, hunter, or weaver. Members also understand what they are likely
to receive. Even if they aren't satisfied, they don't rebel. They understand that it's what has kept the society together and
functioning for generations.

Since traditional economies are small, they aren't as destructive to the environment as developed economies. They don't
have the capability to produce much beyond their needs. That makes them more sustainable than a technology-based
economy.

Disadvantages
Traditional economies are exposed to changes in nature, especially the weather. For this reason, traditional economies
limit population growth. When the harvest or hunting is poor, people starve.
They are also vulnerable to market or command economies. Those societies often consume the natural resources
traditional economies depend on or they wage war. For example, Russian oil development in Siberia has damaged streams
and the tundra. That has reduced traditional fishing and reindeer herding for traditional economies in those areas. 

Examples
America had traditional economies before the immigration of Europeans beginning in 1492. Nomadic Native
American economies had advantages, like stronger immune systems. Their small communities protected them from
smallpox and other imported diseases for a while. But poaching, war, and genocide destroyed them over time. The market
economy gave newcomers weapons and more resources. The traditional economies couldn't compete.
The United States had many aspects of a traditional economy before the Great Depression. At the beginning of the 20th
century, more than half of Americans lived in farming communities. Agriculture employed at least 40% of the workforce.
But they used poor farming techniques to meet high demand following World War I. That led to the Dust Bowl once 10
years of droughts hit. 

By 1930, only 21% of the workforce was in agriculture. It generated just 7.7% of the gross domestic product.
Before the Civil War, the American South was almost entirely a traditional economy. It relied on farming. It used a strong
network of traditions and culture to guide it. These were devastated by the war. 
Two-thirds of Haiti's population relies on subsistence farming for their livelihood. Their reliance on wood as a primary
source of fuel has stripped the forests of trees. That makes them vulnerable to natural disasters, such as the earthquake that
struck Haiti in 2010. Some economists also point to Haiti's tradition of voodoo as another reason for its poverty.
Indigenous tribes in the Arctic, North America, and eastern Russia have traditional economies. They rely on fishing and
hunting of caribou for their existence. For example, the Sami people of Scandinavia manage reindeer herds. A tribe
member's relationship to managing the herd defines his or her economic role. That includes his or her legal status, culture,
and state policies toward the individual. 

The Bottom Line

Most economic structures today are sophisticated descendents of the traditional economy. This economic structure is
governed by culture and characterized by heavy reliance on farming, hunting, and fishing. Today, traditional economies
still exist in some developing countries and among indigenous tribes. Several traditional economies have evolved into a
mixed type that incorporate elements from capitalism, socialism, or communism. 

Command Economy, Its Characteristics, Pros, and Cons

 Five Traits of a Command Economy
© The Balance 2018

BY KIMBERLY AMADEO 
Updated May 30, 2019

A command economy is where a central

government makes all economic decisions.
Either the government or a collective owns the
land and the means of production. It doesn't
rely on the laws of supply and demand that
operate in a market economy. A command
economy also ignores the customs that guide
a traditional economy. In recent years, many
centrally-planned economies began adding
aspects of the market economy. The
resultant mixed economy better achieves their
goals.

Five Characteristics of a Command Economy

You can identify a modern centrally planned economy by the following five characteristics:

1. The government creates a central economic plan. The five-year plan sets economic and societal goals for every
sector and region of the country. Shorter-term plans convert the goals into actionable objectives. 
2. The government allocates all resources according to the central plan. It tries to use the nation's capital, labor,
and natural resources in the most efficient way possible. It promises to use each person's skills and abilities to
their highest capacity. It seeks to eliminate unemployment.
3. The central plan sets the priorities for the production of all goods and services. That includes quotas and price
controls. Its goal is to supply enough food, housing, and other basics to meet the needs of everyone in the country.
It also sets national priorities. These include mobilizing for war or generating robust economic growth.
1. The government owns monopoly businesses. These are in industries deemed essential to the goals of the
economy. That includes finance, utilities, and automotive. There is no domestic competition in these sectors.
2. The government creates laws, regulations, and directives to enforce the central plan. Businesses follow the plan's
production and hiring targets. They can't respond on their own to free market forces. (Source: Bon Kristoffer G.
Gabnay, Roberto M Remotin, Jr., Edgar Allan M. Uy, editors. Economics: Its Concepts & Principles. 2007. Rex
Book Store: Manila.)

