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Role of Government in Economic Systems


The shortcomings of the free market mechanism under which there is no role of government in the economic development of a nation.

Due to the failure of the free market mechanism, the intervention of government became indispensible for the growth of an economy.

Now, the question arises of determining the extent of government in regulating and managing economic activities.


This remains a debatable issue among various economists. This is because of the reason that the government intervention is also not able to eradicate the economic problems of a nation completely.

Different economists have given different viewpoints for the role of government in an economy.

Following are some of the viewpoints given by different economists:

According to Colin Clark, “The role of government must be held at a ceiling of 25 per cent of the national income.”


According to Samuelson, “There are no rules concerning the proper role of government that can be established by a priori reasoning.”

From the aforementioned viewpoints, it can be concluded that the accurate and exact percent or amount of government intervention in an economy is hard to decide and calls for an issue of collective social choice. The extent of role of government differs in different economies. An economic system is a way through which economic resources are owned and distributed.

On the basis of the ownership and distribution of resources, the economic system can be grouped into three categories, which are shown in Figure-1:

Different types of Economic System

Let us learn about the different types of an economic system (as shown in Figure-1).

Capitalist Economy:


A capitalist economy refers to an economy that works on the principle of the free market mechanism. It is also termed as laissez faire system. In a capitalist economy, the role of government is very limited. The main functions of government, as given by Adam Smith, are to maintain law and order in a country, make national defense stronger, and regulate money supply. According to Smith, the market system administers various economic functions. However, over a period of time, the functions of government in an economy have increased.

In a capitalist economy, the main responsibilities performed by the government are as follows:

a. Developing and sustaining the free market mechanism system

b. Eliminating any kind of restrictions on the working of free competitive market

c. Increasing the effectiveness of free competitive market system through various measures

In the view of Meade, following are the responsibilities of a government in a capitalist economy:

a. Regulating and controlling various economic situations, such as inflation and deflation, by formulating and implementing various fiscal and monetary measures

b. Controlling the power of monopolistic and large corporations to elude various economic problems, such as unemployment and inequitable distribution of resources


c. Possessing the ownership of public utilities, such as railways, education, medical care, water, and electricity, which are required by an economy as a whole

d. Prohibiting discrimination among individuals and providing them equal educational and job opportunities

e. Limiting restrictive trade practices and power of trade unions

f. Maintaining law and order, administering justice, and safeguarding the freedom of individuals in an economy


g. Supporting private ventures in an economy

h. Creating central planning body that helps in the development of an economy on a larger scale

i. Handling problems to environment, extinction of natural resources, and growth of population

Therefore, we can conclude that the major role of government in a capitalist economy is to control and encourage the free market mechanism. In addition, the government should encourage private ventures for safeguarding the future of an economy.

Socialist Economy:


In a socialist economy, the function of government is entirely different from the function of government in a capitalist economy. In a capitalist economy, the government acts as a regulatory and complementary body. On the other hand, in a socialist economy, the government plays a comprehensive role in almost all economic activities, such as production, distribution, and consumption, of a nation. In a socialist economy, not only the ownership of private property is allowed to a limited amount, but the concept of free market mechanism is also eliminated.

The private ownership of resources, in a socialist economy, is changed by state ownership. In addition, in a socialist economy, the government plans and regulates all the economic activities centrally at a state level. Moreover, the decisions related to production, allocation of resources, employment, pricing, and consumption, are completely dependent on the government or its central planning authority. In a socialist economy, individual’s decisions are totally dependent on the limit decided by the government.

For example, individuals are given the freedom of choice, but it is subject to the limitations of policy framework of the socialist economy. The countries in which socialist economy is adopted are China, Yugoslavia, Czechoslovakia, and Poland. The objective of the government in a socialist economy is same as in the capitalist economy, such as growth, efficiency, and maintaining justice. However, the ways adopted by the socialist economy to achieve those objectives are different from the capitalist economy.

For example, in the capitalist economy, the main force of motivation is the private profit, whereas in the social economy, the encouraging factor is the social welfare. The socialist way of managing an economy facilitates the elimination of various evil activities of the capitalist economy, such as labor exploitation, unemployment, and inequality in the society. This is only the classical view of the socialist economy.


However, over a passage of time, the scope of socialist economy has also been reduced due to various reasons, such as prohibition of profits from private ventures, inadequate utilization of resources, and restrictions on economic development as noted by Union of Soviet Socialist Republics (USSR).

Mixed Economy:

Mixed economy refers to an economy that-comprises the features of both, the socialist economy and capitalist economy. This implies that working of a mixed economy is based on the principles of the free market mechanism and centrally planned economic system.

In a mixed economy, the private sector is encouraged to work on the principle of the free market mechanism under a political and economic policy outline decided by the government. On the other hand, the public sector, in a mixed economy, is involved in the growth and development of public utilities, which is based on the principle of socialist economy.

In a mixed economy the public sector comprises certain industries, businesses, and activities that are completely owned, managed, and operated by the government. Moreover, in a mixed economy, certain laws have been enacted by the government to restrict the entry of private entrepreneurs in industries reserved for the public sector.

Apart from this, the government also strives hard for the expansion of the public sector by nationalizing various private ventures. For example, in India, the government has nationalized several private banks, which has resulted in the expansion of the public sector. Besides working for the growth and development of the public sector, the government, in a mixed economy, controls the activities of the private sector by implementing various monetary and fiscal policies.

It should be noted here that the free market mechanism is actually a form of a mixed economy. This is because of the reason that in free market mechanism, both the private and public sectors exist simultaneously. However, public sector in a free market mechanism economy is different from the public sector of the mixed economy.

In free market mechanism economy, the public sector is responsible to maintain law and order in a country, make national defense stronger, and regulate money supply. On the other hand the public sector of a mixed economy is involved almost all economic activities, such as production, distribution, and consumption. For example, the public sector of an economy, such as India, is based on the socialist pattern of society.

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