A brief history of Economic Systems

Economic systems are characterized by a set of rules defining the relationship between interacting economic agents. The organization of economic activities is not separate from the political and social institutions adopted by the groups carrying out such activities. Thus, we may categorize many economic systems across the globe and throughout human history.

However, if we consider only broad differentiating factors, we may resume our history to five main economic systems – the gathering and hunting economy, the predatory and slave economy, the medieval serfdom system, centrally planned economies and capitalism or free market system.

With the exception of the centrally planned systems (fascism, national socialism and communism) who were driven by a precedent ideology, all the other systems evolved more or less spontaneously after long periods of gestation. In this brief history of these five major economic systems we highlight their main distinguished features in terms of division of labor, property rights, income distribution and capital accumulation.

Our oldest ancestors (the homo sapiens) appeared as a distinct species some 200-500 thousand years ago organized in small groups, mostly made up of family members. They were basically roving hunters and only settled down and began farming around 10-50 thousand years ago. At this stage their level of organization was much more developed and included a clear division of labor between male (hunter) and female (farmer), a division of property rights between common and family property and an acceleration of capital accumulation on durable goods like lodging and hunting/domestic tools, but also on non-essentials such as jewelry and other cultural and religious artifacts.

As hunters they undertook also predatory activities as a short cut to get what they needed, either by stealing from other tribes or by killing similar species (like the Neanderthals) who competed with them for the same territory and preys. As an alternative to predation, primitive forms of barter trade also appeared, but they were not the primary form of wealth exchange, which continued to be mostly done on a kinship basis. Another important development in terms of farming was the domestication of animals as pets and cattle.

All these developments led to a rapid increase in predatory activities which required larger societies (tribes), a further division of labor, beyond gender and age, between warriors/ hunters, shepherds/ farmers, slaves and clergy, as well as a political power structure beyond the traditional family/tribal hierarchy.

So, in the ancient civilizations of Mesopotamia, Egypt and India that appeared between the 3rd and 4th millennium BC, economic activity was mostly based on predation (conquest) and slavery and the military warriors naturally became the most powerful group within those societies. War permitted not only to obtain slaves to perform domestic, agricultural and construction activities but also to achieve a fast accumulation of durable goods. The organization skills required to command large armies and numerous slaves were essential to increase further the level of specialization in the division of labor needed to construct large durable infrastructures like irrigation, bridges, fortresses or temples.

Although most of these activities were under a centralized command, the development of trade and its tools was also inevitable and facilitated by the development of money exchanges that progressively replaced the traditional barter trade. In particular, the development of pictographic writing by the Sumerians, during the Uruk period at about 3400 BC, was essential to keep trading records and turn Uruk into the most urbanized city in the world and a major trade center in Mesopotamia with more than 50,000 inhabitants.

Ancient civilizations progressively turned into agriculture based societies and big estates, producing wine and oil (the most important commodities for commerce), replaced the small self-sufficient wheat-producing farms. Thus, private ownership of land became one of the crucial factors in the social stratification of those societies. For instance, in ancient Athens and Rome the population was divided into slaves, freedmen, free men, foreigners and women and only some of these groups were considered citizens.

Slaves did most of the work in agriculture, mining and manufacturing. The rulers, whether theocratic, oligarchic or democratic, continued engaged in military campaigns, initially mostly to plunder and destroy the property of the vanquished. However, they soon realized that slaughtering and enslaving their enemies was not always the most profitable course of action. So, they began to demand as an alternative the payment of ransoms and tributes (through various types of taxation) from independent producers and traders. This allowed a much faster accumulation of capital in palaces and jewelry as well as a rise in population.

In Europe and the Mediterranean these civilizations were later vanquished by hordes of barbarians who destroyed most of the cities and centralized forms of government, thus splitting the continent into countless kingdoms. This had two important consequences, the rise of monotheist religions (first Christianity and later Islam) who became a unifying force in those societies and an inward return to the big estates as the base of society. These were invariably involved in frequent wars and alliances that led to the development of a vassalage system - the feudal system.

The driving force of the feudal system was still predation but now the territorial range was much smaller (with a few exceptions like the Charlemagne Empire) and reliance on slaves was slowly replaced by a system of serfdom.

In contrast to what happened with the ancient slaves, the serfs’ master did not have the power of life and death. The serf (whether bound to the soil or to the lord) was considered a living creature with soul and the master had to allow him to attend church and could not force him to work on holy days or to commit immoral acts. The serf usually had a separate hut with an attached plot of land and lived with his family.

Production was often organized in a manor system, where the land was split in three parts, one directly controlled by the lord for his own benefit, another used by the serfs in exchange for labor services and a share of their produce and a third considered free land leased against a money rent. Under this system there was very little incentive to produce surplus for trading, and the lords often reserved a large part of their domain for hunting.

Not surprisingly throughout the middle ages the division of labor, the level of trade and capital accumulation were significantly reduced when compared to the ancient civilizations. This system lasted for a long period, appropriately named the “dark ages”, which only began to change slowly with the fragmentation of the feuds and the resumption of the so-called trade revolution in the XII century and the rediscovery of the ancient civilizations during the Italian Renaissance in the XV century. These developments allowed the rise of a new class of rich traders and bankers who questioned an otherwise rigid class pyramid made up of the Pope, King, Nobles, Knights / Vassals, Freemen, Yeomen, Servants, and Peasants / Serfs / Villeins.

