. 24
( 33)


Defend your response.
to support the protectionist argument.
8. Analyzing Information Explain the infant
5. Identify two attempts to facilitate the growth
industries argument.
of international trade.
Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

JULY 27, 1998
The North American Free Trade
Agreement (NAFTA), is a free trade pact.
The trading area includes Canada, the
United States, and Mexico. NAFTA has
created one of the world™s most produc-
tive economic blocs, rivaled only by the
European Union and by Japan.

Change in
Clothing factory, Aguascalientes, Mexico

Meanwhile, several U.S. producers are build-
Mexico ing new mills in Mexico rather than expand at
home. Guilford Mills, Inc., a Greensboro (N.C.)
manufacturer, is spending $100 million on a
For the first time, Mexico this year overtook
knitting, dyeing, and finishing plant in the Gulf
China as the No. 1 supplier of clothing and tex-
Coast port of Altamira. . . .
tiles to the U.S. . . .
As the foreign-owned companies rev up their
Spurred by the North American Free Trade
export machines in Mexico, savvy local produc-
Agreement (NAFTA), the surge in apparel
ers are making sure they win, too. Denim pro-
exports has touched off an investment boom.
ducer Compa±ía Industrial de Parras expects to
Not only are manufacturers expanding their low-
boost its exports to $146 million this year, up 13
wage plants, but they are building high-tech
times since the start of NAFTA in 1994. It all sig-
operations to spin fibers and weave fabrics. . . .
nals a new era for the Mexican industry”and
To encourage the growth of the industry,
shows how NAFTA is reshaping North
Mexico is trumpeting both its proximity to the
America™s economy.
U.S. and the benefits of NAFTA to potential
”Reprinted from July 27, 1998 issue of Business Week, by special
investors. . . . Although Mexican garment work- permission, copyright © 1998 by The McGraw-Hill Companies, Inc.
ers start at about $6 a day”double their
Chinese counterparts”manufacturers save on
the three- to four-week shipping time from the
Examining the Newsclip
Far East. Mexican garments are trucked to the
U.S. border in two to three days”a crucial dif- 1. Analyzing Information What are manufacturers doing
ference in the time-sensitive garment business. as a result of the increase in apparel exports?
And NAFTA has eliminated U.S. import quotas 2. Understanding Cause and Effect How has NAFTA
on garments made from fabric produced in helped the growth of the garment industry in Mexico?
North America. . . .

Financing and Trade Deficits
Main Idea Key Terms
A long-lasting trade deficit affects the value of a foreign exchange, foreign exchange rate, fixed
nation™s currency and the price and volume of its exchange rate, flexible exchange rate, trade deficit,
exports and imports. trade surplus, trade-weighted value of the dollar
Reading Strategy Objectives
Graphic Organizer As you read the section, complete After studying this section, you will be able to:
a graphic organizer similar to the one below by 1. Explain how foreign currency is used in trade.
describing the effects of a long-lasting trade deficit. 2. Describe the problem of a trade deficit and the
main solution to the problem.
Applying Economic Concepts
Foreign Exchange Do you have any souvenir foreign
Trade deficit currency such as pesos, pounds, or yen? Read to find
out how this foreign exchange is used to finance
international trade.

rade between nations is similar to exchange
Cover Stor y between individuals. The major difference
is that each country has its own monetary
system, which makes the exchange more compli-
Quaking Before cated. The value of some currencies, like the
the Fed Hong Kong dollar in the cover story, is tied to the
value of the U.S. dollar in the hope of simplifying
No place has more to fe
international trade.
from every twitch of
monetary policy than
Kong. Its currency is rig
Boeing 747 flies over
to the U.S. dollar, Financing International Trade
pegged Kowloon peninsula
en U.S. interest rates
and wh
must Scenarios like the following occur every day
go up, Hong Kong™s
its worst recession in
With the economy in across the globe. A clothing firm in the
n ill afford higher rates,
century, Hong Kong ca United States wants to import business suits from a
half a
is now leaning in that
gh the Federal Reserve company in Great Britain. Because the British firm
direction. . . . pays its bills in a currency called “pound sterling,”
ng process of deflation
Hong Kong, the] grindi
[In it wants to receive payment in sterling. Therefore,
down about 50% from
ues. Property prices are
government expects the American firm must exchange its dollars for
mid-1997 peak . . . the
for all of 1999 . . . real British pounds.
umer prices to fall 2.5%
8% . . . the benchmark
st rates [are] more than
intere st
. . 26% below its Augu
g Seng stock index is . Foreign Exchange
Han e
st rates could knock [th
, peak, and higher intere
ry off track. In the field of international finance, foreign
current modest] recove
exchange”foreign currencies used to facilitate
21, 1999
”Business Week, June
international trade”are bought and sold in the

