Traditionally textbooks of economics presented what can be described as 'one-dimensional' classification of economic systems. Pure capitalism and pure socialism were located on the opposite sides of the picture with a linear spectrum of 'mixed economies' between them.
The pure systems were usually presented as hypothetical extremes that do not exist in real world. All the real economies were considered a mixture of elements of both capitalism and socialism. Each country had specific shares of the two pure systems in its mixture. So for example USA was close to pure capitalism, with only minor admixture of socialist elements, but France or Great Britain had much larger dose of socialism in their mixtures. Similarly USSR was close to pure socialism, but Yugoslavia although prevailingly socialist was a significant step away in the direction of capitalism.
The main ingredients that made the country either capitalist or socialist were type of ownership, market and central planning. So pure capitalism was made of private property and market, while pure socialism consisted of public property and central planning.
Formulated by the Dutch economist Jan Tinbergen and popular especially in 1960's. Let us quote from the original paper:
Jan Tinbergen: Do Communist and Free Economies Show a Converging Pattern?
" WE are witnessing today the coexistence of two radically different economic systems, the “communist” and the “free” economies (according to western terminology) or the “socialist” and “capitalist” systems (according to the eastern vocabulary). The various names given to them are far from precise. Perhaps the most imprecise thing about them is the suggestion that each of these systems represents something well-defined and hence invariant. Reality shows both to be in permanent change. Analysis of the nature of this change can prove quite fascinating. This essay proposes to show that the changes are in many respects converging movements. "
"The main forces behind the changes may be brought under two broad headings. On the one hand each system is learning from experience and trying to overcome some of its own weaknesses. On the other hand the systems begin to influence each other more and more. While in the beginning the communist system was not taken seriously by the free system this has changed to a considerable extent. The communist system has been interested in some “capitalist” achievements from its very start. Now it is not so much imitating some of the western methods as learning economics from its own experience."
Convergent hypothesis starts from the assumption that both capitalism and socialism have good and bad features but distinct each from the other. Where capitalism has faults socialism found better solution and where socialism is defective, capitalism works just fine. Some examples:
Countries are learning from each other, adopting institutions and methods that proved successful; capitalist countries are adopting planning, increasing the role of government and the degree of centralization, nationalizing key industries, banks etc.; socialist countries are decentralizing, adopting market incentives, allowing some private business; as a result all the countries are moving toward the center of the spectrum. In the center an optimal mixture of capitalism and socialism, that eliminated all the defects of both pure systems but preserved the positive traits is located. The convergence hypothesis claims that all the countries are over time converging to that optimal mix of capitalism and socialism.
During 1970s and early 1980s the convergence hypothesis lost its credibility. Mixed system failed to prove that they can work better than the pure systems; they tended to exhibit worst rather than best features of both. Decentralization and marketization reforms were discarded in socialist countries and orthodox central planning was restored. Capitalist countries abandoned planning, reduced government intervention and began to privatize public enterprises.
Another hypothesis began to dominate. It claimed that Capitalism and Socialism are mutually incompatible because they work on very different principles. If mixed the admixtures of the opposite system work against the original system so that the performance deteriorates. In other words each system is viable when pure, but in the mixed systems neither capitalism nor socialism works. As if it were a vacuum in between of them.
The vacuum hypothesis was probably first formulated by Hayek. He wrote in 'The Road to Serfdom' (1944 edition, page 42):
" most people still believe that it must be possible to find some middle way between 'atomistic' competition and central direction. Nothing, indeed, seems at first more plausible, or is more likely to appeal to reasonable people, than the idea that our goal must be neither the extreme decentralization of free competition nor the complete centralization of a single plan but some judicious mixture of the two methods. Yet mere common sense proves a treacherous guide in this field."
"Although competition can bear some admixture of regulation, it cannot be combined with planning to any extent we like without ceasing to operate as an effective guide to production. Nor is 'planning' a medicine which, taken in small doses, can produce the effects for which one might hope from its thoroughgoing application. Both competition and central direction become poor and inefficient tools if they are incomplete; they are alternative principles used to solve the same problem, and a mixture of the two means that neither will really work and that the result will be worse than if either system had been consistently relied upon"
In Eastern Europe the vacuum hypothesis was resurrected in 1960s during the attempts to reform their economies. It was resurrected second time in 1990s when the strategy of transition to market economy was discussed.
1) Way how economic decisions are coordinated.
2) Distribution of property rights.