The transition from feudalism to capitalism was also a long process that was only completed in Europe by the end of the XVIII century. One may even say that it began as early as the Crusades in 1096 and was only completed by the British Limited Liability Act of 1855.

The key changes that combined to drive the process were the XIII century trade revolution, the Italian renaissance in the XV century, the Portuguese and Spanish voyages of discovery in the XV-XVI and the scientific, illuminist and industrial/transport revolutions from the XV to the XVII century.

At the institutional level the key marks were the progressive repeal/ ignorance of the usury laws that hampered the use of credit and banking, the creation of joint stock companies who enabled capital accumulation and risk sharing, the development of securities markets and the introduction of limited liability laws that facilitated entrepreneurship.

The end result of this process was that the specialization and division of labor deepened to unprecedented levels, free labor progressively replaced slavery and serfdom and the accumulation of financial and non-financial assets accelerated leading to the fastest ever growth in productivity and trade experienced by humankind. Thus old agrarian societies were replaced by commercial and industrial societies and the traditional rigid social hierarchy was challenged by the new money earned on such activities.

In the Wealth of Nations (1776), Adam Smith refuted Physiocratism and Mercantilism and demonstrated the clear advantages of free labor and free markets, which are the essence of capitalism. The word capitalism itself only made its first written appearance in Thackeray’s novel “The Newcomes” (1855) to refer to those whose capital was not the result of land ownership. The term was also used by Karl Marx in Das Kapital (1867) to denigrate the new economic system by claiming that “social wealth becomes to an ever-increasing degree the property of those who are in a position to appropriate continually and ever afresh the unpaid labour of others”.

The nobility and clergy did not accept easily the loss of power and status brought about by capitalism. Indeed, Marx was not the only one to fight the ideal of “the invisible hand” and decentralization subjacent to capitalism. Among both revolutionaries and reactionaries there were two opposite criticisms of a capitalistic decentralized system. Some proposed a return to a system of small communities (e.g. the model villages of Utopian Socialists or the Anarchist and Hamish communes) while the others proposed a centralized system relying more on economic planning than competition (e.g. communism, national socialism and corporatism).

The experiences with decentralized non-capitalist systems were localized and have been subsiding progressively without a major impact on humankind.

On the contrary, the experiences with central planning had a dramatic impact in our world since they were tried in the first three quarters of the XX century in many developed and less developed countries. The three types of experiments relied on dictatorships to control the economy and the labor market, in accordance with their different ideologies.

Following the Marxist-Leninist doctrine, communists established a so-called proletariat dictatorships, initially run by the oligarchy of the only legal party, which invariably transformed into a single god-like dictator (e. g. Stalin in Russia, Mao in China or Fidel Castro in Cuba). Communists abolished private property and reintroduced forced labor, namely slavery in the Russian Gulags, serfdom in Chinese rural areas and modern forms of slavery in Cuba. They also replaced the markets by some form of central planning.

Forced labor, private property confiscation and central planning proved disastrous, causing the worst man-made famines known to humankind, when 6-8 million people died during the 1932-1933 Soviet famine and 15-40 million starved to death during the 1958-1961 Chinese famine. Capital accumulation and productivity growth lagged so much under this system that in the 1980s communism collapsed by itself in the Soviet Union and the Chinese Communist Party replaced communism by a form of state capitalism.

National-socialism was introduced in the 1930s by the Nazi Party in Germany. It was based on an ideology of racial supremacy, proclaiming that the Aryans were a superior race and the other races should be either destroyed (e.g. the Jews and Gypsies) or become servants of the Germans (e.g. the Eastern and Southern Europeans).

The Nazis did not abolish private property and markets for the Germans, but firms had to work under the direction of the party by contracting to receive forced labor and to supply the government. The Nazis reintroduced the most brutal form of slavery by forcing war prisoners and Jews to work until they died of exhaustion. The party also had a god-like leader - Hitler - who repeated the old forms of predatory economics through outright confiscation of the Jews and the Central Banks of the countries occupied and the introduction of ransoms, forced labor, punitive taxes and the coercive supply of his armies.

The German (and Japanese) imperialist wars to conquer new territories originated the Second World War, the most deadly conflict ever lived by mankind, which claimed the lives of more than 60 million people.

Corporatism, was a milder form of centralized economic system introduced in Italy, Portugal, Greece and Spain during the 1920s and 1930s. Its ideological origin goes back to the Rerum Novarum papal encyclical on the social question issued by Leo XIII in 1891. The basic idea was that labor and capital should cooperate under the guidance of government.

Private property and markets were accepted, but labor relations were regulated by agreement between unions and employers under the supervision of the state. Other markets were also regulated through price controls and licensing.

At the political level, the dictatorships adopted more or less extreme forms of fascism depending on the moderation and warmongering of their leaders, with Salazar in Portugal being the only one who was not involved in war.

The economic consequences of corporatism and the lack of market competition was the impoverishment of Southern Europe relative to the rest of Europe.

Without exception, all attempts to create an economic system by design based on anti-capitalist ideologies only brought oppression, misery and war and have been progressively abandoned in favor of various versions of capitalism.

Despite having so few supporters and so many opponents capitalism vanquished by itself and is now the dominant economic system. So, one is left wondering what is the beauty of capitalism and how long it will last. But, first we needed to understand how mankind got here.