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Capitalism

Introduction
An economic system that features
private ownership of the means of production (such as factories,
offices, and shipping enterprises) and in which market forces determine
the way in which goods are produced and the means by which income and
profit are distributed is called capitalism.
Other names for this
system are free market economy and free enterprise. All three terms
were coined in the late 19th and the early 20th century to describe
economic arrangements that began developing centuries ago in Europe.
Alternatives to capitalism include central planning (or “command”
economies, such as communism) and those based on the principle of
tradition, as experienced in monarchies. Because a pure form of each
economic system exists only in theory, most economic systems follow a
particular approach but incorporate aspects of other systems. Mixed
economies that emphasize central planning and government ownership of
all forms of production are examples of socialism.
The word capital
refers to resources—such as human labor, machinery, land, buildings,
and money—that are used to produce other goods and services. These
resources are also called factors of production, because they
contribute to the production of goods from farms, factories, small
enterprises, and offices. The capitalist is the individual—or group of
individuals—who invests money in an enterprise in exchange for
potential profits in the future.
In the context of capitalism, the
term private property has a specific definition: it signifies the means
of production. A farm as property offers the means by which food is
produced, just as a factory as property represents the means by which
durable goods are produced. As an example of services a physician's
office and equipment are the physician's property, which the physician
uses in the treatment of patients. The heart of capitalism rests on the
entrepreneur's right to produce what he or she wishes and the
consumer's right to choose what to buy, so long as goods or services
being exchanged are lawful.
The other two terms used to describe
capitalism, free market economy and free enterprise put a slightly
different slant on the meaning. They have in common the word free, but
economic liberties should not be confused with political liberties such
as those experienced in a democracy; in other words, it is possible for
a capitalist economic system to develop within a socialist economic
system. The implication is that people are free to choose how they use
their capital resources (for example, they decide how much to save, how
much to spend, and on which goods and services their savings are
spent). Successful free enterprise systems also rest on the
above-stated right to own property, meaning that individuals have the
right to do what they wish with their property, as long as it does not
harm anyone else. (The rights of property owners will vary, however,
between countries or various jurisdictions.) These freedoms set
capitalism apart from all other kinds of economic arrangements: all
other economic systems operate as top-down, command-and-control
political systems in which personal freedom and the rights of property
are considered secondary to the needs of the state.
The creation of
wealth in the past few centuries was made possible because capitalism
emerged in free, or nearly free, societies that allowed individuals to
seek to better their own conditions without being given orders by
higher authorities. In other words, the economic system of capitalism
offers the means by which individuals are motivated to improve their
lives through hard work and innovation.
It was the first modern
economist, Adam Smith, who noted in 1776 that individuals naturally
seek their own advantage. This can be achieved in two ways: by
individual effort or at someone else's expense. But it is impossible
for everyone to succeed at everyone else's expense. Therefore most
individuals will contribute to a productive economic system, seeking to
do or make something that others will pay for, or they will work for an
organization that makes products or provides services that are
purchased and used by others.
In pursuit of their own advantage,
people in a capitalist economic society use their imaginations. They
innovate by finding new ways to do old tasks. They discover new
solutions to old problems and develop new products. Such innovation is
the foundation of continued wealth creation. For example, communication
by wire started with the invention of the telegraph. Then came the
telephone and voice communication by wire. This was followed by radio,
wireless communication. Next was sending visual signals to television
sets. Now global communication can be transmitted through networks of
fiber-optic cable, microwave transmission towers, and satellites
orbiting the Earth. One innovation built upon another. Free people in a
free market economy provided the funding for these innovations and
inventions, and market forces determined the demand for these new means
of communication. Such dynamism fills the marketplace with innovative
and useful products, and it contributes to higher standards of living
for a greater number of people.
An aspect of this dynamism is seen
in the Industrial Revolution. This long-term development truly
revolutionized the way goods were produced, and it created employment
for millions of individuals. Although the earliest working conditions
in the Industrial Revolution were often difficult, dangerous, or
unhealthy, public awareness and social movements led to better
employment standards. The result has been safer job conditions, fairer
labor practices, and a significantly improved standard of living for
whole societies.