foreign exchange market. This market includes American exporters sometimes accept foreign
banks that help secure foreign currencies for currency or checks written on foreign banks for
importers, as well as banks that accept foreign cur- their goods. They deposit the payments in their
rencies from exporters. own banks, which helps the American banking sys-
Suppose that one pound sterling, £1, is equal to tem build a supply of foreign currency. This cur-
$1.62. If the business suits are valued at £1,000 in rency then can be sold to American firms that want
London, the American importer can go to an to import goods from other countries. As a result,
American bank and buy a £1,000 check for $1,620 both the importer and the exporter end up with the
plus a small service charge. The American firm then currency they need.
pays the British merchant, and the suits are imported. The foreign exchange rate is the price of one
country™s currency in terms of another country™s cur-
rency. The rate can be quoted in terms of the United
States dollar equivalent, as in $1.61 = £1, or in terms
ECONOMICS of foreign currency per United States dollar, as in
Figure 17.4
£0.6194 = $1. The rate is reported both ways, as
shown in the foreign currency listings in Figure 17.4.
Foreign Exchange Rates
Fixed Exchange Rates
Today, two major kinds of exchange rates exist”
Exchange Rates fixed and flexible. For most of the 1900s, the world
Thursday, August 10
depended on fixed exchange rates”a system under
U.S. $ which the price of one currency is fixed in terms of
Country per U.S. $
equiv. another so that the rate does not change.
Argentina (Peso)........ 1.0010 0.9990 Fixed exchange rates were popular when the world
Australia (Dollar) ....... 0.6518 1.5342
was on a gold standard. Gold served as the common
Britain (Pound) ......... 1.6145 0.6194
denominator that allowed comparisons of curren-
Canada (Dollar) ......... 0.6680 1.4970
cies, and it also kept exchange rates in line. For exam-
Chile (Peso).............. 0.001952 512.25
ple, suppose that a country allowed its money supply
China (Renminbi) ...... 0.1208 8.2771
Czech. Rep. (Koruna) to grow too fast and that some of the money was
Commercial rate....... 0.02956 33.825
spent on imports. Under a gold standard, the coun-
Finland (Markka)........ 0.1801 5.5511
tries receiving the currency had the right to demand
France (Franc) ........... 0.1633 6.1241
that it be converted into gold. Because no country
Germany (Mark)......... 0.5476 1.8260
wanted to lose its gold, each country worked to keep
Israel (Shekel)........... 0.2372 4.2166
Japan (Yen) .............. 0.008705 114.87 its money supply from growing too fast.
Mexico (Peso)
Floating rate........... 0.1051 9.5190
Russia (Ruble)........... 0.04073 24.550
South Korea (Won)..... 0.000834 1199
Taiwan (Dollar).......... 0.03114 32.109 Economic Espionage
Economic espionage is on the increase as trade
grows between countries. Economic espionage
is the stealing of technology secrets. In order to
be competitive, many countries are tempted to
steal the secrets of another to avoid paying the
Reading the Financial Page Exchange
high costs of research and development. Fax
rates are set according to the demand and
machines, cellular phones, and the Internet
supply of different types of money. About
make it easier than ever to commit economic
how many Japanese yen equals one U.S.
Japanese yen equal one

Figure 17.5

Flexible Exchange Rates
A The Foreign Exchange Market for Dollars B The Foreign Exchange Market for Marks
S D1
S1 S
Price of a $ in DMs

Price of a DM in $
4 DM
2 DM
S D1
S1 D
Quantity of $ Quantity of DMs

Using Graphs The value of foreign exchange, like the value of most other products, is determined
by supply and demand. When investors sell one currency to buy another, what happens to
the value of the currency that is sold?

This practice worked until the early 1960s when
Flexible Exchange Rates
the United States developed a huge appetite for
When the United States stopped redeeming for-
imports. During that time, it bought large quantities
eign-held dollars for gold, the world monetary sys-
of foreign goods with dollars. At first, foreign coun-
tem went to a floating or flexible rate system.
tries willingly held dollars because they were
Under flexible exchange rates, also known as float-
acceptable as an international currency, so only a
ing exchange rates, the forces of supply and
portion of these dollars came back when other
demand establish the value of one country™s cur-
countries bought American exports.
rency in terms of another country™s currency.
As dollars began to pile up in the rest of the
Figure 17.5 shows how flexible exchange rates
world, many countries wondered if the United
work. In 1971, for example, the price of the dollar
States could honor its promise that the dollar was
was four German marks (DM) as shown in Panel A.
“as good as gold.” Eventually France and several
Alternatively, we could say that the price of one
other countries started redeeming their dollars,
DM was $0.25 as shown in Panel B.
which drained U.S. gold reserves. As a result,
Suppose now that an American car dealer
President Richard Nixon announced that the
wanted to purchase Volkswagens that could be
United States would no longer redeem foreign-
bought for 12,000 DMs in Germany. To obtain a
held dollars for gold in 1971. This action saved
single car, the American importer would have to
the gold stock, but it also angered many foreign
sell $3,000 in the foreign exchange market to
governments that were planning to cash their
obtain the 12,000 DMs needed to buy the
American dollars into gold.

Volkswagen. This would simultaneously increase switch to flexible rates did not interrupt the
the supply of dollars shown in Panel A and the growth in international trade as many people had
demand for DM in Panel B. Eventually the con- feared. More countries trade with one another
tinuing American demand for foreign products today than ever before.
would push the value of the dollar down to 2
DM, and its reciprocal, the price of the DM, up
Trade Deficits and Surpluses
to $0.50.
When the dollar reaches 2 DMs, the price of the A country has a trade deficit whenever the
Volkswagen is much less competitive. This is value of the products it imports exceeds the
because the importer now has to pay $6,000 to value of the products it exports. It has a trade surplus
obtain the 12,000 DMs needed to purchase the car. whenever the value of its exports exceeds the value of
Excessive imports thus cause the value of the dol- its imports. Each is dependent on the international
lar to decline, making imports cost more. value of its currency.
This may be bad news for U.S. importers, but it is
good news for exporters. A German firm that bought
The International Value of the Dollar
American soybeans at $6 a bushel before 1971, for
Ever since floating rates became standard in
example, would have paid 24 DMs for each bushel.
1971, the Federal Reserve System has kept a statistic
After the value of the dollar fell, it had to pay only
that measures the international value of the dollar.
12 DMs for each bushel. As a result, soybeans were
Called the trade-weighted value of the dollar, it is
cheaper, and more could be sold abroad.
an index showing the strength of the dollar against
The system of flexible exchange rates has
a group of foreign currencies. When the index falls,
worked relatively well. More importantly, the
the dollar is weak in relation to other currencies.
When the index rises, the dollar is strong.
When the dollar reached strong levels in 1985,
foreign goods became less expensive, and
American exports became more costly for the rest
of the world. As a result, imports rose, exports fell,
and the United States suffered record trade deficits
in 1986 and 1987. The value of the dollar remained
Sociologists study the develop-
relatively stable throughout the early 1990s, and
ment, interaction, and behav-
then rose late in the decade when the rest of the
ior of organized groups as well
as various social, religious, and world, especially countries in Asia, experienced an
business organizations. economic downturn. The stronger dollar led to
another record trade deficit in late 1999.
The Work
Sociologists may work for the
The Effect of a Trade Deficit
government, universities and
colleges, and in private busi- A persistent trade imbalance tends to reduce the
ness. Duties include gathering value of a country™s currency on foreign exchange
firsthand information from markets. The devalued currency then causes a chain
people. They prepare reports to be used in comparative
reaction that affects income and employment in
studies of similar programs in other communities.
that country™s industries.
Sociologists derive conclusions about the effectiveness of
To illustrate, the large deficit in the United States
programs that can lead to formulating policy.
balance of payments in the mid-1980s and late
Qualifications 1990s flooded the foreign exchange markets with
dollars. An increase in the supply of dollars, as
Sociologists must be skilled in research and analysis and
illustrated by the supply and demand curves in
possess the ability to communicate ideas clearly. A mas-
Figure 17.5, causes the dollar to lose some of its
ter™s degree in sociology is a requirement.

