What’s it: Capitalism is an economic and political system in which most of the resources are owned by the private sector. In this system, those who have capital control the economy, and even politics. Also known as a market system.
This system encourages private ownership of the business with profit orientation. Capitalism is characterized by private property rights, a stable rule of law, a free operating capital market, and a competitive market.
It is the opposite of communism. Under communism, production means are owned and controlled by the government.
What are the characteristics of capitalism
Under capitalism, private actors own and control property according to their self-interests. The private sector supplies and buys goods freely in the market. Pricing takes place in a way that serves the best interests of society, namely through a supply-demand equilibrium.
The purest form of capitalism is free-market capitalism or laissez-faire. Under laissez-faire, the private sector (households and businesses) is entirely free to decide where to invest, what to consume, produce or sell, and how to exchange goods and services. Each operates without any government intervention.
In general, capitalism stands on the following pillars:
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- The system recognizes private property rights.
- Each economic actor (business and household) pursues its own interests.
- Market mechanisms determine resource allocation as well as goods and services.
- Government roles are more limited.
Private property rights
Private property is essential in capitalism. This system allows people to own real assets such as land, property, and houses, and financial assets such as stocks, mutual funds, and bonds. Once owned, the only legal means of transferring ownership is through trade, gifts, and inheritance.
Private property promotes efficiency by providing incentives to resource owners to maximize their value—the more valuable the resource, the higher the owner’s power. In the capitalist system, the person who owns the property is entitled to any value associated with that property.
Also, the law must protect private property, and in facilitating and enforcing private property rights, capitalist societies rely on contracts, fair deals, and lawsuits.
Economic actors act to pursue their own good, regardless of socio-political pressure. The main motive of businesses is profit. Meanwhile, the main motive of the individual (consumer) is a utility (satisfaction).
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Those motives guide their behavior and interactions in the economy. Their motives and interactions ultimately benefit society as if Adam Smith says, they are guided by the invisible hand.
Profits are closely related to the concept of private ownership. Individuals only make voluntary exchanges of personal property when they believe the transaction is in their favor.
A capitalist earns the highest profit by using capital goods most efficiently while producing the highest value.
In this system, value is transmitted through the prices at which other individuals voluntarily buy capitalist goods or services. Profits are an indication that less valuable inputs have been transformed into more valuable outputs.
Under capitalism, the market operates perfectly and companies are free to enter and exit the market. The market operates according to the supply and demand mechanism without government intervention.
Competition ultimately maximizes social welfare, namely shared welfare between producers and consumers (also known as economic surplus).
Market mechanisms determine prices
The interaction between buyers (demand) and sellers (supply) determines the price. Price is the basis for a resource-efficient location. Allocation naturally seeks the highest reward, not only for goods and services but also for production factors (such as labor).
Freedom of choice regarding consumption, production, and investment
For example, a dissatisfied customer can switch over and buy a different product. Investors can choose a more profitable business. Workers can leave their current jobs to pursue better wages. Companies are flexible in recruiting the right workforce and producing the most profitable products. You won’t find such freedom in a command economy because the government rules everything.
Limited government roles
The government exists only to protect citizens’ rights and enforce private property. They maintain an orderly environment that facilitates the functioning of the market.
What are the types of Capitalism
Economists classify capitalism into different groups, using various criteria. Capitalism, for example, can be categorized into two types based on how production is organized.
- A liberal market economy is where most of the production process takes place in a decentralized manner. Examples of countries that have adopted a liberal market economy are the United States and the United Kingdom.
- A coordinated market economy depends on formal institutions – such as trade unions and business associations – to regulate markets and coordinate company interactions and corporate relationships with suppliers, customers, employees, and financiers. Japan, Germany, and Sweden are examples of countries that adopt a coordinated market economy system.
Furthermore, economists also divide the four types of capitalism based on entrepreneurship’s role in encouraging innovation and institutional arrangements in which new ideas are placed to promote economic growth.
