Mixed Economic System (Study Notes)!


In the real world today a pure free market economy and pure command economy or a centrally planned economic system are not found.

Almost all economies have now become mixed economic system in which government plays an important role in allocation of resources and distribution of income.

Thus mixed economy or mixed economic system refers to an economic system in which both free market and Government have significant roles in the working of the economy. In a mixed economy elements of both free market system and control or regulation by the Government are present. The proportion of free market working and Government regulation varies from country to country.


Many economies of the present-day world are examples of mixed economy. Mixed economy functions through private enterprise as well as Government. The Government interferes with or regulates the private enterprise in various ways. It has now been realised that the free and unfet­tered functioning of the private enterprise gives rise to many evils.

As a result of free working of the private enterprise, there are violent fluctuations in economic activities; sometimes the condi­tions of depression and unemployment are created and sometimes the conditions of boom and inflation emerge. Thus a free-market economy suffers from what are called business cycles, with all their consequent evils. Besides, as a result of free functioning of the private enterprise and price mechanism, extreme inequalities of income and wealth are produced.

The following of ‘Laissez Faire’ policy by the Government, weaker sections of the society are not protected. On the other hand, the command economic system in which resource allocation and income distribution is decided through centralized planning collapsed due to various deficiencies and failures. Therefore, in both Russia and China free-market economic system along with some govern­ment control has been adopted.

In has also been realised that in a developing country like India, desired rate of economic growth cannot be achieved under free private enterprise. Therefore, in order to avoid the evils of the free private enterprise and free functioning of the market mechanism and to achieve the desired rate of economic growth the Government takes an active part in the functioning of the economic system in most economies of the world.


Today all the capitalist economies have become mixed form of economies, because in all of them economic role of the Government has greatly increased.’ Laissez Faire’ policy advocated by Adam Smith and other classical economists has now been given up because of its several shortcomings and evils.

Therefore, the economies of the United States of America and Britain have also become mixed systems. Paul Samuelson and A.H. Hansen, eminent American economists, have called the economies of America, Britain and France as ‘Mixed Capitalist System’ or’ Mixed Enterprise System’, because in them the Government now interferes in the economic activities and takes active part in the functioning of the economic system and regulates and controls the private enterprise by various methods.

Two Forms of Mixed Economic Systems:

It is worth noting that mixed economies can be classified into two forms. One form of mixed economy is that in which means of production are in the ownership of private sector and the Government regulates and controls the activities of private enterprise through direct controls (such as price control, licensing system, control over imports, etc.) as well as through monetary and fiscal policies. In such a type of economy, the government does not take over the means of produc­tion, and if it does, it does so relatively on a small scale.

That is why such a type of ‘mixed system’ has been called Mixed Capitalist System because such an economic system is basically capital­ist and the Government regulates and controls the economic activities through various types of controls and various measures of monetary and fiscal policies so that the various evils of the free working of the private enterprise and the price mechanism are avoided and the economic system is directed towards the desired goals.


In such a type of ‘mixed economy,’ Government itself does not undertake the work of production on a large scale. Government’s production work is merely confined to the production of equipment’s and materials for the army and the working of the public utility services. Such a type of mixed economic system is also called controlled capitalism.

Indian Economy as a Mixed Economic System:

The second form of a mixed economy is that in which the Government not only regulates and controls the private enterprise through various types of direct controls and appropriate monetary and fiscal policies, it also directly participates in the production of various goods and services.

In such a type of mixed economy, various basic industries and infrastructure industries are generally in the ownership of the public sector and it is the government which organizes and runs them. The remaining industries are in the ownership of private enterprise and it is the private enterprise which is assigned the task of production in them. But it is worth remembering that the government regulates and controls the private enterprise in such industries also through direct control and appropriate monetary and fiscal measures.

The economies of the United States of America and Britain have also become mixed economies. But the nature of mixed economy of India is quite different from them, because in the mixed economy of India the public sector takes more active, more important and more extensive part in the working and growth of the economy.. Whereas the mixed economies of the USA and England are biased towards capitalism, the mixed economy of India is biased towards socialism.

Functioning of a Mixed Economy:

A mixed economy functions through both price mechanism and planning by the Government. So far as the industries in the public sector are concerned the price, output and investment decisions are taken by the government or the authorities appointed by the government according to the strategy and policy frame of the development plans.

