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Definition of Capitalism

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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.


See also: Capitalism vs Socialism vs Communism



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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