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The mixed economy

Mixed economy: The state/public and private sectors provide goods/services between them.

Every economy faces three questions: what to produce, how to produce it and who gets it. In a mixed economy, consumers (through the market) and the government answer these questions together. Most countries today have mixed economies.

The public sector and the private sector

Public sector: a part of the economy which is owned by the government and which operates in the public interest.

Private sector: Firms owned by individuals or groups that provide goods/services.

Examples of organisations in each sector:

• Private sector: sole traders, partnerships and companies, e.g. a local hairdresser, a firm of accountants or a car manufacturer.
• Public sector: government departments, public corporations (also called state-owned enterprises) and local authority services, e.g. a national health service, a state-owned airline or a council’s libraries and fire service.

Differences between the public and private sectors

Ownership

• Private sector: owned by private individuals, alone or in groups. A sole trader has one owner, a partnership has two or more, and a company is owned by its shareholders.
• Public sector: owned by central or local government, so the state owns all the organisation’s assets.

Control

• Private sector: run by the owners themselves or, in a company, by a board of directors that the shareholders vote for.
• Public sector: run by people the government chooses or the public elects. For example, a government minister leads each department, a board of directors selected by the government runs a public corporation, and elected councillors run local authorities.

Aims

• Private sector: the main aim is usually profit. Other aims include survival, especially for new firms, growth and being socially responsible.
• Public sector: organisations exist mainly to provide a public service. They try to improve the quality of their services, keep costs and waste low, and take account of social costs and benefits. Some state-owned businesses, such as airlines, also aim to make a profit.

How a mixed economy solves the economic problem

• What to produce: consumers decide which consumer goods are made, such as food, clothes and entertainment. Firms make whatever people want to buy. The government provides goods that the private sector would not produce enough of, such as education, roads, street lighting and policing.
• How to produce: private firms compete with each other, so they choose methods that keep quality high and costs low. Public sector organisations decide how to deliver their services and try to do so efficiently. The government sometimes pays private firms to do the work, e.g. to build and repair roads.
• For whom to produce: goods made by the private sector go to whoever can afford to buy them. Most public sector services are free for everyone and paid for from taxes. Many governments also give money to people who cannot work, e.g. because of illness or disability.

Market failure

Market failure: exists where resources are not allocated efficiently.

Markets often use resources well, but not always. When a market fails, resources are wasted, the wrong goods are produced, or people pay the wrong prices. This is an inefficient allocation of resources.

Five causes of market failure:

• Externalities: firms ignore some of the costs their production creates for others, e.g. a factory’s pollution damages people’s health.
• Lack of competition: one firm or a few firms dominate a market, so they can charge high prices and limit choice.
• Missing markets: the private sector does not supply some goods at all, e.g. public goods like street lighting.
• Lack of information: buyers and sellers do not know everything about prices, quality or how goods are made. People may buy the wrong things, firms may make the wrong goods, or prices may be wrong.
• Factor immobility: resources cannot easily move to other uses, e.g. a machine built for one factory may be scrapped when that factory closes, which wastes it.

Why governments intervene because of market failure

How a government can deal with each cause:

• Externalities: regulate firms that cause problems such as pollution, or fine them.
• Lack of competition: pass laws to stop firms dominating a market, e.g. by blocking a merger that would harm consumers, or control the prices that dominant firms charge.
• Missing markets: use tax revenue to provide public goods, often free of charge.
• Lack of information: pass laws that make firms give consumers more information about their products.
• Factor immobility: retrain workers whose jobs have disappeared so they can move into other work.

Public goods

Public goods: goods that are not likely to be provided by the private sector.

Two features of public goods:

• Non-excludability: once the good is provided, nobody can be stopped from benefiting from it, even without paying. People also cannot choose to opt out of it.
• Non-rivalry: one person using the good does not reduce the amount left for anyone else.

Examples include national defence, policing, street lighting and flood defences.