value. The weaker dollar causes unemployment to
The Global Economy
rise in import industries as imports become more
expensive, and it causes unemployment to go
down in export industries as their goods become
more competitive.
Eventually the dollar will get strong again as for-
eigners sell their currency in order to buy dollars”
thereby reversing the patterns of unemployment.
As the dollar gets stronger, export industries will
have a more difficult time and import industries
will begin to recover. The economy may adjust
slowly to changes in the value of the dollar, but the
adjustments do take place.
As a result, the shift in employment between
import and export industries is one of the biggest
problems with a trade deficit. In the automobile
industry, for example, Japanese cars once under-
cut the price of cars being produced in Detroit,
causing severe unemployment for both domestic
autoworkers and domestic car dealerships. As the
Japanese yen rose against the dollar in the early Value of Currency Exchange When the value
1990s, however, the price of Japanese cars of the dollar goes up, American exports go
increased, making domestic automobiles more down and imports rise. What causes the value
of the dollar to fluctuate?
attractive and restoring some of the employment
in that industry.
Under flexible exchange rates, trade deficits weak currency tends to cause trade surpluses,
tend to automatically correct themselves through which eventually pull up the value of the currency.
the price system. A strong currency generally leads As a result, the United States and many other
to a deficit in the balance of payments and a sub- countries no longer design economic policies just
sequent decline in the value of the currency. A to improve their trade position.

Checking for Understanding Applying Economic Concepts
5. Foreign Exchange How does a weak
1. Main Idea What is the relationship between
American dollar affect you as a consumer?
the international value of the dollar and
How does a strong dollar affect you?
foreign trade?
2. Key Terms Define foreign exchange, foreign
exchange rate, fixed exchange rate, flexible
exchange rate, trade deficit, trade surplus, 6. Making Generalizations How do exchange
trade-weighted value of the dollar. rates influence international trade?
3. Describe how foreign exchange is used 7. Making Comparisons Explain the difference
in trade. between a fixed exchange rate and a flexi-
ble exchange rate.
4. Explain how trade deficits correct themselves
under flexible exchange rates. Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

Drawing Inferences and Conclusions
To infer means to evaluate information and arrive at a conclusion. When you
make inferences, you “read between the lines,” or draw conclusions that are
not stated directly in the text. You must use the available facts and your own
knowledge and experience to form a judgment or opinion about the material.

manufactured goods. Beginning in the 1860s, Northern
industrial interests in control of the government passed high
protective tariffs to prevent foreign competition from
threatening our young industries. With some fluctuations,
these tariffs remained high until the 1930s, when President
Franklin Roosevelt tried to increase trade by lowering tariffs
and encouraging our trading partners to do the same.
When World War II ended, the United States knew it
would be necessary to help Europe rebuild its economy. The
government did this through the Marshall Plan, which
provided the resources needed to reconstruct European
economies. Along with other nations, the United States set
International flags, airport display up a World Bank for Reconstruction and Development
from which all nations could borrow. The United States
also led the development of the International Monetary
Learning the Skill
Fund, so that nations could borrow foreign currencies in
Use the following steps to help draw inferences short-term loans in order to trade. Finally, the United
and make conclusions: States helped organize the General Agreement on Tariffs
and Trade (GATT). Under this agreement, nations meet
• Read carefully for stated facts and ideas.
regularly to discuss mutual tariff policies.
• Summarize the information and list the impor-
tant facts. 1. What events does the writer describe?
• Apply related information that you may already 2. What facts are presented?
know to make inferences.
3. What can you infer about the effects of the Marshall
• Use your knowledge and insight to develop some Plan on relations between the United States and
conclusions about these facts. Europe today?
Practicing the Skill 4. What conclusion can you make about U.S. trade
Read the passage below, then answer the
questions that follow.
From its beginnings until the mid-1860s, the
United States encouraged trade with other nations,
Study the statistics in Figure 17.1 on page 468.
protecting only a few industries from foreign
From the data, what can you infer about U.S. trade
competition. We encouraged the world to buy
with Canada? Why does this relationship exist?
American agricultural products and traded for
Practice and assess key social studies skills with the
Glencoe Skillbuilder Interactive Workbook, Level 2.
Section 1 • The most favored nation clause is important to
many countries because it gives them the same tariff
Absolute and Comparative reductions that the United States negotiates with
other trading nations.
Advantage (pages 467“470)
• The GATT was established in 1947 and has evolved
• The United States is into the World Trade Organization (WTO), which
extensively involved administers GATT agreements, pro-
in international trade, motes freer trade, and helps
with the average settle disputes between gov-
American spending ernments.
more than $4,200 per
• The North American
year for imports in Free Trade Agreement
the form of goods (NAFTA) will eventu-
and services. ally remove all trade
• Absolute advantage means that a country can pro- barriers among Canada,
duce more of a good than another country can. Mexico, and the United
• The basis for trade today is comparative advantage.
If people and countries specialize in the things they
produce relatively more efficiently, and if they
Section 3
engage in trade to secure the things they do not
produce, then total world output will increase.
Financing and Trade Deficits
(pages 481“485)
Section 2
• Foreign exchange is the lifeblood of international
Barriers to International Trade trade; its value is determined in foreign exchange
markets where currencies are bought and sold.
(pages 472“479)
• Most countries use a system of floating or flexible
• Barriers to trade include tariffs, quotas, licensing, exchange rates, meaning that supply and demand
health certifications, and voluntary quotas, all of determine the currency™s value.
which have been used to restrict the free flow of
• Some smaller countries also use a system of fixed
products. exchange rates, which ties the value of their currency
• Protectionists support trade barriers on the grounds to a major currency like the U.S. dollar.
of national defense, infant industries, protecting
• The large trade deficits in the United States in the
domestic jobs, keeping the money at home, and mid-1980s were partially caused by a strong dollar,
helping the balance of payments. resulting in unemployment in the export industries;
• Free traders believe that all of these arguments are the country would have had a trade surplus if the
flawed, with the possible exception of the infant value of its exports had exceeded the value of its
industries argument. imports.
• •
High tariffs were one of the causes of the Great Because deficits tend to be self-correcting, most
Depression, although the world has moved toward nations no longer design economic policies just
freer trade since then. to improve the balance of payments.

