The world's strongest economies all have one thing in common: their economic systems are based on some form of capitalism. Over the centuries, an economic system based on capitalism has allowed people to prosper and improve their standards of living better than economies based on socialism or communism. Not everyone wins under this system, however.
What Is Capitalism?
Capitalism is based on freedom of choice. Consumers have the right to buy whatever products they want, and companies have the opportunity to find innovative ways to produce those products and make a profit. The intrusion of government into people's lives is limited, and the means of production are owned by private citizens, not the government.
What are the Advantages of Capitalism?
Private property: Everyone is entitled to own assets. People have the right to own their houses, cars and television sets. They can even own stocks and bonds.
Self-interest: People are free to pursue their own good. They can do whatever they want without regard to pressure from politicians or consideration for what their neighbors think of their actions. The idea is that people's actions will help society as a whole. People are the most productive when they can earn money that gives them financial and political freedom.
Competition: Since people have the right to own assets, companies will see this demand and start making products to satisfy consumers. As demand grows, more businesses will jump in the market and start competing with each other for the consumers' money. This should be a good thing; more competitors mean better quality products and lower prices. At the same time, these companies will have to hire more workers and pay them better wages.
Freedom of Choice: Now, the consumer can choose among an offering of different products from several companies. No one can tell them that they have to buy a specific product from a specific company. Workers have the freedom to work for whichever company they choose. They can demand higher wages and better benefits.
Innovation: Among the many capitalism advantages is the idea that capitalism encourages efficiency in the marketplace. Companies must find profitable ways to produce high-quality products that consumers want to buy.
Efficient allocation of resources: Companies produce goods per the demands of consumers. Businesses do not make products that no one wants to buy. Firms have incentives to be productive; inefficient firms will go out of business.
Limited government intervention: In a capitalistic society, the government has a smaller role. Taxes are lower, and there is less government intervention in the free market. The role of government is to protect the rights of private individuals, not to intrude on their personal liberties.
What are the Disadvantages of Capitalism?
Focus on profit: The obsessive focus on profits leads to social and economic inequality. The population that controls the means of production tends to accumulate more wealth than the workers who helped to create those riches for the wealthy. Since rich families can pass on their wealth to their heirs, the rich get richer and the workers stay poor.
Financial instability: Financial markets go through periods of irrational exuberance, causing boom and bust cycles. During a long recession, people can lose their jobs, have their houses foreclosed and suffer a decline in their living standards.
Monopoly power: Because capitalism is a free market, it is possible for a single firm to become all-powerful and dominate a market. When this happens, a company can charge whatever price they want, and consumers have no choice but to pay higher prices.
Workforce limitations: In theory, the factors of production should be able to move from an unprofitable use to a profitable business. But this doesn't work for the labor force. A farmer who just lost his job cannot hop on a plane and fly to a big city to take a job as a waiter.
Neglect of social benefits: Private companies don't really care to provide social benefits such as health care, public transportation and education. None of these areas make a profit. So, the government has to step in to provide these services.
Capitalism isn't necessarily the best economic system, but it is better than the alternatives of socialism, fascism and communism. Most countries have adopted modified versions of capitalism that require limited participation by governments. The challenge is to make sure that the government doesn't acquire too much power and become its own monopoly.
James Woodruff has been a management consultant to more than 1,000 small businesses. As a senior management consultant and owner, he used his technical expertise to conduct an analysis of a company's operational, financial and business management issues. James has been writing business and finance related topics for National Funding, PocketSense, Bizfluent.com, FastCapital360, Kapitus, Smallbusiness.chron.com and e-commerce websites since 2007. He graduated from Georgia Tech with a Bachelor of Mechanical Engineering and received an MBA from Columbia University.