But the private sector of the mixed economy is governed and regulated by the price and market mechanism and therefore in regard to the industries in the private sectors, the decisions regarding price, output and investment are taken by the private entrepreneurs or the industrialists with a view to making profits and these decisions are mainly based on price mecha­nism. The private sector in the mixed economy is, however, influenced, regulated and controlled by the government through monetary and fiscal measures as well as through direct or physical controls.

Prior to 1991 in India, there was a ‘licensing system’ according to which to start and establish factories in certain industries, the government’s permission or license was neces­sary. However, under the economic reforms initiated since 1991 in India, licensing and permit system has been done away with and private sector has been given a lot of freedom for deciding about production and expansion in their enterprises.

Even foreign investment by multinational companies has been allowed to make investment in India and repatriate the profits to their home countries. However the government also regulates and controls the investment and production in the private sector through appropriate monetary and fiscal measures. By providing concessions in taxation, and by making available cheap credit facilities, the government provides incentives to private entrepreneurs for investment in the desired lines of production decided in development plans.

Role of Government in a Mixed Economic System:

As noted above, in the mixed economic system the Government plays a significant role in allocation of scarce resources and distribution of income. However, despite the important role of Government, the people and private enterprises are free to make economic transactions.


They voluntarily decide whether or not to transact, have the right to buy and sell what they want. Workers are free to accept or refuse any work they do not want to do, free to move to different places for employment of their choice. The right to own property and freedom of contract are maintained by the Government.

The Government makes laws which provide right to ownership of property and freedom of contract and courts are set up by it to enforce these laws. Besides, the Government maintains law and order to protect life and liberty of the people and to enforce property rights of the people. It also makes arrangements for defence of the country against foreign aggression.

Besides the above basic functions, Government intervenes in the economy to correct what are called market failures. These are the situations in which free market does not work efficiently. For example, natural resources such as forests, mines, common pastures tend to be overexploited resulting in their destruction under free market conditions.

Further, some goods, called public goods such as defense, law and order are not produced at all by private enterprises which are driven by profit motive. This is because once produced the people who do not even pay for them cannot be prevented from using them.


Moreover, private enterprises while producing goods often impose costs that are called detrimental externalities on others by their economic activities. For example, the production of goods in factories pollutes air and water surrounding them. This environment pollution causes a lot of harm to the people but the private enterprises do not have to pay for the harms they do to others.

Nor do they take into account these externalities in their cost calculations while making their investment decisions. As a result, there is overproduction of such goods whose production pollutes environment and impose costs on others and this causes misallocation of resources. The Government can prevent them by imposing taxes on private enterprises which pollute environment.

Above all, the Government in modern mixed economic systems takes fiscal and monetary policies to stabilize the economy against fluctuations in national income, employment and prices. Recession causes huge unemployment which deprives people of their livelihood. On the other hand, when there is inflation, cost of living of the people rises and as result there is a lot of human suffering. Inflation is a tax that hurts the poor people most. Following J.M. Keynes the Govern­ment adopts discretionary fiscal and monetary policies to lift the economy out of recession.

For example, recently in 2007-09 when due to global financial crisis originated in the US due to bursting of sub-prime housing loan bubble which caused global recession and meltdown, the Governments in the US, Britain, Japan, France and India too increased public expenditure and cut taxes to revive their economies.


In the US and other free market economies the Government even helped private banks with funds to bail them out of the turmoil. In India the Government borrowed heavily in 2008-09 and 2009-10 to increase its expenditure and also to cut taxes to prevent slowdown of the Indian economy due to the impact of global financial crisis. Similarly, when there is inflation the Central Bank of a country adopts tight monetary policy and the Government adopts contractionary fiscal policy to control rise in prices.

Last but not the least, it is a vital function of the modern Government to promote economic growth. Economic growth requires capital accumulation, progress in technology and investment in social sectors such as education and health. Besides, in developing countries like India the Government has to adopt measures to eradicate poverty that prevails on a large scale in these countries. For example, the Indian Government has started Mahatma Gandhi National Rural Employment Guarantee Scheme (MNREGS) under which it provides guaranteed employment to the poor households. Further, to help the poor.

The Government in India has also begun Public Distribution System under which it provides subsidized food grains to the poor households. Just as there are market failures, there are Government failures too. Mixed economy represents a middle path between a purely free-market economy and purely command economy.