3. Explain how comparative advantage can make trade
between countries of different sizes possible.

Section 2 (pages 472“479)
Self-Check Quiz Visit the Economics: Principles
4. Name three barriers to international trade.
and Practices Web site at epp.glencoe.com and
click on Chapter 17”Self-Check Quizzes to pre-
5. Describe five protectionist arguments.
pare for the chapter test.
6. Describe the role of the WTO in the free trade

Identifying Key Terms Section 3 (pages 481“485)
For each of the pairs of terms below, write a sentence or short 7. Differentiate between fixed and flexible exchange
paragraph showing how the two are related. rates.
1. absolute advantage 8. Explain how deficits can be self-correcting when
comparative advantage currency values are flexible.
2. balance of payments
trade deficit
Thinking Critically
3. balance of payments
flexible exchange rates 1. Drawing Conclusions Do you favor protection
4. trade deficit as a national trade policy? Why or why not?
trade surplus
2. Making Comparisons What is the difference
5. foreign exchange
between a protective tariff and a revenue tariff? Use
flexible exchange rates
a graphic organizer similar to the one below to help
6. protectionist
you organize your answer.
infant industries
7. protective tariff
revenue tariff
8. tariff Protective Revenue
9. trade deficit
trade-weighted value of the dollar
3. Analyzing Information Some people feel the
United States should return to a system of fixed
Reviewing the Facts exchange rates. Defend or oppose this view. Cite
examples to support your position.
Section 1 (pages 467“470) 4. Understanding Cause and Effect Does the protec-
tion of inefficient industries hurt an economy?
1. Describe the extent of United States involvement
Why or why not?
in world trade.
5. Making Comparisons How might the issue of
2. Describe a case in which the United States might
protectionism differ for a worker and a consumer?
have an absolute advantage over another country
Use examples to support your argument.
in the production of a good.

Applying Economic Concepts your school. Find out where each item is produced,
and make a log of the items, noting whether each is
1. Comparative Advantage Think of a project you domestic or foreign made.
recently completed with a friend. How could you
Next, write a persuasive argument explaining your
have completed the project more efficiently, apply-
opinion on international trade. In writing a persua-
ing the principle of comparative advantage?
sive argument, it is important to state the issue
clearly and to give your position on it.
2. Quotas You have just started a business manufac-
Use the evidence you gathered in your log notes to
turing toothbrushes. Would you favor a quota on
support your position and to refute any opposing
imported toothbrushes? Why or why not?
position. Use other sources to identify evidence that
3. Foreign Exchange Explain how doubling the will help you establish your claim. Conclude your
$400 tax-free limit on goods brought in from argument by restating your position and summing
abroad by American citizens would affect the up the evidence.
balance of payments.
Finally, e-mail your argument to the editor of a news-
4. Interdependence How does the lack of certain raw paper or magazine. One day soon, you may see your
materials force nations to become interdependent? argument in print!

Math Practice
Suppose you are planning a trip to Russia and plan
Drawing Inferences and Conclusions Read
to bring $500 in spending money. If the exchange
the following passage about U.S. trade with
rates in Figure 17.4 prevail at the time of your other nations. Use the stated facts and your
departure, how many rubles would you have after own knowledge to answer the questions that
you exchanged your dollars for rubles? If you spent follow.
5,000 rubles while you were there, and if you con- In the early 1980s, American producers found
verted the rest of the rubles back to dollars when you it increasingly difficult to sell their products
to other countries. At least part of this prob-
came home, how many dollars would you have?
lem was the result of the high value of the
dollar. To buy American products, foreign
nations must trade their currency for dollars.
Thinking Like an Economist When the dollar™s value is too high, foreign
nations receive fewer dollars in exchange for
Assume that the country is running a large trade their money. Beginning in the mid-1980s, the
deficit. What predictions would you make about value of the dollar declined in relation to for-
future changes in the value of the dollar in the for- eign currencies. That was like putting Ameri-
can products on sale to foreign buyers. U.S.
eign exchange markets. Would these developments
exports increased sharply.
be a matter of concern?
1. What is the main topic of the passage?
2. What facts are presented?
Technology Skill 3. From this passage, what can you infer
about fluctuations in U.S. trade?
Using E-Mail During the course of one day, make a
4. What fact(s) or observations helped you
note of at least 10 manufactured items you handle,
make this inference?
such as your clothing and the cafeteria trays used in
Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

The freedom to use
your own tools and
labor in pursuit of profits is one
of the primary features of
capitalism. In Chapter 18, you
will learn that capitalism is more
than an ideology. It is the way
we live and the way the world is
headed. To learn more about
the different systems of
economics, view the Chapter 25
video lesson:
Comparative Economic Systems

Chapter Overview Visit the Economics: Principles
This scene of the city of Jaipur in
and Practices Web site at epp.glencoe.com and
northwest India shows a blend
click on Chapter 18”Chapter Overviews to pre-
of traditional and modern life.
view chapter information.
The Spectrum of
Economic Systems
Main Idea Key Terms
Capitalism, socialism, and communism are historically capitalism, socialism, communism
three popular economic systems.
Reading Strategy After studying this section, you will be able to:
Graphic Organizer As you read the section, complete 1. Explain the advantages and disadvantages of
a graphic organizer similar to the one below by list- capitalism.
ing six advantages of capitalism and providing an 2. Describe the differences among the doctrines
example of each. of socialism, capitalism, and communism.
3. Compare the features of communism to other
types of economic systems.
Advantages Examples
Applying Economic Concepts
Surplus Value Have you ever felt that the value of
your work was much more than your wage? If so, you
have something in common with Karl Marx, who
founded communism and introduced the concept of
surplus value that is extracted from labor.

