What is Capitalism?

As the Republican Party struggles to redefine its mission in a post-Cold War world, it makes sense to revisit some foundational terms. We might better manage the tension we are experiencing between Capitalism and Conservatism if we took a moment to remember what “Capitalism” actually means.

In a Capitalist economy, the value of things is determined by the price they can command in a free market. Assigning value based on market transactions opens up unheard-of opportunities for ordinary people to be judged by their productive capacity rather than their class, heritage, religion, or other factors that define one’s status in a traditional society.

Capitalism is the greatest instrument we have ever devised to generate wealth and alleviate human suffering. Markets and individual liberty tend to accompany one another in the long term (thought markets and democracy perhaps do not – another subject).

The creative power of Capitalism hinges on the freedom to visit wholesale destruction on anything which fails to compete in this race toward efficiency. Capitalism is an agent of what economists call “creative destruction.”

Creative destruction is not limited to businesses. Markets will tend over time to destroy aristocracies, racial preferences, tradition-based values, religious assumptions, and shared or public resources. It does not matter how valuable something may be in collective or intangible terms. If it cannot hold its own in a commercial transaction between a free, self-interested buyer and seller, it will be devalued, weakened and eventually swept away.

This is where Capitalism finds itself at tension with Conservatism. It is also where Capitalism faces its own internal inconsistencies. This problem has a name: Externalities.

The beauty of Capitalism is the remarkable efficiency of markets in setting prices that accurately reflect value. Unfortunately, markets are unable to incorporate values that are “external” to the transaction between a buyer and a seller.

For example, the market neither knows nor cares whether the goods being traded were obtained by fraud, violence, pollution, or extortion. If a seller is somehow able to produce a cheaper paperclip by polluting your well, kidnapping small children, or simply stealing someone else’s paperclips, a free market with no government intervention will reward that seller and punish anyone who fails to engage in that commercially optimal and socially despicable behavior.

The problem of externalities also affects the survival of core traditional institutions. What is the value of motherhood? What is the value of religious faith? What is the value of respect for our elders? The deeper Capitalism penetrates into a culture the more its emphasis on commoditization erodes values or institutions that are external to any market transaction.

Capitalism reduces everything to a commodity. If fatherhood, for example, fails to pay enough to compensate for its costs, then it gradually becomes too expensive for anyone to afford. In a free market, fatherhood has to go.

The freedom of potential buyers and sellers to reach a price agreement without outside interference is the key to the effectiveness of the system. That same absence of external interference will also destroy that market. The paradox of Capitalism is that its survival is sustained by a partnership between government and markets.

They grow together in constant tension yet feeding on each other. That is why government in a market economy is always larger and more sophisticated than in the agrarian societies that precede it (think of the difference between Northern and Southern states in the US prior to the Civil War).

They are in tension because as a market economy grows more complex and dynamic, its demands on government for infrastructure, dispute resolution, and regulation grow with it. Yet markets still need the freedom to perform independent of intervention to the greatest extent possible. The relationship between government and a free market is like the relationship between a parent and a teenage child. Capitalism is always chafing at restrictions yet unable to support itself without them.

The beating heart of Capitalism is the narrowly self-interested individual in competition with other individuals to wring the maximum commercial value from each interaction. You cannot have unrestrained Capitalism and traditional social institutions any more than you can be hot and cold at the same time. The market value of “family values” is very low and their cost is very high. Without some intervention, non-commercial institutions like churches, community and family life will die under Capitalism.

That is why Charles Murray has found traditional values thriving among the affluent and dying among lower-earners. The erosion of “family values” that so upsets Rick Santorum and James Dobson is a by-product of Capitalism. It is not going away. If we love Capitalism and we love our traditional institutions, then we must recognize this conflict and build a government capable of balancing the needs of both.

In time, Conservatives will likely find themselves moving into partnership with environmentalists and labor in efforts to limit the externalities of Capitalism. If you doubt that, take a close look at the politics of the Catholic Church. Hamiltonian Republicans like Chris Christie and David Brooks will probably move into alignment with traditional Liberals in defense of markets and personal freedom.

Many political earthquakes stand between today’s political parties and a durable post-Cold War realignment. Until that rocky transition is complete, our politics will remain a muddled mess and Washington may be dogged by gridlock. The sooner we all come to remember the meaning of terms like “conservative” and “capitalist,” the faster we can complete this uncomfortable transition.

17 comments on “What is Capitalism?
  1. Bonnie E. Fisher says:

    I recommend Thomas Pickity’s book CAPITALISM IN THE 21ST CENTURY, and Elizabeth Warren’s book on Wealth in American…. both great reads based on careful study of historical and modern capitalism in the western world.

  2. James Jones says:

    I highly recommend Robert Reich’s book “Saving Capitalism” for an excellent explanation of the relationship of a “free market” and government.

  3. Name says:

    when pasting, I accidentally cut off some of comment

    Small-c capitalism is merely gaining income (a fee or rate of return) from loaning capital resource. Allocating capital resources is actually a type of labor, so the ability to control is the critical aspect.

  4. Name says:

    Historically, big-C Capitalism is fascism/totalitarianism, rule by owners of wealth.
    As someone commented above, the USSR was a non-representative government that controlled all capital, thus was Capitalism dressed in the monopolistic language of “People’s this, People’s that”. The USA’s marginally representative rule by wealth, dressed in the near-monopolistic MSM’s “Individual Freedoms and Liberties” teabonics is rapidly approaching the same state.

    “Free Market” is either (at best) a misleading term for a vague idealistic concept, or an inexplicable religious belief.

