The Definition of Capitalism
[1] When people ask about the definition of capitalism, they are
often looking for an answer that explains the "capitalist
system." The definition they expect to receive is one which
explains Adam Smith's "trickle down theory of economics" and
promotes the "unequal distribution of wealth." These
preconceptions represent some of the most common myths and
misconceptions about capitalism which must first be dispelled
before any definition of capitalism can be properly understood.
[2] There is, for example, no such thing as the "capitalist
system," in the sense that it is commonly referred to in the
media. Interestingly, when capitalism is discussed, it is
frequently discussed in the language of Marx. Thus, we hear much
of systems, surpluses, distributions, means and modes of
production, and all manner of precise, scientific-sounding
classifications, but we hear precious little about what the
definition of capitalism actually is.
[3] In fact, the term capitalism was never used by Adam Smith
and its first recorded usage was not until 1854,1
although Marx would frequently dance around the term in
references to "capitalistic production" or the "capitalist
system."2
Smith, on the other hand, referred to what is now called
capitalism as a "system of natural liberty."3
[4] If we are to insist upon precision in our language of
economy, as the social scientists no doubt do, we have to
distinguish between systems that occur naturally and systems
that are devised by human beings. This distinction is not
trivial, because those who refer to the "capitalist system" do
so in order to portray the free market as little more than a
man-made parasite, while elevating their own preposterous
political projects to an equal level of economic science.
[5] As political scientist, Kenneth Minogue, points out,
the thing called an "economy" is essentially capitalist. ...
The economy is preeminently what
ideology seeks to abolish. Instead, a society is
proposed in which the relationship of exchange will be
replaced by deliberate planning in accordance with some such
formula as the famous "from each according to his ability,
to each according to his need." It would be inaccurate to
describe this as a socialist economy, because it isn't
strictly an economy at all.4
[6] As with all systems, an economic system may be either
natural or artificial, the former being defined by freedom and
the latter defined by coercion. The natural system, capitalism,
I will refer to as an informal system; the
artificial systems, I will call formal systems.
[7] Why is capitalism an informal system? A crucial part of
the definition of capitalism is the idea of
laissez-faire, a French term which roughly
translates into "allow to do" or "leave alone." Capitalism is an
informal system in the sense that it does not seek to impose
answers upon society to the three fundamental questions facing
all economies: What should we produce? How should we produce?
And, for whom should we produce?5
[8] Capitalism suggests that rather than these questions
being answered by kings, governments, or even well-intentioned
central planners on society's behalf, these questions should be
answered by you and I and every other individual in a free
market. In other words, capitalism is simply what occurs when we
are all left to our own economic devices; as a system,
capitalism is characterized by the absence of formal systems. As
Adam Smith explained, "All systems either of preference or of
restraint, therefore, being thus completely taken away, the
obvious and simple system of natural liberty establishes itself
of its own accord."6
[9] Milton Friedman put it another way: "Fundamentally, there
are only two ways of co-ordinating the economic activities of
millions. One is central direction involving the use of coercion
... The other is voluntary co-operation of individuals."7
Formal economic systems (communism, feudalism, etc.) are defined
by some form of coercion in order to direct production and to
impose answers upon society; the definition of capitalism, the
informal system, is the absence of coercion.
[10] A more encyclopedic definition of capitalism would be of
an informal economic system in which property is largely
privately owned, and in which profit provides incentive for
capital investment and the employment of labor. Capitalism is
also the philosophy that the government's role in the economy
should be strictly limited and that the forces of supply and
demand in a free market, while imperfect, are the most efficient
means of providing for the general well-being of humankind.
[11] It is commonly thought that average citizens in a market
economy benefit only when profits "trickle down" to them, like
pennies spilling from the overstuffed pockets of the rich. The
economist Thomas Sowell calls this bizarre definition of
capitalism the most politically prominent economic theory to
never exist.8
He explains,
When an investment is made, whether to build a railroad or
to open a new restaurant, the first money is spent hiring
the people to do the work. Without that, nothing happens.