Cover Stor y
hroughout most of the 1900s, the world™s
developed nations fell into three categories
Sweden Pays the of economic systems”communism, social-
Price of High Taxes ism, and capitalism. Communist countries were
closely associated with command economies, capi-
STOCKHOLM”Elect talist countries were most similar to market
AB, the big Swedish economies, and socialist countries had a combina-
obe for a Stephan Carlquist
maker, scoured the gl
tion of both command and market economies.
w da
person to set up a ne n
ar before finding Stepha Sweden is an example of a country with a strong
ocessing division last ye
pr ea
nior executive at ABB As socialist tradition, and”as you read in the cover
rlquist, a Swede and se
nited States. story”the high taxes that go along with it.
Brown Boveri in the U no
mp to Electrolux was
Persuading him to ju The three basic types of economic systems are
m to Sweden, home of
oblem, but bringing hi shown in Figure 18.1. At the far left is communism,
pr her
est tax rates, was anot
dustrialized world™s high in which a strong central government influences
in on,
uist set up shop in Lond
atter. Instead, Mr. Carlq almost every economic decision. At the far right is
where taxes are lighter. capitalism, in which government has a limited role.
plans to build a multin
Over the next year, he
50 people”few of them As one moves from left to right along the spectrum,
nal team of as many as
tio rna-
rd to attract skilled, inte both the ownership of resources and the degree of
Swedes. . . . “It™s very ha
.” Mr. Carlquist said. government involvement in the operation of the
tional people to Sweden
economy change.
16, 1999
Tribune, March
”International Herald

No lines separate communism, socialism, and the countries that have the highest living standards
capitalism. They appear on the spectrum as having and per-capita incomes today are ones with market-
a greater or lesser degree of government involve- based capitalist economies.
ment and private ownership of resources.

Disadvantages of Capitalism
Capitalism Capitalism has its disadvantages. Although it is
efficient in satisfying the demands of consumers, it
Under capitalism, the means of production
does not always satisfy everyone™s needs. At a collec-
are privately owned. Supply and demand
tive level, capitalism ignores the production of many
determine prices, and businesses are free to direct
public goods such as roads, public schools, a system
resources into activities that promise the greatest
of justice, and national defense. Instead, the market
produces private goods and services”items that can
be withheld if people refuse to pay for them.
Advantages of Capitalism At an individual level, capitalism produces only
for those who have demand, which means the abil-
One of the main advantages is efficiency. If there
ity and willingness to pay. A system of pure capital-
are many buyers and sellers, if resources are reason-
ism would ignore poor people, the unemployed, and
ably mobile, and if buyers and sellers are reasonably
less productive members of society like the elderly.
well informed, then resources will be directed to
their most profitable and efficient use.
Another advantage is freedom, which gives con-
sumers the opportunity to purchase the goods and
services that best satisfy their preferences. Producers
Socialism is an economic system in which
also have the freedom to direct productive resources
government owns and runs some of the
into activities that consumers demand most.
basic productive resources in order to distribute
Producers have the incentive to do so because of the
output in ways deemed to be in the best interest
profit motive, and because private property rights
of society. Most socialist societies are democracies
allow them to keep the fruits of their efforts.
in which elected officials direct the allocation of
A third advantage is that capitalism is highly
resources in key industries.
decentralized. Consumers and producers jointly
answer the WHAT, HOW, and FOR WHOM
questions all societies face. This is made possible
Advantages of Socialism
because of the price system, which sends signals to
both producers and consumers. The decentralized Socialism addresses the FOR WHOM question
nature of decision making leads to the fourth directly. Those who are not fortunate or productive
advantage. Specifically, the role of government in enough to earn a competitive income still share in
the economy is much smaller. the benefits of society. Although the government
The fifth advantage is the high degree of con- owns the majority of productive resources in a
sumer satisfaction that comes from the variety of socialist society, people use their electoral power to
products that are produced to satisfy consumer influence many of the WHAT, HOW, and FOR
demands. The sixth advantage is the flexibility to WHOM questions.
accommodate change. When consumer preferences
change, or when the price of resources changes, sig-
Disadvantages of Socialism
nals are sent through the price system and everyone
Socialism is normally less efficient than capital-
adjusts accordingly.
ism. If workers receive government guarantees of
The most visible result of these advantages is
jobs, more workers will be hired than are neces-
the enormous amount of wealth that capitalist
sary, driving up the cost of production. The
nations have accumulated. With few exceptions,

Figure 18.1

The Spectrum of Economic Systems

Directed by Command Directed by the Free Market

Ownership of Resources
All productive Basic productive resources Productive resources
resources are are government owned and are privately
government owned operated; the rest are privately owned and operated.
and operated. owned and operated.

Allocation of Resources
Centralized Government plans ways Capital for production is
planning directs to allocate resources in obtained through the lure
all resources. key industries. of profits in the market.

Role of Government
Government makes Government directs the Government may
all economic completion of its economic promote competition and
decisions. plans in key industries. provide public goods.

Using Charts The distinguishing feature of economic systems is the ownership of the factors of
production and the role of government in deciding WHAT, HOW, and FOR WHOM to produce. How
is capital for production acquired under capitalism?

government also has an incentive to keep these
workers employed”even if they are not all
In its purest form, communism is a political
needed”to show that the government is providing
and an economic framework where all prop-
jobs for everyone.
erty is collectively owned, labor is organized for
Because the government provides a broader
the common advantage of the community, and
range of services such as health care, education,
everyone consumes according to their needs.
and welfare, taxes are generally higher in socialist
To date, no modern country has achieved the
countries. This often causes the type of labor
ideal of pure communism. Countries such as Cuba,
mobility problems discussed in the cover story”
North Korea, and the former Soviet Union instead
where workers may be reluctant to work in coun-
developed rigid command-type economies where
tries with such high taxes.

the state”usually represented by a single authori- to an advanced industrial one in the course of a few
tarian party”claims the ideal of pure communism short decades.
as its eventual goal.

