What is capitalism? The dictionary defines it as follows.
An economic system characterized by private or corporate ownership of capital goods, by investments that are determined by private decision, and by prices, production, and the distribution of goods that are determined mainly by competition in a free market
While I don’t disagree with that definition I find it a bit difficult to comprehend as well as somewhat incomplete and thus I will attempt to provide my own definition. To me the concept of capitalism refers to an economic system where entrepreneurs perceive a need in society and attempt to generate a profit by meeting that need. Consumers choose the good or service that does the best job of meeting their needs at the least cost.
Socialism, on the other hand, refers to an economic system where government perceives a need in society and attempt to meet that need. Consumers generally are stuck with what the government provides for them at the price government sets.
Capitalism is one of those words, like liberal and conservative, that tends to trigger an emotional response which is all out of proportion to their true meaning. In fact the true meaning is often not even understood. To some, capitalism is the solution to all the worlds problem and to others, the source of all its problems. To some, it means opportunity, freedom, and efficiency, while to others it means greed, exploitation, and repression. As usual there is an element of truth in all these viewpoints as well as a complete lack of understanding.
One major difference between capitalism and socialism is that socialism requires a top-down approach. This means that government decides what a society needs, government decides how to address that need, and government decides what to charge. If government makes the right decisions it may arrive at an efficient solution. That is a mighty big IF, however.
Capitalism, on the other hand, is a bottom up approach. There is no need for a government to make decisions. Entrepreneurs make the decisions about what is needed, how to provide it, and what to charge. While it is true that profit is the motivating factor it is not true that greed is a requirement. Certainly it is possible for someone to take pleasure in meeting a need for their fellow man and make a fair profit for themselves without being greedy. In fact under true capitalism entrepreneurs set prices to maximize their profit but they cannot simply charge whatever they want. If they charge too much competitors may well see an opportunity to charge a little less, and/or consumers may find another solution and thus the “invisible hand” of the market corrects itself and a fair price is determined.
Under true capitalism there is a relentless pressure to produce higher quality goods more efficiently in order to out-compete other entrepreneurs and thus it would be expected to result in the best possible outcome. While a socialist economy might produce a functional car it would never result in the kind of constant improvement that leads to the high quality cars produced under a capitalist economy.
So how has capitalism gotten such a bad rap? In order to achieve the efficiency it promises capitalism requires certain conditions. Consumers must have a variety of choices available and they must be able to judge the benefits and costs of the goods and services they desire. In order for consumers to have choices there must be relatively few impediments on producers from entering the market. In order for consumers to be able to accurately judge the costs and benefits they must have access to free and accurate information. In many cases capitalist economies fail to achieve their promised efficiency because it is easy for producers to become overcome with greed and cheat. Instead of competing on the basis of who is able to meet the needs of society by providing best goods and services at the lowest price, as required by capitalism, it is far easier to compete on who can best violate the principles of capitalism by obstructing their competitors and obscuring information to consumers. In effect there is a race to the bottom as the best cheaters rise to the top. The perceived shortcomings of capitalism railed against by its critics are usually the result of the failure of capitalism, rather than its success.
Throughout this blog I will attempt to discuss current and historical issues in terms of how well they adhere to the principles of capitalism outlined above. Recurring themes will be free competition, free flow of information, cheating, incentives, the discrepancies between price and cost, and externalities. Some of these concepts are so important that they will have their own page to provide background.