## jahan-capital

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**Canonical URL:** [jahan-capital](https://www.imf.org/-/media/files/publications/fandd/back-to-basics/jahan-capital.pdf)

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### Overview
- Capitalism: an economic system where private actors own and control property and demand and supply freely set prices in markets.
- Essential feature: the motive to make a profit. Quotation: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”
- In a capitalist economy, capital assets (factories, mines, railroads) can be privately owned and controlled; labor is purchased for money wages; capital gains accrue to private owners; prices allocate capital and labor between competing uses.

### Pillars of capitalism
- private property, allowing ownership of tangible and intangible assets (land, houses, stocks, bonds);
- self-interest, where uncoordinated individuals acting in pursuit of their own good can benefit society (“invisible hand” reference to Smith’s 1776 Wealth of Nations);
- competition, with freedom to enter and exit markets to maximize joint welfare of producers and consumers;
- a market mechanism that determines prices in a decentralized manner through buyers and sellers, allocating resources and wages toward highest reward;
- freedom to choose in consumption, production, and investment (customers, investors, workers can choose alternatives);
- limited role of government, to protect rights of private citizens and maintain an orderly environment facilitating market functioning.

### Forms and classifications of capitalism
- Free markets (laissez-faire): markets operate with little or no regulation.
- Mixed economies: markets play a dominant role but are regulated to correct market failures (examples: pollution, traffic congestion) and to promote social welfare, defense, public safety; mixed capitalist economies predominate today.
- Two organizational types based on production:
  - liberal market economies: competitive market prevalent; decentralized production (examples: United States, United Kingdom);
  - coordinated market economies: private information exchanged through non–market institutions (unions, business associations) (examples: Germany, Japan) — reference: Hall and Soskice 2001.
- Four types distinguished by entrepreneurship role and institutional setting — reference: Baumol, Litan, and Schramm 2007:
  - state-guided capitalism: government decides which sectors will grow; pitfalls include excessive investment, picking wrong winners, corruption, difficulty withdrawing support;
  - oligarchic capitalism: oriented to protecting and enriching a narrow fraction of the population; economic growth not central; accompanied by inequality and corruption;
  - big-firm capitalism: exploits economies of scale; important for mass production;
  - entrepreneurial capitalism: drives breakthroughs (automobile, telephone, computer) usually from individuals and new firms; effective economies combine big-firm and entrepreneurial capitalism (characteristic of the United States).

### The Keynesian critique and role of government
- Keynes (1936 General Theory of Employment, Interest, and Money): capitalism can remain indefinitely in equilibrium with high unemployment and no growth; argued for government intervention to promote aggregate demand and fight high unemployment and deflation.
- Recommended policy tools: cutting taxes and increasing government spending to pull the economy out of recession and temper boom-bust cycles.
- Keynes did not seek to replace markets, but advocated periodic government intervention.

### Risks, distortions, and corrective measures
- Free markets require governments to set rules (property rights) and provide infrastructure (roads, highways).
- Governments may be influenced by organized private interests that use regulation to protect their economic position at the public’s expense, potentially repressing the free market that enabled their success.
- Rajan and Zingales (2003) argument: society must “save capitalism from the capitalists” by protecting markets from powerful private interests; otherwise “crony capitalism” and nepotism may dominate over efficiency.
- Necessary measures emphasized:
  - limit concentration of ownership of productive assets to ensure competition;
  - compensate losers of competition;
  - promote free trade and strong competitive pressure on incumbent firms;
  - build public support for free markets and oppose interventions that protect powerful incumbents at the expense of broad prosperity.

### Inequality and capital accumulation
- Economic growth under capitalism has outpaced other systems, but inequality remains controversial.
- Piketty (2014): historical data back to the 18th century show that the rate of return on investment frequently outstrips overall growth; with compounding, persistent discrepancies can cause wealth held by owners of capital to increase far more rapidly than earnings such as wages, potentially outstripping them by a wide margin.
- Piketty’s findings have generated debate and reinforced views that government policy and public action are needed to steer capitalist economies so that Smith’s invisible hand benefits society.

*Finance & Development chapter “What Is Capitalism?” by Sarwat Jahan and Ahmed Saber Mahmud.*

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_Source: https://www.imf.org/-/media/files/publications/fandd/back-to-basics/jahan-capital.pdf_