- State-guided capitalism in which the government decides which sectors will grow. Originally motivated by a desire to promote growth, this type of capitalism has several pitfalls: over-investing, picking the wrong winners, prone to corruption, and difficulty attracting support when it no longer fits.
- Oligarchic capitalism which is oriented to the protection and enrichment of a small part of the population. Economic growth is not the ultimate goal, and countries of this diversity are subject to economic inequality and corruption.
- Big-firm capitalism in which the economic arrangement depends on big companies that take advantage of economies of scale and dominate production and employment.
- Entrepreneurial capitalism in which the economy rests on the presence of individuals willing to take risks to start production. This system usually produces breakthroughs such as cars, telephones, and computers. These innovations are generally the product of new individuals and companies. However, it takes large companies to mass-produce and market new products, so a mixture of big corporate capitalism and entrepreneurship seems best.
What are the advantages and disadvantages of capitalism
Although it allows efficient allocation of resources, the capitalist system also raises various criticisms. In the economic textbooks you read, the author usually provides a description of each economic system’s weaknesses and advantages. It shows that there is no single best economic system (without weaknesses). Besides, you may not find countries that adopt a purely economic system.
The advantages of capitalism
Proponents of capitalism argue that free markets and competition produce prosperity in the economy and create a superior business. Competition forces firms to provide better, more innovative, and more competitive products and services. That, in turn, leads to a more varied and cheaper product.
This system allows the most efficient allocation of resources. The market decides how to allocate resources based on demand and supply laws. That means that capital, labor, and natural resources are distributed to make the most significant impact.
Well, I will list the advantages of capitalism:
- More efficient use of resources and the distribution of goods.
- High innovation because of the freedom to do what is best for them.
- Encourage economic growth by promoting competition in the market.
- High quality of products due to intense competition and pressure from consumer demand.
- Hard work is highly valued in a capitalist economy. Businesses and individuals who have excellent performance and can continue to innovate will win the competition.
The disadvantages of capitalism
The main criticism of capitalism is about the huge gap in wealth. Inequality is widening between capitalists and people. Capitalists own and control a large amount of economic capital (money and other financial assets) and can create more money and wealth than others. Meanwhile, most of the people are increasingly falling into acute poverty because they do not have capital.
Also, there are opportunities for corrupt behavior in the system. For example, the donations and lobbying of large capital owners to politicians can influence laws that support their interests. This gives them a more favorable position than small capital owners, who have no political influence.
Another criticism is that the profit motive often ignores social, environmental, and community benefits. The capitalist system is responsible for the exploitation and degradation of the environment. The private sector will tend to pursue profits and tend to ignore the negative externalities they produce.
Critics also associate capitalism with imperialism and the counter-revolutionary war. Also, this system produces various forms of economic and cultural exploitation. It encourages materialism, oppression of the weak, social alienation, and economic instability.
What is the difference …
Capitalism is often contrasted with other economic systems. Among others are:
The difference between capitalism and socialism
Socialism is a mix between a market economy and a command economy. In socialism, the private sector and the government own the means of production. However, the government will generally control strategic industries rather than being left to the private sector.
In this system, the private sector and the government can compete. For example, there may be a combination of state-owned and private-owned oil producers in the oil industry. This gives the government more control over strategic assets and can provide more revenue than merely levying taxes.
The drawback of socialism is that the government may not be as efficient as private operators. Therefore, their performance will not be as profitable as private competitors. Also, there is a tendency for state-owned companies to receive more favorable treatment than private companies.
The difference between capitalism and fascism
Fascism is a type of nationalistic economic system. In this system, the government forces businesses to place national interests ahead of owners’ interests.
In this system, the ruling party and central state planners determine what the business owners need to do. The main focus of this system is on nation-building, which is usually combined with muscular military strength.
The difference between capitalism and communism
The system of communism is a more extreme system than socialism because the government owns all production means. The government also sets the standard of living for citizens.
Communism is in stark contrast to capitalism. Under this system, the state adopted a command economy system. All businesses are state-owned. The economy is planned centrally, including in terms of capital allocation.