A command economy has a few advantages, although they come with a few important disadvantages as well.

Advantages

 Can manipulate large amounts of resources for large projects without lawsuits or environmental regulatory issues.
 An entire society can be transformed to conform to the government's vision, from nationalizing companies to
placing workers in new jobs after a governmental skill assessment.

Disadvantages

 Rapid change can completely ignore society's needs, forcing the development of a black market and other coping
strategies.
 Goods production is not always matched to demand, and poor planning often leads to rationing.
 Innovation is discouraged and leaders are rewarded for following orders rather than taking risks.
Advantages
Planned economies can quickly mobilize economic resources on a large scale. They can execute massive projects, create
industrial power, and meet social goals. They aren't slowed down by lawsuits from individuals or environmental impact
statements. 

Command economies can wholly transform societies to conform to the government's vision. The new administration
nationalizes private companies. Its previous owners attend "re-education" classes. Workers receive new jobs based on the
government's assessment of their skills. 

Disadvantages
This rapid mobilization often means command economies mow down other societal needs. For example, the government
tells workers what jobs they must fulfill. It discourages them from moving. The goods it produces aren’t always based on
consumer demand. But citizens find a way to fulfill their needs. They often develop a shadow economy or black market. It
buys and sells the things the command economy isn't producing. Leaders' attempts to control this market weakens support
for them.

They often produce too much of one thing and not enough of another. It's difficult for the central planners to get up-to-
date information about consumers' needs. Also, prices are set by the central plan. They no longer measure or control
demand. Instead, rationing often becomes necessary.

Command economies discourage innovation. They reward business leaders for following directives. This doesn’t allow
for taking the risks required to create new solutions. Command economies struggle to produce the right exports at global
market prices. It's challenging for central planners to meet the needs of the domestic market. Meeting the needs
of international markets is even more complex.

Examples
Here are examples of the most well-known countries with command economies:

 Belarus: This former Soviet satellite is still a command economy.The government owns 80% of the country's
businesses and 75% of its banks. 
 China: After World War II, Mao Tse Tung created a society ruled by Communism. He enforced a strictly planned
economy. The current leaders are moving toward a market-based system. They continue to create five-year plans
to outline economic goals and objectives.
 Cuba: Fidel Castro's 1959 revolution installed Communism and a planned economy. The Soviet Union subsidized
Cuba’s economy until 1990. The government is slowly incorporating market reforms to spur growth.
 Iran: The government controls 60% of the economy through state-owned businesses. It uses price controls
and subsidies to regulate the market. This created recessions, which it has ignored. Instead, it devoted resources to
expanding its nuclear capability. The United Nations imposed sanctions, worsening its recessions. The economy
improved once the nuclear trade deal ended sanctions in 2015. 
 Libya: In 1969, Muammar Gaddafi created a command economy reliant upon oil revenues. Most Libyans work
for the government. Gaddafi had been instituting reforms to create a market-based economy. But his 2011
assassination halted these plans.
 North Korea: After World War II, President Kim Il-sung created the world's most centrally-planned economy. It
created food shortages, malnutrition, and several bouts of mass starvation. Most state resources go into building
up the military. 
 Russia: In 1917, Vladimir Lenin created the first Communist command economy. The Russian people were ready
for a radical change, having suffered starvation during World War I. Joseph Stalin built up military might and
quickly rebuilt the economy after World War II. The Soviet State Planning Committee, or “Gosplan,” has been
the most-studied command economy entity. The USSR was also the longest-running command economy, lasting
from the 1930s until the late 1980s. Then, the state transferred ownership of the largest companies to oligarchs. 

In 2018, command economies like China, Russia, and Iran have shifted toward more economic freedom, while North
Korea and Cuba still remain economically repressed.

Below you can see a world ranking countries by level of economic freedom, from the most free to the most repressed.
Development of the Theory 

Viennese economist Otto Neurath developed the concept of a command economy after World War I. Neurath proposed it
as a way to control hyperinflation. The phrase “command economy” comes from the German word "Befehlswirtschaft.” It
described the fascist Nazi economy. (Source: John Eatwell, Murray Milgate, Peter Newman, "Problems of the Planned
Economy," 1990. p 58.)

