Capitalism is an economic system where individuals and firms have considerable freedom to decide what to produce and how to produce. It is an economy dominated by free markets, private property and limited government regulation.
There are many varieties of capitalism from very free-market economies like Singapore to economies which have elements of capitalism but also a greater degree of state intervention in the economy. For good or bad, capitalism and market-based economies are the dominant form of economic system. Why have nearly all global economies converged onto this particular model?
Why capitalism dominates?
Personal ownership. Capitalism allows ownership of private property. This is an important part of human nature, the ability to accumulate property, capital and land and pass it on to family members. Studies in behavioural economics show that we have a much greater attachment to something we own. If we own a business, we feel a vested interest in making it a success. If we work in an enterprise owned by state, there are usually fewer incentives. Alternatives to capitalism often require a more selfless attitude – but in this situation, there is often a free-rider problem and incentive for individual workers to cut back on effort and initiative.
Freedom to choose. Capitalism enables individuals to have a considerable degree of choice, in which career to pursue or whether they wish to set up a business. A business may fail, but it is part of human nature to take the risk and have the opportunity to develop one’s own business. Capitalism evolved from an agrarian economy where farmers owned (or rented) land to feed themselves. With the freedom to choose, farmers may decide to leave and work in factories and ultimately set up their own business.
Self-regulation. A strength of capitalism is that it is self-regulating. Left to its own devices, it has the incentives and motives to lead to continual progress. Adam Smith in the Wealth of Nations observed how the workings of the free market could combine selfish interest with the greater good.
“Every individual… neither intends to promote the public interest, nor knows how much he is promoting it… he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.”
The Wealth Of Nations, Book IV, Chapter II, p. 456, para. 9. (The Invisible Hand)
Economies directed by a Central government committee were more prone to shortages, surpluses, blockages and got bogged down in red tape and corruption. Capitalism has a degree of competition, which gives individuals and firms the incentive to work and innovate.
Monopoly power. A standard critique of capitalism states that it tends to create a group of very successful capitalists who own profitable business. They can use this profit to reinvest in purchasing more wealth and land. Unchecked, this can lead to an accumulation of wealth in the hands of the wealthy. This wealth gives capitalists power – both economic and political. The wealthy capitalists tend to control media, institutions and have a greater influence over the political system than those who have limited wealth. This concentration of wealth in the hands of the ‘capitalist class’ creates a dynamic to support capitalism. At times, democratic governments have introduced regulation against monopolies, limiting monopoly power and setting higher tax rates on high-income earners. But, the essential capitalist system remains.
Capitalism creates winners and losers, but those who work for low wages, have less influence and ability to change the system. Marxist analysis argued that eventually, the oppressed proletariat would revolt and overthrow capitalism. However, this neglects aspects of human nature. A low-paid worker sees a revolution as risky, intangible and liable to fail. Human nature tends to concentrate on manageable small-scale improvements. Many workers may not aspire to overthrow capitalism but to gain a better position in capitalism – a better paid, job or set up their own business.
Co-operation. Capitalism is often characterised as a ‘selfish’ system as it rewards the profit motive. However, the irony of capitalism is that it promotes a form of interdependence. Capitalists can increase profits by promoting trade. It is in the interests of a country that its neighbours do well so that they can buy its exports. When countries engage in a trade war, it damages the local economy, so there is an incentive to promote good international relations. For example, after the Second World War, Germany and Japan were isolated from international affairs, but through trade, they quickly became reintegrated into the world economy, and the movement of people and capital between different countries promotes the international integration. This pressure towards co-operation creates a reason to protect capitalism.
Ability to adapt and change. One of the strongest elements of capitalism is its ability to change, adapt and continually reinvent itself. This enables it to work in countries with different cultures and demographics. Joseph Schumpeter wrote about the power of ‘creative destruction’ to cause a “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one”
Even after the economic crisis, such as the Great Depression (the 1930s) or the Credit Crunch of 2008, Capitalism has been able to bounce back with new industries and firms.
Behavioural economics and short-termism
Critics of capitalism point out how it creates externalities, damage to the environment, short-termism and ignore long-term costs to human welfare. However, human nature is rarely forward thinking, we value immediate benefits higher than long-term future benefits/costs. Given a choice to make a short-term sacrifice for greater environmental welfare in the long-term, most people choose short-term benefits. Political parties who propose higher tax to deal with congestion, pollution, global warming, rarely succeed. Capitalism has many flaws but overcoming them with a different economic system requires a considerable degree of foresight and
Ironically all the main capitalist economies in the real world have a considerable degree of state intervention to deal with the worst excesses of capitalism and free market economies. For example, even a ‘capitalist’ economy such as the US collects tax to fund public services such as infrastructure, education and a degree of health care. There is legislation to reduce some effects of pollution and look after the environment. There is a limited welfare state which prevents absolute poverty.