Even when one person decides to operate a store or hamburger
stand without employees, that person must first pay somebody
to deliver the goods that are going to be sold. Money goes
out first to pay expenses and then comes back as profits
later�if at all. The high rate of failure of new businesses
makes painfully clear that there is nothing inevitable about
the money coming back. ... In short, the sequence of
payments is directly the opposite of what is assumed by
those who talk about a "trickle-down" theory.9
[12] While profit is a word routinely pronounced with the
negative emotion of a swear word in the modern political
discourse, it is profit alone that provides incentive to
undertake financial risk, such as the risk involved in starting
a business.
[13] Incentive is the key word.
Incentives matter so much that economists James Gwartney,
Richard L. Stroup, and Dwight R. Lee begin a marvelous little
book with the declaration, "All of economics rests on one simple
principle: that incentives matter. Altering incentives,
the costs and benefits of making specific decisions, alters
people's behaviour."10
Where profits are denied, entrepreneurship and innovation are
stifled and all our lives are the worse for it. Beneath the
definition of capitalism is the realization that we are never so
efficient and effective as when we pursue our own reward.
[14] And yet, profit is often portrayed in the media as the
"unequal distribution of wealth" as though the invisible hand of
Adam Smith were reaching down from the clouds to drop billions
of dollars on the evil and the undeserving, while robbing the
righteous poor of what is owed to them. As Dr. Sowell notes,
Most income is of course not distributed at all, in
the sense in which newspapers or Social Security checks are
distributed from some central place. Most income is
distributed only in the figurative statistical sense in
which there is a distribution of heights in a population ...
but none of these heights was sent out from some central
location. Yet it is all too common to read journalists and
others discussing how 'society' distributes its
income, rather than saying in plain English that some people
make more money than others.11
[15] Why do some people make more than others under
capitalism? There can be any number of reasons from the
differing skills of workers to their differing age and
experience to the supply and demand relationship between
employers and employees. Moreover, those who assume more risk
inevitably earn dramatically more or dramatically less than
those who assume less risk. Whatever the case may be, however,
income in a capitalist economy is earned not through
"selfishness" but by helping others. Gwartney, Stroup, and Lee
explain,
People who earn large incomes do so because they provide
others with lots of things that they value. If these
individuals did not provide valuable goods or services,
consumers would not pay them so generously. There is a moral
here: if you want to earn a large income, you had better
figure out how to help others a great deal.12
[16] Economist Walter Williams offers similar insight into
the definition of capitalism: "Capitalism is relatively new in
human history. Prior to capitalism, the way people amassed great
wealth was by looting, plundering and enslaving their fellow
man. Capitalism made it possible to become wealthy by serving
your fellow man."13
[17] While those who equate the definition of capitalism with
the unequal distribution of wealth revile the inequalities that
inevitably result in market economies, Milton Friedman puts
these inequalities in their proper perspective as compared with
the formal economic systems:
Consider two societies that have the same distribution of
annual income. In one there is great mobility and change so
that the position of particular families in the income
hierarchy varies widely from year to year. In the other,
there is great rigidity so that each family stays in the
same position year after year. Clearly, in any meaningful
sense, the second would be the more unequal society. ...
Non-capitalist societies tend to have wider inequality than
capitalist, even as measured by annual income; in addition,
inequality in them tends to be permanent, whereas capitalism
undermines status and introduces social mobility.14
[18] This concept of social mobility is a routinely
overlooked aspect of the definition of capitalism. In a
capitalist society, individuals are not condemned to their lot
in life. Capitalism not only encourages individuals to better
themselves, but provides market incentives for them to do so.
All The World's A Market
[19] What is a market? It is not the mystical,
impersonal force that is so deeply reviled on the left and so
strangely worshiped as an omniscient deity on the right. A
market is simply an environment of exchange that brings buyers
and sellers of products, services, labor, and ideas together and
facilitates trade between them. Far from being impersonal, a
market, just like a society, is the sum of the individuals
involved in it and therefore contains all the information
presently known. In a broader sense, a market is merely a mirror
of ourselves.