Characteristics of Free Enterprise
A shopping mall offers a great array of goods, or circulating capital, to customers.
In
addition to personal freedom, private property rights, and innovation,
capitalism is characterized by the specialization of jobs (known as the
division of labor), a price system, profits, and generally accepted
rules. None of these originated with capitalism. They have existed as
long as people have performed economic functions. The difference lies
in the distinctive roles they were made to play in the free market
economy.
Capitalism is society organized as a market, in contrast to
society organized as government and subjects. Money, land, machinery,
labor, channels of distribution, and buying and selling all work
together to form such a market. Some institutions, notably government
and religion, stand apart from the market; but they also depend upon
the wealth it creates for their well-being. Taxes, for instance, are
portions of wealth taken from society to pay for government functions.

Division of Labor
At
one time nearly all work was agricultural. (In poor countries it still
is.) As civilizations developed and cities were formed, the role of
agriculture as an employer of people began to diminish. Individuals
undertook new tasks: mining, handicrafts, trade, and weaving cloth, for
example. This simple division of labor paved the way for a greater
creation of wealth in a society, because it permitted people to
specialize in certain types of work, thereby creating more efficient
ways for producing the wares required in daily life. Greater quantities
of goods, in more varieties and of better quality, were produced for
commerce and trade.
In contrast to the earliest agricultural
societies, the division of labor in the contemporary world is
extraordinary, represented to consumers by the great diversity of
products and services available. The division of labor is more clearly
evident in the factories that make these products. A look into an
automobile plant, in which cars are assembled in a series of steps,
will show specialization along a production line: managers have decided
which tasks each worker will perform, and they have also determined
which production tasks can be handled by machines, and which must be
performed by humans.

Price
In a market economy, price is the
controlling factor. If a seller charges too much for a product or
service, buyers in a free market economy will turn to other vendors who
offer fairer prices. Likewise, a seller who charges too little might
fail to keep up with demand for products—or worse, the seller might not
earn enough to cover the costs of the products for sale. The price
mechanism brings order to these economic exchanges. Certainly prices
have existed as long as goods and services were bought and sold. But
only under capitalism did land, labor, money, and resources all become
subject to the price mechanism. In capitalist economic systems, nearly
everything is subject to price, because price is the fairest means of
allocating the factors of production to their best use. Price is
essentially a rationing system for all factors of production.
Prior
to capitalism land, labor, resources, and money were largely under
government control or under the control of wealthy elites with close
ties to government. During the European Middle Ages, for instance, land
was required to remain the property of a family for generations.
Similarly, ordinary people were locked into specific jobs that were
carried on by their descendants generation after generation: being a
farmer or artisan was passed from father to son and from mother to
daughter. Production was undertaken to support the state and religion,
and the very little left over had to suffice to sustain the mass of
people.
Although the continuous development of capitalism as a
system dates only from the 16th century, antecedents of capitalist
institutions existed in the ancient world and flourishing pockets of
capitalism were present during the later European Middle Ages. The
development of capitalism was spearheaded by the growth of the English
cloth industry during the 16th, 17th, and 18th centuries. What
distinguished this era of capitalism from previous systems was the use
of profits to expand production in ways that could create even greater
wealth. Before this, profits were just as likely to be spent on
luxuries or invested in economically unproductive projects, such as the
construction of monuments, palaces, pyramids, and cathedrals.
Over
time, the medieval system in Europe gave way to a new social and
economic order: land was sold by kings and nobles in desperate need of
money. Workers and craftspeople, driven from the land that had been
owned by their lords and masters, became a landless class of poor
subsistence workers. But as a market economy started growing, these
poor were able to hire themselves out as laborers for whatever wages
they could command. A wage is considered a price—in this case, a price
paid for labor.
Just as products command a price, so money, too, can
be obtained for a price—the price of borrowing it. This price is called
interest. The rate of interest varies with the supply of money
available for investment in an enterprise. Like money, the other
factors of production are not in unlimited supply. When it is free to
react to market conditions (such as supply and demand), the price
mechanism proves to be the most useful way of allocating all the
factors in the economy in the most efficient way. A large labor supply
in one place naturally tended to depress wages, so workers went to
other places where they could obtain a greater price for their labor. A
shortage of a resource such as copper tended to raise its price, while
the discovery of new copper mines lowered it by increasing the supply.
When replacement materials for commodities such as copper are either
discovered or invented, these so-called substitute commodities also
reduce prices. Thus, the development of fiber-optic cable reduced
dependence on copper wire, just as kerosene and electricity had
eliminated the reliance on whale oil for lamps and lighting.
In a
perfectly free market (which exists only in theory), prices tend to be
stable. Resources are allocated to those who can make best use of them
at the time. The level of employment also tends to be stable and high,
because workers will go where they are most needed. If the carriage
maker's factory closes because automobiles are making carriages
obsolete, the labor force will shift to the new industry.
When
carriages can no longer be sold, their prices collapse; but the prices
of cars will increase. In this way prices work together with supply and
demand to sort out the elements of the economy. Pricing is therefore
somewhat like an ongoing auction, with the buyers bidding for the
specific factors they need, whether it be money, workers, raw
materials, or land. This is also known as an allocation of resources.
If there were enough of everything for everyone, prices would be
unnecessary; but then, there would be no need for an economic system
either.

