Transitioning to a Market Economy

Instructor: Beth Loy

Dr. Loy has a Ph.D. in Resource Economics; master's degrees in economics, human resources, and safety; and has taught masters and doctorate level courses in statistics, research methods, economics, and management.

This lesson discusses the difference between a command and market economy, the complexity of transitioning to capitalism, and the challenges faced by governments, consumers, and producers. Learn more about countries that are currently transitioning.

Economic Systems Defined

The most common types of economic systems are market, traditional, command, and mixed. The type of economic system determines the way goods and services are distributed, what goods and services are produced, and how scarce resources are allocated among producers. This lesson looks at how an economy transitions from a command economy to a market economy. Before we get into discussing the transition process, though, it will help to learn a bit more about a market economy and a command market.

What Is A Market Economy?

A market economic system is the one that we know as capitalism, where goods and services are freely exchanged on an open market. The key features of a market system are that:

  • All resources are privately owned by producers and consumers
  • Producers and consumers are motivated by self-interest and profit
  • Producers and consumers are free to produce, sell, and purchase outputs
  • The government does not intervene in the market except to assure it remains free
  • Prices are determined from the supply and demand of outputs

The U.S. economy is considered the world's leading market economic system; however, it does not meet the pure definition of what is needed to be a free market. We can find the latest smartphone available for purchase, and the price is set by the market, not the government. As we all know, the U.S. economy is affected by some government intervention. It does, however, far supersede any other economy when it comes to striving to be a market economic system.

What Is A Command Economy?

A command economic system is also called a centrally planned economy. It is one that is controlled by a central government or leader, either directly or indirectly. The key features of a command economic system are that:

  • Decisions are made by a centralized body, usually the government or a single leader
  • Many resources are owned by the government
  • Prices do not adjust based on supply and demand
  • Producers are not free to produce, sell, and purchase outputs
  • Consumers have limited choices
  • Salaries, employment rates, and prices are determined by a centralized body

Examples of a command economic system include Iran and North Korea. In these countries, you may not be able to buy the latest smartphone, but if you are able to, the price is likely set by the government.

Challenges When Transitioning To A Market Economy

Traditionally, Cuba, China, and Russia were seen as command economies; however, over time, they have allowed some capitalism to enter their nations and operate without interference. However, these countries did face challenges in transitioning to a market economy, including:

  • Poor existing infrastructure
  • Erratic trade imbalances
  • Leery foreign investment
  • Lagging privatization of state-owned businesses
  • Rising prices from deregulation
  • Lack of market economy regulations
  • Insecurity from new cultural influences
  • Nonexistent social supports
  • Transition gap unemployment
  • Limited banking institutions

Transitioning to a market economy means that new answers must be found to questions that central planners used to answer. In particular, countries deal with high government unemployment, poverty level wages, and a lack of career opportunities. Because of employment uncertainty, growth is limited once central planners step away from controlling labor issues. It takes a great deal of time for a market to recover from this lack of control. Countries may need to find a transition plan to slowly reduce government payrolls and increase minimum wages. An investment in education and technology can help with creating jobs, and at the same time, open new career opportunities.

It is also important that an economy have at least basic financial, technological, and transportation infrastructures in place before central planners step away from their control. Growth in a market economy is dependent on banks, insurance, taxes and incentives to improve technological, communication, and transportation infrastructure. Without a base to support these systems, it will be difficult for citizens to feel confident enough to spend, borrow, and save their money.

Cuba's Transition

One of the most recent countries to begin transitioning to a market economy is Cuba. In the last few years, the country's transition was stimulated by diplomatic talks with the United States. Cuba's positive signs of growth include:

  • Beginning a marketing campaign to stimulate tourism
  • Opening its doors to share medical research and technology
  • Streamlining the process for approving business licenses

Some specific roadblocks Cuba needs to overcome in its transition include:

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