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Category 2 – Citizenship
Skill 3 – National Defense
Economic Systems of Government
If you asked political scientists what they
thought the most important document written
in 1776 was, they would probably say Thomas
Colonies that could be markets for
manufactured goods and sources of raw
Well-developed industries; and
A large enough population to provide
A primary reason that the British fought
the American Revolution was because the colonies
were very important to British economic success,
and Britain did not want to lose this segment of
their economy.
However, if you asked an economist that same
question, he might answer Adam Smith’s The
Wealth of Nations. It was Smith’s book that
outlined the theory of capitalism that became
the basis for the economic systems of many
countries. In this lesson, we will explore the
Capitalism- A New Kind of
development of capitalism and compare it with
socialism and communism.
Adam Smith’s book, The Wealth of
Nations, outlined a new kind of economy called
capitalism. Under this system, government
practiced a policy called laissez-faire economics.
Laissez-faire is French for “let do.” In a pure
capitalist society, the government does not
interfere in the economic system. As long as
people respected the personal and property rights
of others, they should be allowed to make
decisions for themselves.
Between 1600 and 1800, the most
successful economic practice in Western Europe
was called mercantilism. According to
mercantilism, a country’s economic success could
be determined by how much wealth it had
acquired. This wealth was generally measured in
gold or silver. The gold and silver were acquired
through discovery and trade. It was important that
the countries had a positive trade balance. Nations
with a positive trade balance export more goods
than they import. A successful mercantile country,
like Great Britain, would have the following:
A strong agricultural industry so that food
would not have to be imported;
Enough sea power so that they could
convey trade goods, and enough military
power so that they could protect them;
Under pure capitalism, entrepreneurs
became very important. Entrepreneurs are
individuals who organize, operate, and assume the
risk in business activities. These individuals are
also sometimes called capitalists. They own the
industries that produce goods for trade. They
employ the workers. They invest in machinery to
produce goods. They set the prices for the market
place. Capitalists believe in free trade without any
laws or regulations that limit competition in the
market place.
Category 2 – Citizenship
Skill 3 – National Defense
In a capitalist society, the price of goods
is determined, not by the government, but by the
marketplace through the Law of Supply and
Demand. Under this economic theory, goods are
more expensive if they are limited in supply and
the demand for them is great. Prices are lower if
the supply is great and the demand is low.
was greater than the demand. Some in the
automobile industry called for higher taxes and
limits on the number of vehicles imported from
foreign countries in an effort to protect the U.S.
auto industry. In this way, foreign car companies
would not have a competitive edge on American
cars. This type of government action, sometimes
called Protectionism, allows the industry affected
and its workers some benefit. However, the
consumer is faced with paying a higher price in
the marketplace. So, although the car industry is
protected from foreign competition, the American
car buyer is faced with a higher price for the
purchase of a new automobile.
Another factor in the theory of capitalism
is that it operates in cycles. The economy as
measured by the Gross National Product
(GNP), will go up and down. The GNP is the
total value of goods and services produced in an
economy. When the GNP goes down, there are
usually higher rates of unemployment, greater
numbers of businesses going bankrupt, and a
decline in prices. When an economic downturn
lasts for an extended period of time, it is called a
recession. In capitalist theory, the recession ends
as the cycle reverses itself. Low prices increase
demand. Increased demand lowers the supply
level. Short supply calls for an increase in
production. Increased production requires more
labor creating new jobs. New jobs lower the
unemployment rate. More people working
increases the sale of goods. The economy then
In modern capitalist societies, the
government plays an active role, stimulating the
economy as needed. One example of government
intervention in the economy is the laying of tariffs
on imported goods. A tariff is an additional tax
placed on certain products that raises the price of
those imported goods. During the 1970s, there
was a huge increase in the cost of gasoline at the
pump. Since the American automobile industry
made large cars that consumed a great deal of fuel,
Americans started buying German and Japanese
cars in greater numbers. These cars tended to be
smaller in size and more fuel-efficient. As a result,
the American automobile industry was forced to
lay-off autoworkers. The supply of U.S. made cars
Efforts by the government to stimulate
the economy by imposing tariffs, lowering interest
rates, or cutting taxes is generally thought to be in
keeping with the philosophy of John Maynard
Keynes. This economic theory, called Keynesian
economics, is designed to even out the business
cycle and stop recession periods. On the other
hand, supply-side economics, sometimes called
Reaganomics because President Ronald Reagan’s
administration proposed them, emphasizes the
need to constantly improve efficiency as a way of
economics also promotes the idea that high taxes
Category 2 – Citizenship
Skill 3 – National Defense
on corporations and on high-income capitalists
discourages business expansion. They argue that
people will be unwilling to take investment
chances if the government takes profits away
through taxes and regulations. Supply-siders want
to increase competition by removing barriers to
free trade. They would repeal special tax breaks to
certain industries and have a more uniform tax
rate across the board. If individuals and
corporations have more money to work with, they
will expand business and wealth will “trickle
down” to the average worker.
