A mixed economy is defined by the co-existence of a public and private sector. The specific mix between public and private can vary significantly from one mixed economy to another, however. Based on their respective natures, the private sector is subservient to the public sector. Private exchange can only take place where the government has not forbidden it or already assumed that role.
Mixed economies fall in between free markets and command economies. The free market is most closely associated with pure capitalism. A command economy is most closely associated with socialism. Mixed economies, with state-supervised markets, are most related to fascism (in the economic sense) and have several common features.
In a command economy, all resources are owned and controlled by the state. In a mixed system, private individuals are allowed to own and control some (if not most) of the factors of production. Free market economies allow private individuals to own and trade, voluntarily, all economic resources.
Government intervention and political self-interest play a key role in a mixed economy. This intervention can take many forms, including subsidies, tariffs, prohibitions, and redistributive policy. Some of the most universally applied mixed economic policies include legal tender laws, monetary control by a central bank, public road and infrastructure projects, tariffs on foreign products in international trade, and entitlement programs.
Changing Economic Policy
One important and understated feature of a mixed economy is its tendency for reactionary and purposeful economic policy changes. Unlike in a command economy (where economic policy is very often directly controlled by the state) or a market economy (market standards arise only out of spontaneous order), mixed economies can go through dramatic changes in the "rules of the game," so to speak.
This is because of the changing political pressures in most mixed economies. An example of this can be seen in the aftermath of the Great Recession when most governments moved to regulate financial markets tightly, and central banks lowered interest rates.
Advantages of a Mixed Economic System
Allows capitalism and socialism to coexist: A mixed economic system allows capitalism and socialism to coexist and function by segregating the roles of the government and the private sector. Capitalism sets prices through an equilibrium between supply and demand on private goods, while socialism sets prices through planning where the private sector fails or does not want to produce certain goods, such as public transportation, universal health care, and education. The government plays a crucial role in promulgating and enforcing laws and ensuring fair competition and business practices.
Allows government to internalize positive and negative externalities: The production of certain goods and use of resources by the private sector can come at a cost of their underproduction or overuse. For example, paper mills and mining companies are known for using too much water or polluting it during the production process, generating a negative externality for the general population who drinks this water. A mixed economic system ensures the government can step in and correct for the negative effect of the externality by either prohibiting harmful activity or heavily taxing it.
Allows for correction of income inequality: Capitalism is known for generating income inequality through a concentration of capital. A mixed economic system can correct such a phenomenon by taxing and redistributing wealth to the households located at the bottom of the income distribution.
Disadvantages of a Mixed Economic System
Spontaneous order and the price system: The concept of spontaneous market order grew out of Adam Smith's insight about the "invisible hand." This theory argues market information is imperfect and costly, and the future is uncertain and unpredictable. Since information is imperfect, some system of information coordination is necessary to facilitate trade and voluntary cooperation. For Ludwig von Mises and F.A. Hayek, by far the most successful information signals are market prices. Their term for this process is "catallaxy," which Hayek defines as "the order brought about by the mutual adjustment of many individual economies in a market."
Whenever government interferes in market prices, catallaxy is distorted, causing misallocations of resources and deadweight losses. Despite their best intentions, mixed economies are a burden on the price mechanism.
Government market failure: Public choice theory applies the principles of economic analysis to the government. The chief proponents of public choice theory argue governments necessarily create more market failures than they prevent and mixed economies rationally produce inefficient outcomes. American economist James Buchanan showed special interest groups rationally dominate in democratic societies because government activities tend to offer benefits directly to a concentrated, organized group at the expense of a poorly informed, disorganized tax base.
Milton Friedman showed that government-caused market failures tended to lead to increasing failures. For example, poor public schools create low-productivity workers, who are then priced out of the market by minimum wage laws (or other artificial workplace expenses) and must then turn to welfare or crime to survive.
Regime uncertainty: Economic historian Robert Higgs noted that mixed economies tend to have continuously changing regulations, or rules of trade. This is especially true in Western democracies with opposing political parties.