The free rider problem

Free rider: A person who takes advantage of a common resource without paying for it.

Nobody can be excluded from a public good, so people have no reason to pay for it. They can simply let others pay and still enjoy the benefit. A private firm could not make enough people pay, so it would not supply the good at all. This is why governments provide public goods and pay for them from taxes.

The role of the public and private sectors in production

• Private sector: provides most of the everyday goods and services that people buy, such as food, clothes, cars, electrical goods, holidays, entertainment and banking. It also supplies businesses with raw materials, components, machinery and services such as cleaning, IT and insurance.
• Public sector: provides public services, especially public goods and other services the private sector would under-supply, such as education, healthcare, policing and roads. These are usually free and paid for from taxes or government borrowing.

Because the public sector works in the public interest, its services are open to everyone. For example, a public park can be used by anyone, which may improve people’s health. However, money spent on parks cannot also be spent on other services, such as schools or hospitals.

The relative importance of the public and private sectors in different economies

The balance between the two sectors varies from country to country. One way to measure it is government spending as a share of national income: the higher the figure, the bigger the part the public sector plays.

Examples of large and small public sectors:

• Large public sector: in countries such as China, Russia, Sweden, the UAE and France, the government provides many key services and also owns large stakes in businesses such as banks, airlines and energy companies. In Cuba, the state owns and runs most industries and employs most workers.
• Smaller public sector: in countries such as Australia, Singapore and the USA, the government plays a smaller role and the private sector provides more goods and services.

Possible benefits of a large public sector:

• Jobs: the state can guarantee many jobs.
• Public goods: it is easier to provide the public goods a country needs.
• Externalities: the government is in a better position to monitor and control problems such as pollution.

However, a larger public sector has to be paid for, so taxes tend to be higher.

In recent decades, many economies have moved towards the private sector by privatising industries such as water, electricity and telecommunications.

Privatisation

Privatisation: The act of selling a company/activity controlled by the government to private investors.

For example, a government might sell its national airline, railway company or airports to private owners.

Effects of privatisation

Consumers

Possible benefits:

• Lower prices: a private firm wants to be efficient and win customers from its rivals, so it may cut costs and prices.
• Better quality: to make a profit, the firm has to keep its customers happy, so it may improve its products and service.
• More choice: competition may push the firm to widen the range of products it sells.

Possible drawbacks:

• Higher prices: the new owners want profit. If the firm faces little competition, e.g. a water company, it can raise prices.
• Worse service or safety: the firm may cut costs in ways that lower quality.
• Fewer services: the firm may stop providing services that make a loss.

Workers

Possible drawbacks:

• Job losses: a common way to cut costs is to cut jobs, so many people may be made redundant, raising unemployment.
• More pressure at work: workers may be pushed to raise their productivity or accept more flexible working.

Businesses

Possible benefits:

• Freedom to make decisions: the business can set its own objectives, prices and investment plans without government interference.
• More investment: private investors may put money into the business, helping it to expand.
• Greater efficiency: the profit motive encourages the business to cut costs and waste.

Possible drawbacks:

• No state support: the business can no longer rely on government money, so it needs profit to survive.
• Takeovers: a newly privatised firm may be bought by another company.
• More competition for others: rival businesses may face a tougher, more efficient competitor.

Government

Possible benefits:

• Revenue from the sale: the money can be spent on areas such as healthcare or education, used to reduce government debt, or used to avoid raising taxes.
• Tax on profits: the government can collect tax each year on the profits the privatised firm makes.
• Lower costs: the government no longer has to run or fund the business, so it can focus on other things.

Possible drawbacks:

• Costs of selling: advertising and organising a sale is expensive.
• Selling too cheaply: if assets are sold for less than they are worth, the government loses revenue.
• Lost profits: if the business was profitable, its future profits now go to shareholders instead of the government.
• Hard to reverse: buying the business back later can be very expensive.