But centrally planned economies existed long before Nazi Germany. They included the Incan empire in 16th century Peru
and the Mormons in 19th century Utah. The United States used a command economy to mobilize for World War
II.  (Source: John Gary Maxwell, "The Civil War Years in Utah." University of Oklahoma Press. 2016. "Inca Government
and Economy." Early Civilizations in the Americas Reference Library, edited by Sonia G. Benson, et al., vol. 1: Almanac,
Vol. 1, UXL, 2005, pp. 179-198. World History in Context.) 

The Bottom Line

A command economy does not allow market forces like supply and demand to determine what, how much, and at what
price they should produce goods and services. Instead, a central government plans, organizes, and controls all economic
activities, discouraging market competition. Its goal is to allocate resources to maximize social welfare. 
The main advantage is that the government can rapidly move resources and transform the structure of society to achieve a
national goal. But there is not much room for innovation. As a result, China, Russia, and Vietnam have veered away from
a pure command economy. They've combined elements from both command and free market economies.

Market Economy, Its Characteristics, Pros, and Cons, with Examples

 How the U.S. Constitution Protects America's Market Economy
Image by Joshua Seong © The Balance 2019

BY KIMBERLY AMADEO 
Updated May 20, 2019

A market economy is a system where the laws of supply and demand direct the production of goods and services. Supply
includes natural resources, capital, and labor. Demand includes purchases by consumers, businesses, and the government. 

Businesses sell their wares at the highest price consumers will pay. At the same time, shoppers look for the lowest prices for the goods
and services they want. Workers bid their services at the
highest possible wages that their skills allow. Employers
seek to get the best employees at the lowest possible price.
Capitalism requires a market economy to set prices and
distribute goods and
services. Socialism and communism need
a command economy to create a central plan that guides
economic decisions. Market economies evolve
from traditional economies. Most societies in the modern
world have elements of all three types of economies. That
makes them mixed economies.

Six Characteristics of a Market Economy

The following six characteristics define a market economy.

1. Private Property. Most goods and services are

privately-owned. The owners can make legally-
binding contracts to buy, sell, or lease their property. In other words, their assets give them the right to profit from ownership.
But U.S. law excludes some assets. Since 1865, you cannot legally buy and sell human beings. That includes you, your body,
and your body parts. 
2. Freedom of Choice. Owners are free to produce, sell, and purchase goods and services in a competitive market. They only
have two constraints. First is the price at which they are willing to buy or sell. Second is the amount of capital they have.
1. Motive of Self-Interest. Everyone sells their wares to the highest bidder while negotiating the lowest price for their
purchases. Although the reason is selfish, it benefits the economy over the long run. This auction system sets prices for goods
and services that reflect their market value. It gives an accurate picture of supply and demand at any given moment.
2. Competition. The force of competitive pressure keeps prices low. It also ensures that society provides goods and services
most efficiently. As soon as demand increases for a particular item, prices rise thanks to the law of demand. Competitors
see they can enhance their profit by producing it, adding to supply. That lowers prices to a level where only the best
competitors remain. This competitive pressure also applies to workers and consumers. Employees vie with each other for the
highest-paying jobs. Buyers compete for the best product at the lowest price. There are three strategies that work to maintain
a competitive advantage.
1. System of Markets and Prices. A market economy relies on an efficient market in which to sell goods and services. That's
where all buyers and sellers have equal access to the same information. Price changes are pure reflections of the laws of
supply and demand. There are five determinants of demand.
2. Limited Government. The role of government is to ensure that the markets are open and working. For example, it is in
charge of national defense to protect the markets. It also makes sure that everyone has equal access to the markets. The
government penalizes monopolies that restrict competition. It makes sure no one is manipulating the markets and that
everyone has equal access to information. 

Four Advantages of a Market Economy

Since a market economy allows the free interplay of supply and demand, it ensures that the most desired goods and services are
produced. Consumers are willing to pay the highest price for the things they want the most. Businesses will only create those things
that return a profit.
Second, goods and services are produced in the most efficient way possible. The most productive companies will earn more than less
productive ones.

