Problems of Capitalism

Capitalism is an economic system based on free markets and limited government intervention. Proponents argue that capitalism is the most efficient economic system, enabling improved living standards. However, despite its ubiquity, many economists criticise aspects of capitalism and point out is many flaws and problems. In short, capitalism can cause – inequality, market failure, damage to the environment, short-termism, excess materialism and boom and bust economic cycles.

problems-of-capitalism

Problems of Capitalism

1. Inequality

The benefits of capitalism are rarely equitably distributed. Wealth tends to accrue to a small % of the population. This means that demand for luxury goods is often limited to a small % of the workforce. The nature of capitalism can cause this inequality to keep increasing. This occurs for a few reasons

  • Inherited wealth. Capitalists can pass on their assets to their children. Therefore, capitalism doesn’t cause equality of opportunity, but those born in privilege are much more likely to do well because of better education, upbringing and inherited wealth.
  • Interest from assets. If capitalists are able to purchase assets – bonds, house prices, shares, they gain interest, rent and dividends. They can use these proceeds to buy more assets and wealth – creating a wealth multiplier effect. Those without wealth get left behind and may see house prices rise faster than inflation.
  • The economist Thomas Piketty wrote an influential book Capital in the Twenty-First Century, which emphasised this element of capitalism to increase inequality. As a general rule, Picketty argues wealth grows faster than economic output. He uses expression r > g (where r is the rate of return to wealth and g is the economic growth rate.)

2. Financial instability/economic cycle

Capitalism relies on financial markets – shares, bonds and money markets but financial markets have a tendency to cause booms and busts. In a boom period, lending and confidence rise, but frequently markets get carried away by ‘irrational exuberance‘ causing assets to the spike in value. But, this boom can quickly turn to a crash when market sentiment changes. These market crashes can cause economic downturns, recession and unemployment. At various times, capitalism has suffered prolonged recessions (the 1930s), periods of mass unemployment and a decline in living standards.

3. Monopoly Power

In a free market, successful firms can gain monopoly power. This enables them to charge higher prices to consumers. Supporters of capitalism argue only capitalism enables economic freedom. But, the freedom of a monopoly can be abused and consumers lose out because they have no choice. For example, in industries like tap water or electricity supply, which are a natural monopoly, consumers have no alternative but to pay the prices charged by consumers. In the Nineteenth Century, monopolies like Standard Oil bought our rivals (often with unfair competitive practices) and then became very profitable.

4. Monopsony

Monopsony is market power in employing factors of production. For example, firms can have monopsony power in employing workers and paying lower wages. This enables firms to be more profitable but can mean workers don’t share from the same level of proceeds as the owners of capital. It explains why with increasing monopsony power we have seen periods of stagnant real wage growth while firms profitability has increased (2007-17 in UK and US)

5. Immobilities 

In a free market, factors of production are supposed to be able to easily move from an unprofitable sector to a new profitable industry. However, in practice, this is much more difficult. E.g. a farmworker who is made unemployed cannot just fly off to a big city and find a new job. He has geographical ties to his birthplace; he may not have the right skills for the job. Therefore, in capitalist societies, we often see long periods of structural unemployment.

6. Environmental costs and externalities

In capitalist economies, there is limited government intervention and reliance on free markets. However, market forces ignore external costs and external benefits. Therefore, we may get over-production and over-consumption of goods that cause harmful effects to third parties. This can lead to serious economic costs – pollution, global warming, acid rain, loss of rare species; external costs that damage future generations.

7. Encourages greed/materialism. The nature of capitalism is to reward profit. The capitalist system can create incentives for managers to pursue profit over decisions which would maximise social welfare. For example, firms are using theories of price discrimination to charge higher prices to consumers who want to jump the queue. This makes sense from the perspective of maximising profit. However, if we have a society, where the rich can pay to jump a queue at a Fairground – or pay to see Congressman quicker – it erodes social norms and a sense of ‘fair-play’

The pursuit of the profit motive has encouraged some law firms to aggressively pursue litigation claims. This has created a society where we devote resources to protecting ourselves from being sued.  Further reading – “Moral Limits of Markets” by Michael Sanders

See also:

6 thoughts on “Problems of Capitalism”

  1. Just to let you know, you spelled two words wrong under “Encourages greed.” It’s maximized with a Z, not an S. You might want to fix that.

    Reply
  2. This is rather biased, and frankly incorrect in a number of ways.

    Capitalism doesn’t cause the boom and bust cycle. Monetary policy does. This is expressed in the Austrian mantra “the market coordinates time with interest.” This is the result of the prime interest rate synchronizing the expansion operations of millions of firms at once.

    Environmental costs and externalities are not features of capitalism per se. They result from consumption in *every* socioeconomic system, including socialism and communism. Jared Diamond has documented these problems, along with local resource overconsumption, in his book Collapse. They date from the very earliest civilizations, and in some cases are found even in foraging societies.

    Monopoly power does not derive from the market alone. Except in the case of natural monopolies, every true monopoly that ever existed was created by government. The canonical example usually trotted out of “monopoly” is Standard Oil, which was never a monopoly (never fewer than 100 domestic competitors and 300 or so global competitors). “Monopoly” is simply overused, and badly misused, by the critics of capitalism.

    Standard Oil’s market share did climb upwards of 91%, but by the time the Sherman Act was enacted, its share had fallen to 70%, and was around 65% by the time it was prosecuted. There was little that was “unfair” about its practices. It offered a superior product at a better price, and consumers responded to that. It was all but the exact opposite of a “predatory monopoly,” often allowing the heads of the firms it bought out to continue running their offices as subsidiaries, provided they agreed to meet Standard’s quality and price guidelines.

    Inequality is perhaps exacerbated by corporatism, but is not a feature of capitalism per se. Again, it’s found in every socioeconomic system, and is known to have existed from the advent of civilization onward. A complete rebuttal of your thesis would require more space than I think is merited in a reply, but the short answer is that in the freest markets–the so-called “pure competition model”–there are no barriers to entry, and therefore P = MC and P = min ATC. This means there are no long-run economic profits, and therefore no tendency to drive wealth upwards. It’s in the oligopolistic markets that you see wealth concentration…and these, always and everywhere, are the consequence of barriers to entry…which in turn are the consequence of regulations.

    The concentration of wealth is a feature of highly-regulated markets, not free markets. So, not capitalism per se, but rather corporatism.

    Reply
    • So basically capitalism doesn’t cause capitalism? Rather capitalism is this utopian mythical system that has been corrupted by its own institutions that make it up? And it doesn’t cause any of the bad things that are the manifestations of its inherent logic like (i) concentration of land and capital (economic power), (ii) wealth accumulation and profit, (iii) competition (and monopoly as a result of economic power concentration(i)) and (iv) wage slavery for those who don’t have access to accumulated wealth(ii)?

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