Profit
This has been the most controversial aspect
of capitalism, because it has been so thoroughly misunderstood. Critics
of capitalism have contended that profit was the goal of capitalist
greed: something to which the workers were rightfully entitled but
which the bosses stole; or something extra for the owners above all
real costs. One reason profits have gained a bad reputation is the
popular misconception that company profit margins are enormous. In fact
they are quite small in proportion to total revenues—usually running
about 5 to 6 percent of total sales, but often less—in fact, some
companies with very high sales volumes, such as discount retailers and
grocers, might have profit margins in the range of 1 to 2 percent.
Profit
is, in fact, nothing more than the portion of revenue that exceeds
current expenses. A business that earns a profit is not only able to
keep operating; it is also able to innovate, to seek new markets, and
to expand with new machinery and plants. Without profit, only the costs
of current production, such as raw materials and wages, would be
covered. If there were a loss, even those costs could not be paid. In
any business, profit acts as a signal to indicate the health of the
company. A loss signals serious problems. A company that covers only
costs but earns no profit will have few options for change. Winning
over new customers will be unlikely because advertising and sales
promotions cannot be afforded, nor can new products be developed or
efficient plants constructed.

Rules
Order is brought to the
economy by the price system and by rules that everyone agrees upon.
Some rules are common to society: for example, no theft or fraud shall
be permitted, nor will any transactions involve illegal goods or
services. In an increasingly complex economic system, other
requirements, such as licensing, certification, or proof of
citizenship, will limit access to the market. Many transactions are
also guided by the rules of contract. Contracts are voluntary (but
legally binding) agreements entered into by two or more individuals.
They normally specify the performance of some work or delivery of
specific goods at a certain time. A contract therefore is a set of
promises signed by the parties to it. As such, a contract has the force
of law; and there is a whole branch of law devoted to contracts. The
establishment and recognition of property rights also play a major role
in ordering an economy. Of increasing importance is the recognition of
intellectual property—intangible items that represent great value to
their owners. Copyrights and trademarks represent a form of property,
for example, because they are signs of ownership. Property rights can
also be infringed by counterfeiting and forgery, and by copyright and
trademark infringement.

Unplanned order
The four
characteristics described above (division of labor, price, profit, and
rules) have worked together to establish a society (even on a global
scale) connected by an intricate network of market relationships. This
market system was unplanned. It evolved slowly, as did the rules by
which it operates. The market is a product of spontaneous human action
but not human design. People, impelled by nature to maximize their
well-being, created what proved to be workable arrangements that
augmented individual and social prosperity. The market system does not
depend on people sharing the same values, belonging to the same ethnic
group, or having the same religion. It does not even depend on their
liking each other. It is rooted only in the common desire to improve
the material conditions of one's life.