Third, it rewards innovation. Creative new products will meet the needs of consumers in better ways that existing goods and services.
These cutting-edge technologies will spread to other competitors so they, too, can be more profitable. This illustrates why Silicon
Valley is America's innovative advantage.
Fourth, the most successful businesses invest in other top-notch companies. That gives them a leg up and leads to increased quality of
production. 

The Disadvantages of a Market Economy

The key mechanism of a market economy is competition. As a result, it has no system to care for those who are at an inherent
competitive disadvantage. That includes the elderly, children, and people with mental or physical disabilities.
Second, the caretakers of those people are also at a disadvantage. Their energies and skills go toward caretaking, not competing. Many
of these people might become contributors to the economy's overall comparative advantage if they weren't caretakers.

That leads to the third disadvantage. The human resources of the society may not be optimized. For example, a child who might
otherwise discover the cure for cancer might instead work at McDonald's to support her low-income family.
Fourth, the society reflects the values of the winners in the market economy. A market economy may produce private jets for some
while others starve and are homeless. A society based on a pure market economy must decide whether it's in its larger self-interest to
care for the vulnerable.

If it decides it is, the society will grant the government a significant role in redistributing resources. As such, there are so many mixed
economies. Most so-called market economies are mixed economies. 

How the Constitution Protects the U.S. Market Economy

The United States is the world's premier market economy. One reason for its success is the U.S. Constitution. It has provisions that
facilitate and protect the market economy's six characteristics. Here are the most important:

 Article I, Section 8 protects innovation as property by establishing a copyright clause.

 Article I, Sections 9 and 10 protects free enterprise and freedom of choice by prohibiting states from taxing each other’s
goods and services.
 Amendment IV protects private property and limits government powers by protecting people from unreasonable searches and
seizures.
 Amendment V protects the ownership of private property. Amendment XIV prohibits the state from taking away property
without due process of law.
 Amendments IX and X limit the government's power to interfere in any rights not expressly outlined in the Constitution.

The Preamble of the Constitution includes a goal to "promote the general welfare." The government could take a larger role than what
a market economy prescribes. This led to many social safety programs, such as Social Security, food stamps, and Medicare. 

The Bottom Line

A market economy functions under the laws of supply and demand. It is characterized by private ownership, freedom of choice, self-
interest, optimized buying and selling platforms, competition, and limited government intervention. Of these hallmarks, competition
mostly defines the market economy, and it’s a two-sided coin. On the plus side, it fosters innovation, efficiency, and quality in the
production of goods and services. Unfortunately, it marginalizes those that are unable to contend such as children, the elderly, the sick,
and those who care for them. Competition often creates income inequality. The U.S. constitution has laws that protect America’s
market economy.

Mixed Economy With Pros, Cons, and Examples

Illustration by Alison Czinkota © The Balance, 2018

BY KIMBERLY AMADEO 
Updated January 20, 2019

A mixed economy is a system that combines characteristics of market, command and traditional economies. It benefits from the
advantages of all three while suffering from few of the disadvantages.
A mixed economy has three of the following characteristics of a market economy. First, it protects private property. Second, it allows
the free market and the laws of supply and demand to determine prices. Third, it is driven by the motivation of the self-interest of
individuals.

A mixed economy has some characteristics of a command

economy in strategic areas. It allows the federal government to
safeguard its people and its market. The government has a large
role in the military, international trade and national
transportation.

The government’s role in other areas depends on the priorities

of the citizens. In some, the government creates a central plan
that guides the economy. Other mixed economies allow the
government to own key industries. These include aerospace,
energy production, and even banking. The government may
also manage health care, welfare, and retirement programs.
Most mixed economies retain characteristics of a traditional
economy, but those traditions don't guide how the economy
functions. The traditions are so ingrained that the people aren’t
even aware of them. For example, they still fund royal families.
Others invest in hunting and fishing.

 Advantages

A mixed economy has all the advantages of a market economy. First, it distributes goods and services to where they are most needed.
It allows prices to measure supply and demand.
Second, it rewards the most efficient producers with the highest profit. That means customers get the best value for their dollar. Third,
it encourages innovation to meet customer needs more creatively, cheaply or efficiently.
Fourth, it automatically allocates capital to the most innovative and efficient producers. They, in turn, can invest the capital in more
businesses like them.