[20] As part of the definition of capitalism, it was noted
that capitalism is an informal system in so far as it does not
require implementation by some higher authority. The reason for
this is that capitalism is fueled by the power of markets, which
are as natural and as necessary to human beings as water to a
fish. As long as there are human beings, there will always be
markets.
[21] While this aspect of the definition of capitalism is
commonly denied, we see evidence of the inevitability of markets
wherever trade is forbidden or restricted. In modern capitalist
societies, black markets flourish for vices the government has
attempted to outlaw, such as drugs, weapons, and prostitution.
In communist societies, black markets thrive in response to
frequent consumer shortages. In developing nations where laws
and bureaucracy impede rather than facilitate legal exchange,
black markets are the primary source of economic growth, often
replacing legal markets entirely.
[22] In short, if one doubts the definition of capitalism as
a natural system and markets as essential to human life, one
needs look no further than the indestructibility of markets
throughout human history as evidence to the contrary.
[23] The most common critique of market-driven economies is
that they are "unfair." The market, we are told, "exploits
people." The fallacy here is two-fold. First, the market in and
of itself is neither fair nor unfair; it is merely a reflection
of ourselves. If we perceive the market to be unfair, such as in
the difference in wages between teachers and professional
athletes, then that injustice is a reflection on who we are as a
people not on the market system in the abstract.
[24] "Fairness," like beauty, is in the eye of the beholder.
Beneath the definition of capitalism is a belief in the
supremacy of economic freedom, and freedom entails protecting
individuals from outside interference, even in the name of
"fairness." Dr. Friedman wisely observes that one of the biggest
objections to a market economy is that "it gives people what
they want instead of what a particular group thinks they ought
to want. Underlying most arguments against the free market is a
lack of belief in freedom itself."15
[25] Second, a free market cannot, by definition, exploit
anyone, given the elementary economic principle that a voluntary
and informed trade always benefits both parties; why would
either party make the trade otherwise?
[26] Ultimately, what a market accomplishes is to collect all
the information presently available between buyers and sellers,
and then to determine the relative value of what is being
exchanged. We live in a world of scarce resources, and those
resources must somehow be divided; the market accomplishes this
through fluctuating prices. High prices ration goods and signal
producers to produce more where possible and for consumers to
conserve; low prices encourage consumption and signal producers
to allocate scarce resources elsewhere.
[27] As Friedrich von Hayek explains, in this kind of price
system
only the most essential information is passed on and passed
on only to those concerned. It is more than a metaphor to
describe the price system as a kind of machinery for
registering change, or a system of telecommunications which
enables individual producers to watch merely the movement of
a few pointers, as an engineer might watch the hands of a
few dials, in order to adjust their activities to changes of
which they may never know more than is reflected in the
price movement.16
[28] In other words, there is a little bit of magic in every
price tag, as every price contains an astonishing amount of
information about the choices made by consumers and producers
condensed into a few numbers.
Criticism of Capitalism
[29] If there is a valid criticism of capitalism to be made, it
is essentially the same argument against anarchism of the right,
which is that freedom feeds upon itself.
[30] Thomas Sowell writes that when he taught economics, he
used to offer an A to any student who could find a kind word
that Adam Smith had to say about businessmen in The Wealth
of Nations. No one ever did.17
Perhaps the skepticism of Smith and many other free market
economists over the benevolence of business people stems from
the melancholy truth that those whom the market most rewards
seldom have any qualm with subverting it; all too often, those
who should be the capitalism's most ardent defenders are quick
to bite the hand that feeds them.
[31] Monopolies are by no means precluded by the definition
of capitalism, and with such power comes the power to stifle
innovation, crush competition, and harm the average consumer
with higher prices. Moreover, where individuals or corporations
violate the principles of fair trade, such as by concealing or
falsifying information, their own personal freedom and wealth
may be enhanced at the expense of both society and the free
market they betray.