Disadvantages of Communism
Advantages of Communism One of the first disadvantages of communism is
One of the main advantages of communism, that individual freedom is lost. People have little or
from the typical worker™s point of view, is that of no say in their jobs, and economic planners deter-
equality. Because everyone is theoretically equal, mine even the choice of occupation.
the wages of workers from the assembly line in the Communism also lacks effective incentives that
factory to the surgeon in the hospital are nearly encourage people to work hard. Most people receive
identical. the same pay regardless of how hard they work.
To make up for the lack of purchasing power, the Communism generally fails to meet the needs
state provides a broad range of public goods such and wants of consumers, primarily because the
as health care, transportation, education, and a mil- WHAT to produce question is determined by cen-
itary defense system. These services are normally tral planners. Most communist states place a high
supplied at little or no cost. priority on military preparedness, resulting in the
A third advantage is the lack of uncertainty con- neglect of consumer goods that are highly prized in
cerning careers and job security. This is because the other parts of the world.
state directs workers into their jobs, and workers are One of the biggest drawbacks to communism is
not fired or dismissed as they could be in other the inefficiency of centralized planning. The
societies. resources needed to execute the planning, and the
A fourth advantage is that the centralized con- overwhelming obstacles to effective execution, are
trol allows the economy to shift directions in a rel- serious problems that countries encounter after
atively short period of time. In the case of the reaching a certain size. Finally, communist
former Soviet Union, the entire economy changed economies, like most command economies, lack the
from a relatively underdeveloped agrarian nation flexibility to deal with day-to-day changes.

Checking for Understanding by paying them less than they are worth in
order to make a larger profit. Do you think
1. Main Idea Identify the three broad economic
Marx™s opinion is valid in the United States
systems of the last century.
today? Why or why not?
2. Key Terms Define capitalism, socialism,
3. List the advantages and disadvantages of
7. Making Comparisons How does the role
4. Explain how capitalism, socialism, and com-
of the individual differ under capitalism,
munism are different.
socialism, and communism? Explain your
5. Describe how communism differs from other reasoning.
types of economic systems.
8. Finding the Main Idea What people does
Applying Economic Concepts pure capitalism tend to ignore? Explain why
6. Surplus Value According to Karl Marx, this is the case.
employers take advantage of their employees Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

Using a Database
A computerized database program can help you organize and manage a large
amount of information. After entering data in a database table, you can
quickly locate the information according to key words.

Learning the Skill
An electronic database is a collection of facts that
are stored in a file on the computer. The information
is organized into categories called fields. For example,
one field may be the names of your clients. Another
field may be the street addresses of your clients. All
the related fields make up a record. Together, all the
records make up the database.
A database can be organized and reorganized in
any way that is useful to you. By using a database
management system (DBMS)”or special software
developed for record keeping”you can easily add,
delete, change, or update information. When you
want to retrieve information, the computer searches
Using a database can help organize population
the files, finds the information, and displays it on the statistics, clients™ names and addresses, and even
screen. baseball card collections.

Practicing the Skill
2. Follow the instructions in the DBMS that you™re
Follow these steps to build a database on
using to set up fields. Then enter each item of data in
economic reform in China.
its assigned field.
1. Determine what facts you want to include in
3. Determine how you want to organize the facts in the
your database and research to collect that
database”chronologically by the date, alphabetically,
or by some other category.
4. Follow the instructions in your computer program to
sort the information in order of importance.
5. Verify that all the information in your database is
correct. If necessary, add, delete, or change information
or fields.

Research and build a database that organizes
information about U.S. trade with countries in
Asia. Explain why the database is organized the
way it is and how it might be used in this class.
The Rise and Fall of Communism
Main Idea Key Terms
Communism is an economic system that has both Five-Year Plan, collectivization, Gosplan, state farm,
centralized control of the means of production and collective farm, piecework, storming, perestroika
of the political system.
Reading Strategy After studying this section, you will be able to:
Graphic Organizer As you read the section, complete 1. Explain the rise of the Soviet economy under Lenin
a graphic organizer similar to the one below by and Stalin.
explaining how the economic system in the former 2. Describe the complexities of a centrally planned
Soviet Union answered the basic economic questions. economy.
3. Understand the forces that brought about the col-
lapse of communism as an economic system.
Soviet Union
Applying Economic Concepts
What For whom Perestroika Have you ever thought that some aspects
of the economy should be changed from top to bot-
tom? If so, read to find out more about perestroika,
which is the Russian term for “restructuring.”

n the absence of pure communism, the former
Cover Stor y Soviet Union is the most frequently cited exam-
ple of a communist economic system. The early
Kiev to Pay Russian Debts Soviet economy showed the main advantage of a
command system”that it could mobilize resources
with Bombers and change direction in a short period of time. The
sudden disintegration of the Soviet economy in the
Russia has agreed
to accept bomber late 1980s, however, demonstrated the essential flaws
aircraft as payment of communism.
Blackjack bomber
part of Ukraine™s
huge debt to Russia bn
aine owes Russia $1.8
r natural gas . . . Ukr
The Economy Under Lenin and
fo to
es and $1bn according
cording to Russian figur
ac eight
ssia has agreed to take
krainian figures . . . Ru Stalin
U e.
in payment from Ukrain
-160 Blackjack bombers
Tu -
r gas in barter, with nom
Ukraine typically pays fo In 1917 a revolutionary named Vladimir
ree times the market pr
al prices set at around th Ilyich Ulyanov, or Lenin, overthrew the
in n-
kraine and Russia are co
r the goods . . . [but] U government of Russia. In its place, he set up a
er gas debts.
stantly at loggerheads ov communist government. Lenin was a strong
shut off gas supplies
Russia in the past has believer in theoretical communism, and he
s then
yment, but Ukraine ha
Ukraine due to non-pa ad. quickly took steps to develop a communist soci-
s bound for Europe inste
simply stolen Russian ga rough ety. Large estates were taken from the rich, and the
rts to Europe travel th
All of Russia™s gas expo land was divided up and given to the peasants.
Ukrainian pipelines.
Lenin also outlawed private property and turned
st 9, 1999
”The Financial Times,
the country™s few factories over to the workers.