A mixed economy also minimizes the disadvantages of a market economy. A market economy could neglect areas like defense,
technology, and aerospace. A larger governmental role allows fast mobilization to these priority areas.
The expanded government role also makes sure less competitive members receive care. That overcomes one of the disadvantages of a
pure market economy which only rewards those who are most competitive or innovative. Those who can't compete remain at risk.  

 Disadvantages

A mixed economy can also take on all the disadvantages of the other types of economies. It just depends on which characteristics the
mixed economy emphasizes.

For example, if the market has too much freedom, it can leave the less competitive members of society without any government
support.

However, central planning of government industries also creates problems. The defense industry could become a government-
subsidized monopoly or oligarchy system. That could put the country into debt, slowing down economic growth in the long run.

Successful businesses can lobby the government for more subsidies and tax breaks. The government could protect the free market so
much that it doesn’t regulate enough. For example, businesses that took on too much risk could receive taxpayer-funded bailouts. 

 Examples
The United States Constitution established a mixed economy. It protects ownership of private property. It also limits government
interference in business operations. That promotes the innovation that's a hallmark of a market economy.

At the same time, the Constitution encourages the government to promote general welfare. That creates the ability to use aspects of a
command economy where needed.

The Constitution also protects the rights of groups to practice their customary beliefs. For example, the Amish in
Pennsylvania continue their traditional economy.

Most of the world's major economies are now mixed economies. Globalization makes it difficult to avoid. A country's people are best
served through international trade.

It’s smart to import oil from Saudi Arabia, clothing from China and tequila from Mexico. When a country encourages its businesses
to export, it gives up some control.

Second, the free market is the basis for the global economy. That's because no single government controls it. World organizations
have implemented some regulations and agreements, but no world government has the power to create a global command economy.

 More on a Market Economy

The U.S. stock market shows how a free market economy works. (Photo: Spencer Platt/Getty Images)

A market economy has six defining characteristics. The United States has all six characteristics of a market economy.
First, the law protects ownership of private property. Second, everyone is free to live, work, produce, buy and sell whatever they
choose (as long as it's legal.) Third, self-interest drives the buying and selling of goods and services, including employment. Sellers
want the highest price and buyers want the best value for their money.
Fourth, the law protects competition. Fifth, prices are allowed to float along with supply and demand. Sixth, the primary role of
government is to make sure that everyone has free access to a free market.

Congress passes regulations to make sure no one is manipulating the market. The Constitution protects the free press to give everyone
equal access to information.

 More on the Command Economy

Many aspects of the U.S. economy follow the characteristics of a command economy.
First, there is an annual federal budget that outlines the government's priorities and takes the place of a central plan. Second, Congress
guides the allocation of resources. Taxes discourage some activities while subsidies encourage others.
Third, government spending follows the priorities for the country. For example, U.S. military spending increased after the 9/11
terrorist attacks. Fourth, the government owns a monopoly in important national industries.
These include NASA, the interstate highway system, and defense. Fifth, the federal government uses regulations to support economic
priorities, such as agriculture.

 More on the Traditional Economy

The United States is moving further away from a traditional economy, but tradition still guides many economic policies. First, a
traditional economy relies on agriculture, hunting, and fishing.

American traditions support the family farm. That has led to millions in agricultural subsidies. This is despite the predominance of a
few global agribusinesses.

Laws and treaties also protect the fishing industry. Hunting is no longer needed as a primary source of food for America, but tradition
still supports it. Laws and permits protect the right to hunt.
 Adam Smith

When the Scotsman Adam Smith (1723–1790) was born, industrialization and a profit-driven market system were
replacing custom and command-driven economic systems across Europe. These changes reflected the intellectual shift
toward rationality, progress, liberty, and secularism, generally referred to as the Enlightenment.

An undated etching of Adam Smith, public domain

Smith studied in Glasgow, Scotland, and Oxford, England. As a professor and
lecturer, private tutor to the children of European royalty, government economic
adviser, and a customs commissioner for Scotland, Smith had a comprehensive
understanding of economics, which was captured most powerfully in An Inquiry Into
the Nature and Causes of the Wealth of Nations, better known (and referred to
hereafter) as The Wealth of Nations.