  5. The issue with capitalism and the free market is that it is a
    “Positive Feedback System”

    If you were to start with everybody with equal capital and also equal skill and diligence then as chance gave somebody an edge the “edge” would continue to feed on itself and give more of an edge
    This would continue until a small number owns all of the capital

    We have known this for ever (Adam Smith talked about it)
    Them as has – Gets
    Piketty (Capital in the 21st Century) actually measured the effect of this in the returns on investment achieved by different levels of investment

    So its a positive feedback system and is naturally UNSTABLE – it will concentrate wealth – normally until the wealth represents sufficient power as to subvert the system

    In order to fix this “BUG” in an excellent system governments must act to keep it in the correct (optimum) zone by taxation or some other means

    • myth buster says:

      That would be true but for the fact that humans only live 80 years or so. Death provides a check on the concentration of wealth and power, either dividing it among heirs or destroying it outright. Furthermore, it is hard for heirs to maintain fortunes they didn’t earn, because they tend not to respect what is needed to earn them. The result is an imperfect meritocracy: the hardworking, frugal and disciplined tend to rise while the lazy, spendthrifts and hedonists tend to fall, though there are a few exceptions to this general rule.

  6. Smeagel4T says:

    Actually you fell into a common trap. “Capitalism” and “free market” are not synonymous. They just happened to (usually) occur together.

    For example, the USSR was actually NOT Marxist. That misnomer results from both USSR and US propaganda. It was what can be more accurately called “state capitalistic” (which the power brokers within the USSR didn’t want to admit to). The state provided the capital, the state owned the business, and more importantly the state decided how the resulting wealth would be distributed.

    This is different than Marxism in which the workers, not the state, own the businesses and most importantly decide how the resulting wealth will be distributed. We actually have the equivalent of “Marxism” operating just fine within western “free market” economies. They’re called “employee owned co-ops”.

    Once we’ve accurately identified the USSR system as “state capitalistic”, we can more readily see how “capitalism” and “free market” are not the same thing. Within the USSR, it would have been entirely possible for the state to own the business, but then allow the prices of products to be influenced within a “free market”. There is clearly nothing to make this impossible.

    In the US private individuals own the businesses but yet allow a “free market” to establish prices. In the USSR it would simply have been the state owning business but yet allowing a “free market” to establish prices.

    Indeed if the USSR had allowed a free market to operate even while the state owned the businesses, then the USSR likely would have lasted longer — although still economically weaker than the US. If the USSR had allowed their citizens to provide clearer market signals as to what was needed and what wasn’t, the business operations in which the state was invested could have been better reallocated to adjust.

    I’m not claiming this would have been perfect. Also the lack of ownership of the businesses, and the associated incentives to do better, would have always been a weak point in the system.

  7. Jack Quirk says:

    This analysis is outstanding. My only criticism is that you might be too optimistic that conservatives will follow such a rational course as aligning themselves with labor and environmentalists. Irrationality is the entropic engine in social systems.

  8. No market functions in a lawless environment. You can’t discuss the market implications of, for instance, assault or property destruction. It’s a category error.

    Your presuppositions about the market value of “family values” is similarly mistaken. Non-commercial institutions like the church are dying because belief in structured religion is dying. The utility of family values to society and therefore any business in it, is high.

    Externalities are ill defined. Not a transaction exists that doesn’t have effects external to cost considerations.

    All in all, I can see Garrett Hardin lurking behind most of what you write. The problem with tragedy of the commons type thought experiments is that they always ignore the ability of people to see problems cropping up and deal with them.

    • IAdmitIAmCrazy says:

      There is almost a Marxian quality of GOPlifer’s description of the internal strains of capitalism. It is probably dumb to say so because many people will see this as sufficient proof that GOPlifer is wrong. However, as a non-Marxist, I think that both Marx and Ladd are on to something. Let’s take family values you refer to. I’d hold (and leave it to Ladd to concur or not) that the utility of family values to society is high. But does it follow from there that market competition will preserve family values? Obviously not, since preserving the family structure isn’t exactly on the mind of an employer who almost by necessity must strive to maximize the flexible disposition of his employees, loosening up the family ties in the process.
      Suffice an admittedly particularly extreme example from my own life experience: For a decade I worked in international cooperation, and the employer would have greatly profited from our disposition to work two or three months in one place, then in another, and so on. Do you seriously think that in such a situation it is possible to sustain a normal family life? Divorce, I would hold, came about not because of loosening morals but because of exactly the necessity of people offering their service in the labor market to be flexible, idem birth control. Oh, yes, women entering the labor force in drones first came up because of the non-market event of war but later it would become obvious that businesses were in ever growing need of the productive potential of women. I will even radicalize my position: Without the “destructive forces” of the market, abortion would never have become as acceptable as it has become – despite however successful rear guard fights against.
      When you write that “Not a transaction exists that doesn’t have effects external to cost considerations,” you are at the core of GOPlifer’s argument: Some of these effects are detrimental to the fabric of society, and you need non-market COLLECTIVE action for mitigation and/or remedy.

  9. Ted Hu says:

    This piece is the best real-world down-to-earth explainer of Coase’s transactional economics (externalities) ever.

  10. Darnell says:

    Capitalism is not the problem. The real problem….there is no TRUE free market capitalism in a debt money system.

    The debt money system hinders capitalism and free markets.

    Economics 101 is NOT going to cover this topic.

  11. rob says:

    This text should become a must read for anybody that is going to talk about capitalism. Your explanations of externalities are perfect to understand for everybody. I’m so sick of people talking about “the free market” while not taking into effect externalities.

    Maybe we should just require anybody to take an economics 101 before they go on TV to talk about our economic system called capitalism.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s


Enter your email address to subscribe to this blog and receive notifications of new posts by email.

Join 454 other subscribers
%d bloggers like this: