Capitalism is an economic system characterised by:
- Lack of government intervention
- Means of production owned by private firms.
- Goods and services distributed according to price mechanism (as opposed to government price controls)
Pros of Capitalism
- Economic freedom helps political freedom. If governments own the means of production and set prices, it invariably leads to a powerful state and creates a large bureaucracy which may extend into other areas of life.
- Efficiency. Firms in a capitalist based society face incentives to be efficient and produce goods which are in demand. These incentives create the pressures to cut costs and avoid waste. State owned firms often tend to be more inefficient (e.g. less willing to get rid of surplus workers and less incentives to try new innovative working practices.)
- Economic growth. With firms and individuals facing incentives to be innovative and work hard this creates a climate of innovation and economic expansion. This helps to increase real GDP and lead to improved living standards. This increased wealth, enables a higher standard of living; in theory, everyone can benefit from this increased wealth, and there is a ‘trickle down effect’ from rich to poor.
- There are no better alternatives. As Winston Churchill, ‘“It has been said that democracy is the worst form of government except all the others that have been tried.’ A similar statement could apply to capitalism.
Cons of Capitalism
- Monopoly Power. Private ownership of capital enables firms to gain monopoly power in product and labour markets. Firms with monopoly power can exploit their position to charge higher prices. See: Monopoly
- Monopsony Power. Firms with monopsony power can pay lower wages to workers. In capitalist societies, there is often great inequality between the owners of capital and those who work for firms. See: Monopsony exploitation
- Social Benefit Ignored. A free market will ignore extenalities. A profit maximising capitalist firm is likely to ignore negative externalities, such as pollution from production. This can harm living standards. Similarly, a free market economy will under-provide goods with positive externalities, such as health, public transport and education. This leads to an inefficient allocation of resources. Even supporters of capitalism will admit that government provision of certain public goods and public services is essential to maximise the potential of a capitalist society.
- Inherited Wealth and Wealth inequality. A capitalist society is based on legal right to private property and the ability to pass on to future generations. Capitalists argue that a capitalist society is fair because you gain the rewards of your hard work. But, often people are rich, simply because they inherit wealth or are born into a privileged class. Therefore, capitalist society not only fails to create equality of outcome, but also fails to provide equality of opportunity.
- Inequality creates social division. Societies which are highly unequal create resentment and social division.
- Diminishing marginal utility of wealth. A capitalist society argues it is good if people can earn more leading to income and wealth inequality. However, this ignores the diminishing marginal utility of wealth. A millionaire who gets an extra million sees little increase in economic welfare, but that £1 million spent on health care would provide a much bigger increase in social welfare.
- Boom and Bust cycles. Capitalist economies have a tendency to booms and busts with painful recessions and mass unemployment. See: Boom and bust economic cycles
A Note on Different Types of Capitalism
All types of capitalism implies that the economy is ‘market based’ However, within the broad term of capitalism, there are different varieties which can have profoundly different outcomes. For example, unregulated capitalism – sometimes termed ‘turbo capitalism’ will see greater problems associated with inequality, under-provision of public services and greater inequality. A primarily ‘capitalist’ society with some regulation on inequality, environment and monopoly power can create a very different outcome to a pure ‘capitalist’ society.
When people talk about capitalist societies, e.g. US, there is actually significant government intervention in areas such as education, health care and transport. US government accounts for around 35% of GDP.
Even a country like France, where the government spend 50% of GDP has an economy which may be considered to be primarily ‘free market’. There is no clear cut point when an economy stops being capitalist and becomes a ‘mixed economy.