In 1848, Karl Marx wrote the
Communist Manifesto. In it, he described some of
the weaknesses of the capitalist economies. Marx
argued that in order for capitalists to be
successful, they had to take advantage of their
workers. According to Marx, capitalists paid
workers low wages and maintained dreadful
working conditions so that they could make a
profit. He argued that in time, the workers would
join together, like slaves overthrowing their
masters, in a revolution that would replace
capitalism with a form of socialism he called
communism. Marx believed in a communist
utopia, a perfect society, where everyone would
be expected to co-operate in the production of
goods. In Marx’s communist society, everyone
would produce according to his or her level of
ability. Everyone would have access to consumer
goods according to their needs. He believed in a
classless society where everyone was treated
equally. Unfortunately, Marx also believed that the
only way to achieve this level of perfection is
through a violent revolution of the working class
against those in authority.
The factors of production are the
resources that are used to produce other goods
and services. These include land, labor, finance,
and human capital or entrepreneurship and will
influence the type of capitalism found in a
country. In many cases, the factors of production
will determine the approach a country takes
toward its economy. Capitalism includes a number
of differing philosophies or approaches because
each country differs in the way it is able to
implement its economic policy. A country rich in
natural resources like oil is not dependent on
other countries to run its manufacturing plants.
Japan must import nearly all of its oil while Great
Britain, on the other hand, is self-sufficient when
it comes to fuel. As a result, the price of
manufactured goods in Japan is dependent to
some extent on the price of oil. Some countries
are rich in agriculture, and others may have a very
educated labor force.
“Communist Revolution” would occur in an
industrialized country like France, England, or
Germany, it actually happened in Russia 70 years
after the writing of the Manifesto. Russia, at the
time, was primarily an agricultural country run by
a monarch called the czar.
While some version of capitalism is today
found in most countries, the degree of
government involvement varies. Even countries
that view themselves as socialist or communist
often have some degree of capitalism.
While the leader of the revolution in
Russia was Vladimir Lenin, the person who led
the Russians for much of the twentieth century
was Joseph Stalin. Marx argued that after the
revolution, the country would be run by a
dictatorship that would prepare the way for the
ideal society that he envisioned under
communism. Russia eventually became the Union
Category 2 – Citizenship
Skill 3 – National Defense
of Soviet Socialist Republics (USSR), and the
dictatorship never ended. Another 70 years would
pass before the USSR would crumble in 1989.
private industry. Whatever private production and
distribution exists is carefully regulated by the
government rather than by the free market
Under Stalin, the government owned the
means of production. The whole national
economy was administered as one giant firm.
There was little or no private ownership. The
economic planning was centralized into annual,
five-year, and long-term plans established by the
government. Rapid industrialization, a high
investment rate, and a low level of consumption
characterized Stalinism. Ironically, under this form
of communism the government employed various
forms of slave labor. Stalin was ruthless in
gathering and maintaining his power. In addition,
the communist society was atheist, and under
Stalin’s dictatorship, literally tens of thousands of
Christians and Jews were killed.
There are democratic and non-democratic
forms of socialism. Both forms agree that running
the economy must reflect the best interests of the
people. How this is done is reflected in the varying
attitudes of the government toward personal
freedom, civil liberties, political participation,
bureaucracy, and political competition. In Western
Europe, the socialist countries like Sweden tend to
be more democratic than third world countries
that tend to be totalitarian.
Third world countries generally have
fewer resources. Their populations are less
educated. Their economies are generally focused
on one industry such as agriculture or oil. One
example of such a country is The Great Socialist
People's Libyan Arab Jamahiriya or simply Libya.
Since 1969, Colonel Muammar Qadhafi has
been Libya’s leader. In 1992, the political structure
was changed when Colonel Qadhafi, the leader of
the revolution, divided Libya into 1500
mahallat (communes). Each mahal is vested with
its own budget, and legislative and executive
powers. Revolutionary committees, hand-picked
by Colonel Qadhafi, "supervise" the mahallat.
Unlike Libya under Qadhafi, the trend in socialist
countries is to allow more and more opportunity
for private ownership and less government
economic restrictions.
On an economic level, everyday life was
marked by food shortages and fear. Stalin changed
Soviet society from a rural agricultural focus to an
urban industrialized one. There was a rapid
expansion of education in the Soviet society.
Another trend in the Stalinist government was the
effort to bring other countries under Soviet
control. After World War II, much of Eastern
Europe became communist. Communism also
spread to China, North Korea, North Vietnam,
and eventually to Cuba. However, as the decades
passed, it became clear that economically, the
communist form of socialism with strict controls
of both the people and the economy would not be
The modern European version of the
socialist economy has often been called the
welfare state. In a welfare state, such as Sweden,
the government focuses on providing services for
its population. These services can include benefits
such as government issued funds to support
programs such as old age and disability pensions,
unemployment benefits, aid to families with
Many consider communism an extreme
form of socialism. Under socialism, all or most
sources of production are the property of the
government. Most goods and services are
administered by the government and not by
Category 2 – Citizenship
Skill 3 – National Defense
dependent children, income supplements for the
poor, public housing, health care, food stamps,
public education, and child care. In countries that
focus on providing for the welfare of its people,
taxes tend to be very high.
One thing that should be clear is that in
today’s world no single economic system
completely rules. In the United States, generally
thought of as the most capitalist of economies, the
government provides subsidies to industries,
stimulates the economy by lowering interest rates
and imposing tariffs, and provides a number of
welfare programs at state and national levels.
Communist and socialist countries are opening up
their doors to private ownership, freer trade, and
greater competition. As each nation develops, it
becomes more important for its leadership and its
people to realize that differences in economic
systems may exist, but common goals for the
people make it necessary for greater international
cooperation. 
Category 2 – Citizenship
Skill 3 – National Defense