The workers, however, did not have the skills to planning dominated the Soviet economy, but the
manage the factories. Before long, production fell real force was the ruling Communist Party.
and the economy began to disintegrate. People lost
faith in the money supply, and a system of barter
Complexities of Central Planning
emerged. The government sent armed forces to the
farms to confiscate surplus food for the hungry city In the Soviet economy, the Gosplan was the cen-
dwellers and industrial workers. The angry farmers tral planning authority that devised the Five-Year
retaliated by reducing their production so there Plans. As the Soviet economy grew, however, this
would be no surplus crops. process became increasingly complex.
By 1927, many changes had taken place. Russia Consider the difficulties in a single industry such
had become the Soviet Union, and the country was as shoes. First, the planners have to decide how
under Communist Party control. Lenin had died, many shoes should be produced in any given year.
and Joseph Stalin was the new leader. Stalin wanted This amount would depend on the population and
to transform the Soviet economy from agriculture the number of pairs that each person, on average,
to industry. would need. The planners would then have to
To accomplish this goal, he introduced the gov- decide how many pairs to make of each style,
ernment™s first Five-Year Plan”a comprehensive, including colors, sizes, and widths.
centralized economic plan designed to achieve Next, the various sizes, grades, and amounts of
rapid industrialization. leather, dye, metal eyelets, thread, glue, and other
Under Stalin™s leadership, the process of materials needed to produce the shoes had to be
collectivization”the forced common ownership estimated. After the central planners developed this
of all agricultural, industrial, and trading enter- data, individual factories were given monthly and
prises”began. Not surprisingly, many people annual quotas. Even a factory that produced thread
opposed the reforms. Peasants even destroyed would be told how much thread of every diameter
their livestock and sabotaged their equipment and color to produce for use in shoes.
rather than turn their property over to the collec- Similar decisions had to be made for all indus-
tive farms. tries, including clothing, farm implements, sta-
Stalin™s retaliation was brutal. Millions of people tionery, and military goods. The planners detailed
were killed or imprisoned. Ukrainian grain stores everything that would be needed in the economy
were seized in the winter of 1932, causing the star- right down to nails and paper clips. Even these
vation of more than five million peasants. The suf- minor items required the planners to make esti-
fering in the cities was nearly as harsh. Workers mates of iron ore, coal, coke, blast furnaces, mining
were forced to work in heavy industry, and the equipment, trains, and ore cars.
standard of living deteriorated drastically. To ensure the growth of the economy from
Although the first Five-Year Plan did not achieve one year to the next, all the planners had to do”or
all of its goals, the government continued with more so they thought”was to increase the quotas given
planning. The plans that followed concentrated to the factories. In short, the central planners deter-
heavily on defense industries, heavy manufacturing, mined almost everything beforehand.
and some consumer goods.

Difficulties With Agriculture
The situation was similar in agriculture, where
The Soviet Economy After Stalin food was raised on state, collective, and peasant
Stalin™s brutal regime ended in 1953. By farms. The state farms were large farms entirely
then the Soviet economy had successfully owned and operated by the state. Workers on the
completed its transition from a backward agrarian state farms were paid for the number of items they
economy to a major industrial power. The Soviet produced. All output was turned over to the gov-
government and its comprehensive system of ernment at prices fixed by the government.

Peasant families worked collective farms, small To offset low morale in the factories, a number of
private farms collected into large units for joint incentive programs were attempted. One involved
operation. The land, buildings, tools, livestock, and the use of piecework, meaning that workers are paid
machines belonged to the government, which for each piece of output they produce rather than for
bought a certain amount of produce per acre. the number of hours they work.
Peasant families were allowed to keep their homes Although this system may seem like a good idea,
and household goods, and a small plot of land. piecework quotas often were set at unrealistically
Despite its efforts, the government was not able to high levels. This led to storming, the practice of
make agriculture as efficient as that of many capital- rushing production at the end of the month to
ist countries. In the mid-1980s, before the collapse of make up for the slower pace at the beginning of the
the Soviet Union, nearly 25 percent of the workforce month. The rush at the end often affected the qual-
was in agriculture. In the United States at the time, ity of the products. Because of storming, knowl-
only 3 percent of the workforce was in agriculture. edgeable Soviet shoppers often avoided buying
goods made at the end of the month.
Other incentives included patriotic and emo-
The Soviet Economy Collapses tional appeals. Workers who had outstanding
records or did something special were awarded hero
The Soviet Union made considerable progress medals, such as the Order of Lenin and the Hero of
with industrialization, but it never caught up Social Labor. Some of these medals brought rewards
to the United States. Despite its larger population such as free public housing or vacations.
and land area, the Soviet Union™s GNP never
exceeded two-thirds of that of the United States.
Production Quotas
As with incentives, quotas also failed at the fac-
tory level. During the 1950s, the Soviet economy
had a reputation for producing some of the world™s
poorest consumer and industrial goods. Shoe fac-
Customs Inspector
tories, for example, were given quotas in terms of
millions of pairs of shoes. Because small shoes
Do you like detailed work? Are
could be made fastest, more were made than were
you able to accept responsibility
needed. When the quotas were changed to measure
and deal with people in a firm
production in the amount of shoe leather con-
but friendly manner?
sumed, the result was shoes with some of the thick-
est soles in the world.
The Work
Customs inspectors are part of the
Production of Consumer Goods
Treasury Department. Duties
include examining baggage at
Another major problem was the inadequate sup-
airports or seaports to ensure that
ply of consumer goods. After World War II, the
all merchandise is declared and
Soviet people were asked to make sacrifices so their
that duties are paid. Commercial
children might have a better life. Many willingly
and noncommercial cargoes are
did so. In the 1970s and 1980s, those children were
inspected to determine admissi-
adults. When they were asked to make sacrifices so
bility and the amount of tax due.
their children could have a better life, they were
Qualifications not as willing as their parents had been. The new
generation had not suffered from the ravages of war
Customs inspectors need training in laws governing
and they were aware of the standards of living in
imports and exports and in inspection procedures. A col-
other parts of the world. As a result, they were
lege degree is preferred. Passage of a civil service exam is
impatient for more consumer goods.

