Although everyone and their mother thinks they understand capitalism, chances are you might be a bit hazy on the definition or perhaps just in need of a refresher. In any case, here is my attempt to explain to you what I believe capitalism is, in the hope that it might help you understand aspects of our current economic system:
Capitalism is a social, political and economic system of production and exchange based on the accumulation of capital by private owners for profit.
First, what do I mean by an economic system? Note that “capitalism” is not necessarily the same thing as “the economy”, although the two are often used interchangeably. An “economy” is typically defined as a system of production, exchange and distribution of goods and services implemented by a given group or society that is not necessarily based around “capital”. In a feudalistic economy, for example, economic production tended to have the aim of providing the landlords and their sovereign with the financial means of protecting the kingdom.
Capitalism as an economic system, by contrast, sees private profit as the main incentive for production and exchange. It depends first and foremost on the institution of private property or ownership, which is what “allows” private individuals to accumulate capital (land for example) in the first place. “Capital” refers, more broadly, to any resource needed for the production of a good or service (raw inputs, machines, factories, etc.). It can also refer to the revenue earned through the sale of that produced good or service. We can think of it more generally, though, as money, since all capitalist goods are attributed a certain monetary value.
Capitalism is a social, political and economic system of production and exchange based on the accumulation of capital by private owners for profit.
In practice the system looks something like this: capital is “invested” in the production of a good or service with the help of laborers who work in exchange for a wage. The final good or product, once “input” costs such as wages have been subtracted, is then sold or exchanged for a profit. This allows the original investor, or capitalist, to accumulate more capital than he or she originally began with, enabling the cycle to continue. This profit incentive encourages economic growth, which, along with market competition, commodification, some level of voluntary exchange (ability to buy or not buy a particular good, ability to leave one’s job, etc.) are some of the central pillars of capitalism.
Now, in what way is capitalism a social system? Well, individuals are generally attributed a higher social status depending on their level of “capital”. In more concrete terms, this may refer to one’s occupation, salary or general level of wealth. This can be “signaled” not only through one’s profession, but also through the consumption of certain goods or services that act as social markers of one’s position in society (the car you drive, the clothes you wear, the vacation you take, etc.). However, note that there are of course other factors in addition to wealth, such as one’s gender, ethnicity, and even beauty, that shape socio-economic position.
Lastly, capitalism viewed as a political system essentially equates the accumulation of “capital” with “power”, implying that those who obtain the former will be able to yield more of the latter. Capitalists often do so by attempting to influence the political system in such a way that they are able to accumulate more capital and thus obtain higher profits (by lobbying in favor of lower taxes or repealing “trust-busting” policies for example). The extent to which this plays out in practice of course depends on a given government, not to mention the legal and constitutional constraints in place.
Labor vs. Capital
Laborers, or “labor” for short, refers to those who sell their labor in exchange for a wage. Capitalists, or “capital” in this context, refers to the group of individuals distinct from these laborers who own the means of production. The latter employ the former in order to produce goods and services that they sell at a profit.
You might perhaps be beginning to see some of the problems that arise from this contradiction. Let’s go through a few of them:
- Capitalism is built in such a way that capitalists always seek to make a profit over their workers (or, put another way, workers must collectively always be paid less than what the price of a final good or service is sold for). If that is the case, then how do workers afford to buy the goods they produce and thus “stimulate” the economy?
- Disputes regularly take place over a company’s profit distribution, or in other words, how much workers receive as opposed to those who own and control the company (managers, board members, stockholders). Without any form of worker protection or bargaining power, capitalists will often be able to capture a larger share of the profits for themselves.
- Capitalism thus tends towards inequality due to the nature of capital accumulation. Those who are able to make considerable profits can reinvest their capital in other lucrative ventures, increasing their capital stock over time and generations, which can then be used to “buy” political power.
Of course, in “real life”, these issues may not always be so black and white. For example, the discrepancy between what workers are paid and what they are able to afford largely depends on factors such as the openness of an economy, the availability of cheap imports, inflation and the potential for savings and advancements in technology. The tendency towards inequality, which goes hand and hand with the formation of monopolies and cartels, also depends on a government’s willingness to adopt “trust-busting” and redistributive policies.
Without any form of worker protection or bargaining power, capitalists will often be able to capture a larger share of the profits for themselves.
Capitalism has undoubtedly demonstrated unprecedented dynamism, innovation and efficiency over the course of its more than 200-year history, but many of these problems, as well as others such as environmental damage, are simply inherent to its functioning. Naturally, critics of the system have not only proposed a number of economic alternatives, but also “softer” versions of capitalism.
Economic Systems and Varieties of Capitalism
Economies tend to fall into three broad categories: command, market and mixed, the latter of which combines elements of the first two. Command economies, like the feudal system mentioned earlier, are those in which the government controls or “commands” economic activity in order to meet some particular goal such as funding the crown or, in more recent times, economic growth. Market economies, by contrast, typically have very little to no government oversight, allowing private individuals and enterprises to control most of the production and distribution of goods and services via the market.
Notice that much of the difference between command and market economies has to do with the level of government involvement in economic activity. In the abstract, capitalism, as an economic system based on private ownership, generally falls into the category of market economy, whereas communism tends to falls into the category of command economy. While I won’t go into detail in this article on the differences between capitalism and communism (or anarchism or socialism or social democracy), note for now that they tend to differ in their answers to the following three questions:
- Who owns the resources?
- Who or what “dictates” the production and distribution of goods and services or economic activity more generally?
- What is the “goal” of the economy?
We can thus picture capitalist market economies on one end of a scale, with the answers to these questions being private actors acting in their self-interest, competitive markets, and capital accumulation and profit, respectively. On the other end of the scale, we can consider communist “command” economies, with the answers to these questions being the workers or the people, the government or the “collective”, and social welfare, respectively.
Much of the difference between command and market economies has to do with the level of government involvement in economic activity.
While most countries, especially after the Cold War, have adopted at least some elements of a capitalist market economy, they have done so to varying degrees, thus adopting a mixed model. For example, many of the English-speaking countries, led by the United States, tend to have what is known as a liberal market economy that primarily relies on the market to solve issues of resource allocation. In more concrete terms, this translates to high autonomy for business owners, a high level of privatization, a small government, a small welfare state and generally weaker workers’ rights.
In coordinated market economies, by contrast, economic outcomes tend to be determined more by collective bargaining processes between firms and workers. Although these types of economies fall perhaps slightly more towards the “communist” end of the economic spectrum, especially compared to the United States, they remain highly capitalistic. Exemplified by Western European nations such as Germany, coordinated market economies typically have larger governments and more public-owned enterprises, not to mention more protective welfares states and stronger workers’ rights due to higher levels of unionization.
While there are, of course, many exceptions and alternatives to these two models that this article cannot even begin to cover, this should hopefully provide a better understanding of capitalism as it is practiced in much of the world today.