The first characteristic determines the "Coordinating mechanism". Grossman distinguished three different types of coordinating mechanisms: Tradition, Market and Command. In contemporary societies mainly market and command are used, tradition exists but does not dominate the other two.
The second characteristic has two basic varieties: private property and public property. If private property prevails the system is called "Capitalism". If public property prevails then it is called "Socialism".
For more details see the excerpts from the book "Economic Systems" by Gregory Grossman.
This new approach to the classification of economic system is more flexible than the one-dimensional spectrum. It allows to combine capitalism not just with market but also with command. As an example of command capitalism Grossman pointed out Nazi Germany. Similarly Socialism may have two varieties command socialism and market socialism.
Most of the scholars in the Comparative economic Systems area adopted Grossman's classification and in some cases modified it further so that the real economies better fit in it .
In the following animation I use Grossman's classification with a small modification. Notice that the two-dimensional classification also allows richer specification of mixed economies. Now we can mix market and command or capitalism and socialism or both. It has also nontrivial implications for the convergence and vacuum hypotheses. For example there may be a vacuum between market and command (do not mix!) but convergence of capitalism and socialism.
The two dimensional classification penetrated also into some introductory economic textbooks. For example the chapter 40 of "economics" by Fischer, Dornbusch and Schmalensee shows the similar table as the one just above
The main difference between this and Grossman's classification is replacement of the term "Command" by "Central Planning". This is not a trivial difference. As will be argued bellow, there is a significant difference between the "command principle" and "central planning". Under the heading "planned capitalism" many other countries than South Korea and Japan may fit. Many West-European countries used central planning for some time after the WWII so that to call them "planned economies" might be quite appropriate. But it would be hardly appropriate to call them "command economies".
For explanation of the difference between command system and planning I will quote here from my paper "The Market Mechanism in a Socialist Economy" presented to a seminar at St. Anthony's College, Oxford in 1965. (Note: Keep in mind that this text is 35 years old and that I was at that time teaching at the Charles University in Prague. For obvious reasons I used the term "administrative methods of a highly centralized system of management" instead of "command economy" )
" for many years Marxist as well as non-Marxist economists seem to have held the over-simplified belief that socialism should be as thoroughly equated to centralized planning as is capitalism to a free market. This equation, together with variant methods of distributing the national income and different class and political relationships, were considered to be the decisive characteristics distinguishing socialism from capitalism...
The traditional conflict between planning and the market mechanism arose from mistaken premises: both sides identified planning with the administrative methods of a highly centralized system of management
In other words, the term "planning" was used to designate a situation in which virtually all economic decision-making was concentrated in some central agency - in the sense of Barone's Ministry of Production - leaving individual enterprises merely to fulfill its orders. This view is well enough known from von Mises and subsequent discussion, and was until recently the majority view in the socialist countries.
... it is possible to distinguish between a system of highly centralized day-to-day management of the economy and long-term planning. To plan means primarily to anticipate the probable and preferable evolution of the economy in the future and, within the potential defined by objective characteristics, to choose the optimal path to that development.
Planning, so conceived, may be associated with a system of centralized administrative day-to-day management of the economy which aims at an exact fulfillment of the plan, but it may also be connected with an economic system where economic decision-making is largely devolved to the individual enterprise, and coordination of the whole is achieved by the market mechanism, not by decree.
Correspondingly, a centralized system of administrative management does not necessarily have to be linked with planning, if the orders given by the central agency to enterprises are not based on reliable projections of the long-term development of the economy. In fact the Czechoslovak economy was for a time managed only under annual plans, of which the period covered was so short that it could hardly be said to have been planned.
In other words, while highly centralized administrative management negates the operation of the market mechanism, it does not necessarily coincide with planned development. The alternative to the market mechanism is administrative centralized day-to-day management of the economy - not planning.
Hence four types of economies may be distinguished:
Note that separation of planning from command or "administrative centralized day-to-day management" brings another dimension into the classification. Of course, the full classification would have also the division between capitalism and socialism. In this case we could have eight distinct categories:
Today I would make the following modification: Both plan vs. non-plan and market vs. command divisions belong to the coordinating mechanism, however one is a short run coordination and the other is long run coordination. In the long run coordinative mechanism the opposite of plan is not just "non-plan" but primarily the coordination by "future markets". There is one distinction between short run and long run coordinative mechanism. No economy can work without a short run coordination, but it can work without long run coordination. Such an economy could be statically efficient but dynamically would be inefficient.