[32] Ironically, the same concept of laissez-faire that is so
essential to the definition of capitalism can devolve into
tyranny if interpreted too literally. The incentive for profit
is unfortunately also incentive to cheat. It is easy to see how
a pure market economy in absence of all rules and regulation is
little more than survival of the fittest. Coupled with prudent
governance, capitalism produces democracy; without it, a
capitalist society is little more than an oligarchy.
[33] Very few people, much less conservatives, desire a
society built on economic Darwinism where gross inequalities of
opportunity are the norm and where only the affluent have access
to basic social services. Moreover, few would want to conduct
business in an environment where no set of standards was
enforced in the market and where no rules governed the behavior
of businesses and individuals.
[34] It is for this reason that modern capitalist economies
are often called "mixed economies" in that they combine free
markets with the oversight of government. Though they adhere to
the definition of capitalism, they are not enslaved to it. For
capitalism to avoid self-destruction, even the most pro-business
conservatives usually agree that government is crucial as a
regulator and a referee.
Why Are Most Conservatives
Capitalists?
[35] While Adam Smith is usually credited as the father of the
free market, the basic idea beneath the definition of capitalism
was aptly expressed thousands of years before his birth by the
Chinese sage, Lao Tzu, who advocated the almost paradoxical
concept of wei wu wei, or action without action, an
idea which speaks to the essence of laissez-faire.
[36] While conservatives differ with one another on many
individual economic issues, most modern conservatives agree that
a free market is the sole path to prosperity for humankind. The
idea of action without action appeals to the average
conservative who deeply believes that government should not
meddle in the fiscal affairs of the individual beyond its
function as regulator and referee. But conservatives are not
utopians, and they hold little hope for a world in which
everyone is perfectly happy and everyone's wants are perfectly
met; rather, conservatives view our economic options as a set of
imperfect choices and regard capitalism as the least evil among
them.
[37] Conservatives are routinely accused of being obsessed
with money and of reducing human beings to economic creatures.
The definition of capitalism established here clearly refutes
that claim. If conservatives are passionate about capitalism, it
is not because they are passionate about money; rather, it is
because they are passionate about freedom.
[38] In an age in which the definition of capitalism is
routinely distorted to bolster the arguments of ideological
interests, it is rarely mentioned that capitalism is a liberal
economic idea; the liberal argument, between conservatives and
modern liberals, is not an argument about whether to abolish the
free market, but a conflict between two differing visions of
capitalism.
2006
2008
See also:
Capitalism vs Socialism vs Communism Source:
http://www.conservative-resources.com/index.html
Footnotes: 1. Douglas Harper,
Online Etymology Dictionary.
2. Karl Marx,
Capital
(New York: International Publishers, 1987).
3. Adam Smith,
The Wealth of Nations
(New York: The Modern Library, 1994).
4. Kenneth Minogue,
Alien Powers: The Pure Theory of Ideology
(New Brunswick: Transaction Publishers, 2007) 291.
5. John E. Sayre and Alan J.
Morris, Principles of Microeconomics, 5th
Ed. (Toronto: McGraw-Hill Ryerson, 2006) 5.
6. Smith,
Nations
745.
7. Milton Friedman,
Capitalism and Freedom
(Chicago: University of Chicago Press, 2002) 13.
8. Thomas Sowell,
Basic Economics: A Common Sense Guide to the Economy
(New York: Basic Books, 2004) 388.
9. Sowell,
Basic,
389.
10. James Gwartney, Richard L.
Stroup, and Dwight R. Lee,
Common Sense Economics
(New York: st. Martin's Press, 2005) 6.
11. Sowell,
Basic,
146.
12. Gwartney et al,
Common Sense,
19.
13. Walter E. Williams,
"Capitalism and the Common Man," 25 August 1997.
14. Friedman,
Capitalism,
171-172.
15. Friedman,
Capitalism,
15.
16. Friedrich A. Hayek, "The Use
of Knowledge in Society," American Economic
Review, XXXV No. 4, September 1945, 519-530.
17. Sowell,
Basic,
382.
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