Capitalism: Definition, History, Characteristics, Benefits and Challenges

What is Capitalism in Economics?

Capitalism can be defined as an economic model in which individuals in a society can own and control capital goods. As opposed to socialism where the economy is centrally planned, capitalism involves a free market approach in which the forces of demand and supply determine the price mechanism of the market. In a capitalist market, individuals are not restricted in terms of what to produce or consume. Individuals also determine where and how to invest their resources without external checks and control.

Capitalism can also be explained as a planning approach in which economic decisions are established through decentralization and voluntary decisions rather than centralized political decisions.

The most important element of capitalism is private ownership of property. In this approach, people have property rights which are protected by laws. Capitalism also involves voluntary exchange, where individuals have the power to sell or dispose their property. Once a person owns property legally, the only way to dispose or give away its ownership is by voluntary means. People in a capitalist society can transfer property through gifts, voluntary exchange, or inheritance.

History of Capitalism

Capitalism was institutionalized in the 16th century, but its theoretical underpinning emerged from the ancient world. In fact, Britannica encyclopedia suggests that small elements of capitalism existed in Europe during the Middle Age.

The development of capitalism as an economic system emerged as a result of the development of the cloth industry in England during the 16th, 17th and 18th centuries. The key characteristic of this early form of capitalism was the accumulation of capital to increase productive capacity.

Hard work and frugality were encouraged in Christian societies during the Protestant Reformation of the 16th century. The Church encouraged people to pursue wealth as a way of becoming virtuous.

Another factor that accelerated capitalism was the increase in the supply of precious metals in Europe, which led to inflation. The benefit of price inflations were the early capitalists who also enjoyed the rise of nationalism and mercantilism. Nation states offered the required monetary systems, social conditions and legal codes to enhance economic development and private initiative.

In the 18th century, capitalism shifted from commercial to industrial focus. Capital accumulation led to practical application of technical knowledge during the Industrial Revolution.

In the book An Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith proposed an ideology of capitalism which recommends that societies should leave economic decisions to be self-regulated by market forces. This brought about the concept of the invincible hand and the resultant initiatives to promote liberalism and free trade.

Characteristics of Capitalism

Contract and tort laws must exist to enhance exchange and use of property. For individuals and organizations to use their property in a way that maximizes their utility, there must be laws that protect their legal right to own or use such properties. Thus, contracts, fair dealing and civil laws are important to deal with the enforcement of property rights.

Other important elements of capitalism are:

  • Private ownership of the means of production
  • Provision of incentives for the ownership and use of property
  • Enforcement of property rights through constitutional law
  • Availability of mass-market consumer goods
  • Free market system
  • Determination of price through the forces of demand and supply
  • Motive to make profit
  • High unequal distribution of resources
  • Rational self-interest

According to Adam Smith, capitalism is enhanced by the need for economic incentive. Smith says, “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 voluntary exchange, both parties have an interest in the property, but none of them has the right or motivation to obtain their interest at the expense of the other. For example, through the sale of lane, the owner is incentivized by the need to make a profit while the recipient wants to benefit from the ownership and use of the land.

The rational self-interest in a capitalist economy leads to economic prosperity. This is why capitalism has historically been associated with massive economic growth and development in western societies.

Advantages and Disadvantages of Capitalism

One of the key advantages of capitalism is that it promotes efficiency. It gives citizens the incentive to maximize the value of their property because they benefit directly from any property they own. Properties or resources that have more value often give the owners the most trading power and earnings. Property owners in a capitalist society is entitled to the gains or profits generated from the use or sale of property. This gives individuals the incentive to maximize their productivity, leading to efficient utilization of resources.

Capitalism has the disadvantage of individualism where people incur losses individually and carry their own burdens. Considering that an individual has the right to use their property as they please, any loss of value in any property is often incurred by the owner of such property alone. In a communist approach, resources are shared and any loss of value is also shared by all people, hence reducing the burden of lost property.

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