Composed at the dawn of the Industrial Revolution, The Wealth of Nations describes

a world increasingly dominated by commerce and capitalism. Here, Smith gives his
observations of a visit to a pin-making factory:

One man draws out the wire, another straights it, a third cuts it, a fourth points it, a
fifth grinds it at the top for receiving the head; to make the head requires two or three
distinct operations; to put it on is a peculiar business, to whiten the pins is another; it
is even a trade by itself to put them into the paper; and the important business of
making a pin is, in this manner, divided into about eighteen distinct operations.... [An
average factory of ten workers] could make among them upwards of forty-eight
thousand pins in a day. Each person, therefore...might be considered as making four thousand eight hundred pins in a day.
But if they had all wrought separately and independently, and without any of them having been educated to this peculiar
business, they certainly could not each of them have made twenty, perhaps not one pin in a day. (The Wealth of Nations,
p. 10)

In other words, the division of labor enabled one man to be as much as 4,800 times more productive than if he worked
alone! In addition, Smith argued that people have a natural drive to improve their own lives. This self-interest, he
suggested, propels markets to satisfy individual demands by producing the goods and services people want. He called this
the “invisible hand,” and wrote, “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our
dinner, but from their regard to their own interest” (The Wealth of Nations, p. 20).

He suggested that competition between businesses prevents exploitation of consumers by ensuring fair prices and quality
products, encouraging constant economic innovation, and satisfying consumer demand. In short, competition keeps
everyone honest, because customers treated unfairly by one business can always patronize another instead.

Smith’s view that the complex functions of society and economy emerged, unintentionally yet effectively, from the self-
interested actions of each individual must have been both reassuring and liberating to a world grasping for new means of
economic, social, and political organization. It was certainly popular: the first edition of The Wealth of Nations sold out
within six months.

Smith’s remarkable insights not only captured his own time accurately; they also foresaw much of the economic future,
which is evident in the endurance of free-market capitalism as the world’s foremost economic model for the last 200-plus
years. Today, we call this arrangement “economic liberalism” (different from the “liberal” political alignment in America)
and the liberalization of economies continues around the world (Balaam and Veseth, p. 48-49).

Though Smith predicted many of the successes of industrial capitalism, he lived too early in the Industrial Revolution to
see its worst excesses. It would take several more decades to produce a critic whose cynicism toward capitalism matched
Smith’s optimism. That critic was Karl Marx.
 Karl Marx

Karl Marx (1818–1883) was born in the midst of the Industrial Revolution, into a middle-class family in Prussia (a former
German kingdom straddling parts of present-day Germany and Poland). He led a tumultuous life: he was jailed for public
drunkenness as a college student; his home and personal appearance were unkempt; and he spent income frivolously,
causing his family to frequently live on the brink of poverty. For most of his professional life, Marx was a writer for a
variety of liberal, radical, and foreign newspapers, moving between Prussia, France, Belgium, and England because he
was continually blacklisted or deported for his radical views.

Karl Marx, January 1870 © adoc-photos/CORBIS

Marx’s attitude toward capitalism was scathing. In an age when “the Industrial
Revolution had changed the process of production into a factory system and created a
new ruling class of factory owners” (Bussing-Burks, p. 85), Marx perceived injustice,
inequality, and the inevitability of change. Marx and his frequent coauthor, Friedrich
Engels were outraged at the hardships faced by the working classes of industrial
European cities, and they channeled this anger into two monumental written works that
formed the basis of modern communism: The Communist Manifesto, published in 1848,
and a four-volume, 2,500-page opus, Das Kapital, published in 1867.
Marx’s analysis sees the “history of all...societies [as] the history of class struggle.”
Marx interpreted human history as a series of eras, each defined by systems for
producing goods, which created classes of rulers and the ruled. This process had already
progressed from slavery to feudalism to capitalism and, in Marx’s view, would
eventually lead to a classless society called communism.