Perestroika buy and sell in pursuit of profits, and small busi-
ness was encouraged.
When Mikhail Gorbachev assumed power in
Perestroika represented a halfway point between
1985, the Soviet economy was weaker than anyone
a market economy and centralized planning.
imagined. The main cause was the burden imposed
Gorbachev, however, did not remain in power long
by centralized planning. The economy had
enough to see his plans realized. Those in industry
become too complex and too large to be managed
who opposed Gorbachev™s reforms allowed short-
in the traditional manner.
ages and other problems to persist, and then used
Plant managers were under increasing pressure
these problems as proof that the reforms were fail-
to meet or exceed quotas. Glitches in planning,
ing. Gorbachev™s successor, Boris Yeltsin, faced sim-
however, were creating shortages and other prob-
ilar opposition. Ultimately, the collapse of the
lems. To facilitate the process, “fixers” called tolkachi
economy, the collapse of the political leadership,
were employed to resolve shortages or dispose of
and the stresses of ethnic diversity and unrest com-
excess inventories. The tolkachi soon became indis-
bined to cause the downfall and breakup of the
pensable to producers who wanted to fulfill their
Soviet Union.
quotas. At the same time, they also caused prob-
lems for other plants whenever they rerouted a
shipment or otherwise interrupted the master plan
of the central planners.
To solve these problems, Gorbachev intro-
duced a policy of perestroika, the fundamental
restructuring of the economy and government. Siberia covers 75 percent of
Frozen Treasures
Under the restructuring, Five-Year Plans were Russia. It has the largest supply of mineral resources
in the country, including gold, diamonds, and coal.
retained, but the various ministries of production
Siberia remains mostly undeveloped because of its
were to be converted to efficient, state-owned
harsh climate and few transportation routes.
enterprises that would compete in a market econ-
omy. Plant managers were given more freedom to

Checking for Understanding Applying Economic Concepts
1. Main Idea Using your notes from the graphic 6. Perestroika Since the mid-1980s, the former
organizer activity on page 496, describe how Soviet Union has undergone tremendous
the former Soviet Union™s economic system changes, some of which led to hyperinflation.
functioned. Why would this hyperinflation hinder the
movement toward capitalism?
2. Key Terms Define Five-Year Plan, collectiviza-
tion, Gosplan, state farm, collective farm,
piecework, storming, perestroika.
7. Making Predictions Based upon recent
3. Explain how the Soviet economy developed
changes, is the former Soviet Union moving
under Lenin and Stalin.
toward capitalism or away from capitalism?
4. Identify several complexities of central
Give evidence to support your conclusions.
8. Summarizing Information What did Soviet
5. Describe how central planning contributed to
planners think they had to do to ensure
the breakdown of the economy of the Soviet
economic growth?
Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

Reshaping the World:
Karl Marx

Marx was an economic historian
and a social scientist. He earned his
doctorate in philosophy and his-
tory from the University of Berlin,
but because of his radical views, he
could not get a teaching position.
Throughout the 1840s, he wan-
dered from Cologne to Paris to
because they have no means of
Brussels. He joined with socialist
production of their own. Their
and radical groups. Persecuted by
oppressors? The capitalists or
Prussian and Parisian authorities,
bourgeoisie”people who own the proletariat would, Marx argued,
Marx fled to London in 1849
means of production. have to depend on a strong gov-
where he began a life of exile and,
Marx argued that labor was ernment: a “Dictatorship of the
eventually, died in poverty.
exploited in a capitalist society. He Proletariat.” Thus, authoritarian
gave the name “surplus value” to Communism as practiced in the
the difference between the wage Soviet Union and other countries
Marx is best known for The paid to the worker and the market was born.
Communist Manifesto, published in value of the worker™s output. He Marx believed that eventually
1848, and Das Kapital, the first vol- believed this value was unfairly the dictatorship would be replaced
ume of which was published in kept by capitalists as profits. by a “classless society,” without
1867. In these works, Marx argues Marx argued that each cycle of government, in which people
that “the history of all hitherto prosperity would add to the suffer- would produce to the best of their
existing society is the history of ing of the proletariat and the abilities and consume to the extent
class struggles.” In each era, one wealth and power of the capitalists. of their needs.
class was pitted against another: Eventually, he said, oppressed
master against slave, lord against workers would rise up in a violent
serf, capitalist against worker”the revolution. “Let the ruling classes
Examining the Profile
“oppressor and oppressed.” tremble at a communist revolu-
1. Analyzing Information According to
tion,” he wrote. “The proletarians
HIS IDEAS Marx, through what stages must soci-
have nothing to lose but their
ety go before it can reach the ideal
chains. They have a world to win.
Marx argued that the oppressed
state of communism?
Working men of all countries,
of his day was the proletariat”
2. For Further Research Annotate a
unite!” During the transition, the
people who must work for others
world map to show the extent of
Marxist economies in the world today.

The Transition to Capitalism
Main Idea Key Terms
Reforms in the former Soviet Union, China, and many privatization, Solidarity, black market, Great Leap
Latin American and eastern European nations have Forward
moved these economies toward more capitalistic,
market-oriented systems.
After studying this section, you will be able to:
Reading Strategy 1. List four problems encountered when an economy
Graphic Organizer As you read the section, complete makes the transition to capitalism.
a graphic organizer similar to the one below by 2. Recognize the major countries and regions that are
selecting a country and describing how it is making making the transition to capitalism.
the transition to capitalism.
Applying Economic Concepts
Privatization Do you value and take care of the




things you own? Read to see why private ownership


Capitalism is essential if countries are to make the transition



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