## What Is Capitalism?

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## Bibliographic details
- Authors: SARWAT JAHAN, AHMED SABER MAHMUD
- Published: May 10, 2018

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### Definition and core features
- Capitalism: an economic system in which private actors own and control property in accord with their interests, and demand and supply freely set prices in markets in a way that can serve the best interests of society.
- Essential motive: the motive to make a profit; illustrated by Adam Smith’s remark: “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.”
- Typical attributes in a capitalist economy:
  - capital assets—such as factories, mines, and 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 assets (land, houses) and intangible assets (stocks, bonds);
- self-interest, with uncoordinated individuals benefiting society through an “invisible hand” (Smith’s 1776 Wealth of Nations);
- competition, with firms’ freedom to enter and exit markets maximizing the joint welfare of producers and consumers;
- a market mechanism that determines prices in a decentralized manner through buyer–seller interactions and allocates resources and wages;
- freedom to choose in consumption, production, and investment (customers switching products, investors pursuing ventures, workers changing jobs);
- limited role of government, to protect rights of private citizens and maintain an orderly environment that facilitates market functioning.

### Varieties and classifications of capitalism
- Spectrum by degree of market regulation:
  - 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 and promote social welfare.
- Production-organization typology:
  - liberal market economies: competitive market prevails; decentralized production (examples: United States, United Kingdom);
  - coordinated market economies: exchange of private information via non–market institutions such as unions and business associations (examples: Germany, Japan) (Hall and Soskice 2001).
- Four types distinguished by entrepreneurship and institutional settings (Baumol, Litan, and Schramm 2007):
  - state-guided capitalism: government decides sectoral growth priorities; risks include excessive investment, picking wrong winners, corruption, and withdrawal difficulties;
  - oligarchic capitalism: oriented to protect and enrich a narrow elite; economic growth is not central; associated with high inequality and corruption;
  - big-firm capitalism: exploits economies of scale; important for mass production;
  - entrepreneurial capitalism: drives breakthrough innovations (automobile, telephone, computer); often generated by individuals and new firms.
- Typical combination: a mix of big-firm and entrepreneurial capitalism is described as most effective; the United States exemplifies this mix.

### The Keynesian critique and the role of government
- Historical context: the Great Depression of the 1930s led to widespread unemployment in advanced capitalist economies.
- Keynes’s argument (General Theory of Employment, Interest, and Money, 1936):
  - capitalism can remain in equilibrium with high unemployment and no growth;
  - laissez-faire may fail to recover from investment slowdowns without state intervention;
  - government intervention—cutting taxes and increasing government spending—was necessary to restore aggregate demand and pull the economy out of recession.
- Keynes did not seek to replace markets permanently; he advocated periodic government action to temper business-cycle booms and busts.

### Risks to market functioning: capture, cronyism, and inequality
- Market success depends on governments setting rules (property rights) and providing infrastructure (roads, highways).
- Risk of regulatory capture: organized private interests can leverage regulations to protect their position at public expense, potentially repressing the free market that enabled their success.
- Rajan and Zingales (2003) warning: society must “save capitalism from the capitalists” by protecting markets from powerful private interests to prevent crony capitalism and nepotism becoming more rewarding than efficiency.
- Policy implications highlighted:
  - limit concentration of ownership of productive assets to ensure competition;
  - compensate losers created by competition;
  - promote free trade and strong competitive pressure on incumbents to keep powerful interests at bay;
  - maintain public support for the virtues of free markets and oppose government intervention that protects powerful incumbents at the expense of overall prosperity.

### Inequality and capital accumulation
- Debate: whether private capital accumulation inexorably concentrates wealth or whether growth, competition, and technological progress counterbalance inequality.
- Piketty (2014) finding summarized:
  - 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 other earnings (wages), potentially leading to large wealth concentration.
- Policy implication: capitalist economies must be steered by government policies and public engagement to ensure market mechanisms serve society’s broader interests.

*Authors: SARWAT JAHAN and AHMED SABER MAHMUD*

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_Source: https://www.imf.org/en/publications/fandd/issues/series/back-to-basics/capitalism_