Why did Marx object to capitalism? He believed that “capitalists” (the owners of the
machines, property, and infrastructure used to produce things) were a separate class from the workers, or “proletariat,”
who own nothing but the right to sell their labor in exchange for wages. Marx theorized that capitalists, in competition
with each other for profits, would squeeze as much work as possible out of the proletariat at the lowest possible price.
Furthermore, competition would cause some capitalists’ firms to fail, increasing unemployment (and thus misery and
poverty) among the proletariat. Innovations in technology were not necessarily positive; new machines would add to
unemployment (by rendering human labor increasingly inefficient and obsolete) while also making work dull, repetitive,
and alienating.

Yet Marx was not altogether dismissive of capitalism, which he saw as a necessary stage for building a society’s standard
of living. But in his view, the proletariat’s discontent would inevitably lead it to overthrow the ruling classes and create a
more equitable society, at first socialist (wherein the state would control the economy and distribute resources more
evenly) and then purely communist (a stateless, classless, egalitarian society without private property or nationality).

Marx’s beliefs, theories, and predictions represent a school of thought called Marxism. International political economy
professors David Balaam and Michael Veseth caution, however, that there is no definitive reading of Marx, and that
“Marxism is at once a theory of economics, politics, sociology, and ethics. For some, it is also a call to action” (Balaam &
Veseth, p. 73). As a call to action, Marxism was most influential in the 20th century, when it inspired various brands of
revolutionary activity, including the Russian Revolution in 1917 and the rise of communist governments in China,
Vietnam, and Cuba, as well as in many Eastern European and African nations. It has since fizzled out, with the U.S.S.R.
collapsing in the early 1990s, China shifting toward a market-friendly economy, and smaller communist countries that
depended on them adopting more market-oriented systems.

As a theory, Marxism is arguably more durable. While some believe that communism’s decline disproves Marx, others
draw upon his approach to critique economic phenomena on social grounds. Even as capitalism defines most of the
world’s economies, Marxism remains alive in “the idea that capitalism can undergo serious scrutiny and adaptation”
(Bussing-Burks, p. 95). In other words, Marx’s skepticism about capitalism initiated an ongoing conversation about its
shortcomings and how it can be improved.
 John Maynard Keynes

John Maynard Keynes (1883–1946, last name rhymes with “rains”) was born into an educated family, and during his life
he worked in academia, economic publishing, private financial advising and management, currency speculation, and as an
official in the British Treasury.

A studio portrait of John Maynard Keynes by Gorden Anthony, late 1930s ©

Hulton-Deutsch Collection/CORBIS
While his contributions to economics were extensive, Keynes is most famous
for his ideas about the Great Depression, the major economic crisis of the
20th century. The Depression’s effects were felt worldwide from roughly the
early 1930s to the mid-1940s. The United States saw unemployment increase
from 3 to 25 percent, a halving of the national income, and a near cessation
of residential construction (Buchholz, p. 210).

Keynes’s analysis of the Great Depression focused on the role of savings. In

his 1936 book The General Theory of Employment, Interest and Money,
Keynes argued that excessive savings could lead to economic ruin. A weak
economy made businesses hesitant or unable to make investments that
created jobs. Without jobs, people had no income that, if spent, would have
stimulated demand for more production. Savings increased in anticipation of
economic hardship. But then savings dried up as joblessness persisted.
Individual rationality (saving in hard times) led to collective irrationality (an
unbreakable cycle of economic decline).

Keynes believed the government should support the economy. While Keynes
generally endorsed free-market capitalism, the Depression’s unique challenges required unique solutions. Keynes argued
that only the government had the resources to spend the money that individual consumers and businesses could not, and
so break the cycle.

This approach proved relevant in the 1930s and ’40s. The New Deal government relief programs of President Franklin D.
Roosevelt were designed to stimulate the economy in the early 1930s, while cuts to the federal budget in the late ’30s
caused an immediate economic downturn. Extensive government spending funding World War II coincided with the end
of the Depression. While some Keynesian policies had mixed results, the overall picture seemed to confirm Keynes’s
arguments, and until the 1970s, Keynesianism predominated American economics. The “Great Society” domestic social
programs — including Medicare and education funding — reflected Keynesian thinking. So too did the establishment of
many of the institutions that form the basis of international trade and finance, such as the International Monetary Fund and
the World Bank. While the 1980s and ’90s saw a resurgence in “classical” economic theories closer to Smith than to
Keynes, the recent “recession” presents a new opportunity to debate whether Keynesian economics are still viable.