Goods and services
Given
the great variety of items sold in a capitalist economic system, a
distinction must be made between goods and services. In the case of
goods, something is produced: food, clothing, cars, houses, and more.
Goods are also called products or commodities (though sometimes
commodities are natural resources). Services are not products, though
services use many products. A motion picture, for example, is a
product, but some means of delivering that product are defined as a
service. To show the movie publicly is to provide a service that
involves film, a projector, and a theater. Customers see the movie but
they do not take anything home with them except the memory of the
entertainment. By comparison, a DVD copy of the same movie purchased
for home use is considered a product.
There is another significant
difference between goods and services. Products provide the basic
wealth of society, because wealth is typically represented by tangible
goods. A service cannot be wealth; because once it has been performed
it ceases to be. Services can, however, be a signal of wealth, because
societies that have produced a great deal of wealth, such as the United
States, Germany, and Japan, are notable for the variety and quantity of
services. By contrast societies that have little wealth will have fewer
services available. People in such poor countries can barely afford the
necessities, much less the luxury of services—even such important ones
as medical care. A society depends on the continued creation of wealth
for its prosperity and survival. Services cannot perform this function.
They depend, in fact, upon wealth creation for their continued
improvement.


Consumers and Value
Just as producers sell
goods and services, customers buy value for themselves. In a truly free
economy the consumer is thus the dominant partner in the relationship,
because it is the consumer who ascribes value to his purchases—or he
would not make them. Products and services that consumers do not want
have no market value, no matter how highly the producers regard them.
In
the past some economists mistakenly assumed that producers created
value by the effort, material, and time that went into making a
commodity. But the time and effort put into a product or service cannot
be readily quantified. To be sure, there are costs of production, but
they are influenced by the price the producer believes he will get from
selling the product. The producer, in other words, must try to guess
what value the consumer will ascribe to the product and estimate the
price customers would be willing to pay for the product; then he must
adjust all production costs accordingly.
The role of the consumer in
determining value indicates that the market system parallels some of
the ways in which a democracy operates. Consumers “vote” for or against
products and services with the money they spend. If a product fails to
meet the buyers' expectations, the buyers will switch to another; and
the producer will be voted out of business. Workers can also vote by
moving away from jobs with poor pay or unhealthy conditions to jobs
that pay higher wages and offer a safe working environment.











Critics of Capitalism
Supporters
of capitalism declare that economic freedom is the most basic of human
liberties, because it creates greater opportunities for advancement for
the greatest number of people. Yet the market system has been strongly
criticized by opponents who claim that it fails to provide an equally
high standard of living for all. The claim is true: there are and
always will be inequalities of wealth under capitalism, but they are
not as extreme as the inequalities to be found in other economic
systems.
The goal of equality of wealth can only be pursued by
force, and governments must do the forcing. An economy itself has no
mechanisms of coercion available to it. Those 20th-century systems that
relied on force—communism and fascism—failed to achieve a high standard
of living for any but a minority. But these are not economic systems;
they are political systems. The market economy, by contrast, does not
guarantee equal outcomes for all. It merely operates on the assumption
of liberty and equality under law for all participants. Success in a
free market depends in large part on individual effort and ability, but
effort and ability are unevenly distributed among human beings.
Capitalism
has been denounced for having business cycles, periods of “boom and
bust". Although individuals and societies tend to prefer security and
stability, it is true that capitalism is always changing. But an
economy is never a finished process. The market economy is dynamic,
flexible, and always in flux, because its continuation depends to a
great extent on technological change, new information, and innovation.
New needs emerge and alternate means of producing established products
are devised. Just as industrializing economies saw losses in the number
of farming jobs, so now the number of manufacturing jobs is shrinking
worldwide. Such dislocations are inevitable, as the economy continually
corrects and readjusts itself. Attempts to halt or reverse change
would, if successful, lead to stagnation and a decline in the standard
of living.