In this post, we’ll unpack all you need to know about capitalism, defining exactly what it is, the five pillars that form the foundations of capitalism, the role of government, capitalism and socialism, capitalism and evolution and more.
What Is Capitalism?
Capitalism, also known as free market economy, is a socioeconomic system whereby the means of production and distribution are controlled by private actors rather than by the state.
The 5 Pillars Of Capitalism
There are 5 core pillars that support the effective functioning of capitalism. They are: Private Property, Private Enterprise, Market Competition, Profit As Incentive and Consumer Sovereignty. The extent to which these pillars operate distinguishes the various forms of capitalism.
Below we’ll unpack each of the 5 pillars in more detail.
1) Private Property
Private property allows people to own tangible and intangible assets.
Private property promotes efficiency by giving the owner of resources an incentive to maximize its value. The more valuable a resource, the more trading power it provides the owner of that resource.
2) Private Enterprise
Private enterprise allows individuals to control businesses independent of the state.
Private enterprise allows customers to determine the success of a business, provides employees with wages and salaries and ensures investors are responsible for providing capital to entrepreneurs.
3) Market Competition
Market competition allows individuals to compete to provide superior goods and services.
Market competition promotes innovation and forces individuals to maximise efficiency and offer the best products and services at the best prices which maximises the welfare of both producers and consumers.
4) Profit As Incentive
Profit allows individuals to benefit financially from their endeavours.
Profit operates as the financial incentives for individuals to produce goods and services. It promotes innovation, increases efficiency and motivates individuals to take risks and seek new opportunities.
5) Consumer Sovereignty
Consumer sovereignty allows individuals to freely buy and sell.
With consumer sovereignty, a market economy gravitates to equilibrium — a place where supply and demand are equal. Prices settle where producers and consumers are satisfied.
Capitalism & The Free Market
In a free market economy, prices set by supply and demand provide real-time, decentralized information about the scarcity and value of goods, guiding capital owners in resource allocation.
High demand and prices signal profit opportunities which prompts investment. Low demand and prices signal a shift of resources elsewhere. This dynamic price mechanism ensures efficient resource distribution, aligning production with consumer needs and preferences, thus enabling informed and effective capital investment decisions.
Capitalism & Reason
Capitalism is a system geared to the life of a rational being. Reason is man’s means of survival. Human beings either survive or die in proportion to the degree of their rationality.
Capitalism & Individual Rights
Capitalism is based on the recognition of individual property rights. A “right” is a moral principle defining and sanctioning a man’s freedom of action within a social context.
The recognition of individual rights entails the banishment of physical force from human relationships.
Capitalism & Property Rights
Property rights are embedded into nature, as seen by the way animals mark out territories for their exclusive use in foraging, hunting and mating. The recognition of such rights to control and exclude minimises conflict.
Without representations, assets are dead capital. A formal property process enables individuals to represent their property and create capital.
Capital can be extracted and processed from assets. A conversion process is required to transform the invisible into the visible and enable assets to be used as collateral.
Property allows for the flow of communication about assets and their potential and enhances the status of their owners who become economic agents able to transform assets within a broader network.
Property obeys Metcalfe’s Law by increasing in value as the network of interconnected ownership, usage or economic activity grows.
However, the great paradox of the capitalistic system is that it creates its own demise because it concentrates capital in a few hands.
Capitalism & Government
Government is essential both as a forum for determining the “rules of the game” and as an umpire to interpret and enforce the rules decided on.
Thus, in a capitalist society, there are three primary functions of government.
Firstly, it must maintain law and order by ensuring that property rights are protected and contracts are enforced.
Secondly, it must provide public goods and services such as infrastructure, education and defense which might not be efficiently provided by the private sector.
Thirdly, it must regulate markets by preventing monopolies and protecting consumers.
Capitalism & Socialism
Believers in capitalism tend to hold the view that it is human nature to be primarily greedy, self-interested and competitive.
Believers in socialism tend to hold the view that it is human nature to be primarily compassionate, group-interested and cooperative.
The truth, however, is that human nature contains elements of both systems. Humans are both greedy and compassionate, both self-interested and group-interested and both competitive and cooperative.
What distinguishes capitalism from mere market activity is that in a capitalist society social relations are embedded in the economy rather than the economy being embedded in social relations.
A free market system effectively provides a perpetuating cycle of innovative entrepreneurs breaking monopolies and then creating new ones.
Capitalism & Evolution
Evolutionary theory supports the idea that capitalism — in a broad sense and in its true form — is a system that best fits our evolved psychology.
Furthermore, just like evolution, capitalism is also an optimizing process. Specifically, it optimizes for profit, with consumers exerting the selective pressure instead of the environment. Thus, the result is that every niche in the market is filled with a product or service suited to that particular consumer desire.
Below are just a few features of human nature emphasized by evolutionary psychology that align with the characteristics of capitalism.
- Humans Are Coalitional — Free trade encourages market participants to see members of unfamiliar groups (other businesses) as partners, not enemies — as us, not them.
- Humans Are Hierarchical — Free trade motivates market participants to create the best products and services in return for status.
- Humans Are Self-Interested — Free trade motivates market participants to create the best products and services in return for personal gain.
- Property Rights Are Natural — Free trade encourages our innate desire to acquire, possess and control our own property.
- Mutually Beneficial Exchange Is Natural — Free trade encourages our natural proclivity to navigate through the world of personal exchange.
- The Division Of Labour Is Natural — Free trade encourages the separation of tasks and allows individuals to specialize in productive endeavours.
Evolutionary psychology, by helping us better understand human nature, can aid us in cultivating social orders that do not foolishly attempt to cut against the grain of human nature.
We can learn how best to work with the material of humanity to encourage and preserve societies, that are not only effective, but will endure.
“The moral justification of capitalism lies in the fact that it is the only system consonant with man’s rational nature.“ — Ayn Rand Lexicon
Summary (TL;DR)
Capitalism is a socioeconomic system whereby the means of production and distribution are controlled by private individuals instead of the state.
Capitalism stands alone as the only feasible way to rationally organise a modern economy. It exemplifies personal freedom, ownership of one’s self, ownership of one’s property and the right of self determination.
While not perfect, capitalism seems to be one of the most effective systems humanity has come up with that best aligns with human nature and our evolved psychology.
