CAPITALISM

Our discussion on Capitalism will start with a brief look at Feudalism.

Feudalism was a system by which few people owned land (Landlords) where many
people worked, not for profit but as a way of life under the protection of the landlord,
who apportioned food to the people together with other benefits. This was not
considered as employment and there was no concept of profit. It was a way of
life, very much approved by the Church, which itself created many religious holidays
in order to give workers some rest. The means of business in the feudal system was
bartering: the exchange of goods according to needs.

But then along came the trader who brought goods that were not readily available
within a particular area. Such goods were brought from long distances and trading
centres (stores) were born. Such traders were men who had courage, who took risks,
and who sold their goods at a profit. Soon enough these traders broke away from the
feudal system and came together in groups to build forts to protect their properties.
These forts resembled the protected areas of the landlords, which were called burgs.
And so the forts of the traders also came to be known as burgs and the traders were
called burgers or bourgeois/bourgeoisie. If a nobleman joined the group of traders,
he was considered an outlaw. The Church disapproved of this new system of doing
business and condemned moneymaking through profit, loans and interest. This was
judged unchristian. But after many years of struggle (700 to 800 yrs.) the bourgeois
managed to influence the mentality of the general population so that people began to
be conscious of their individual possibilities and began to defend private property as
a personal right.

In the 15th to 16th centuries kings and clergy became dependent on the traders.
This coincided with discoveries of new continents. Effectively, it was trade that
led to the scramble of Africa, for example. Traders pushed kings for the
acquisition of cheap raw materials from abroad. By the 18th century this trade
system (capitalism) established itself as an economic system. During the
industrial revolution the person who had money (capital) could buy machines
and produce more goods for profit while paying little money to his workers. The
capitalists took the risk and sometimes went bankrupt as a result.

Capitalism is derived from the word capital, which in turn is derived from the Latin
word caput meaning head. It came to mean a unit of movable wealth (the way one
can move cattle except in this case cattle is replaced by money). Individuals privately
determine the use of this wealth, as well as its circulation.

Capitalism is an economic system characterized by private or corporate

ownership of capital goods, by investments that are determined by private
decision, and by prices, production, and the distribution of goods that are
determined mainly by competition in a free market. To put it simply, it is a
system of social organization whereby ownership of private property and profit or
moneymaking are its chief end.

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Liberal (Laissez Faire) Capitalism
Laissez faire means let them do it alone. Capitalists of this nature made the
argument that:
1. The owners of capital alone should decide the price of goods, the kinds of
goods to produce and the amount of salaries to pay workers and how to hire
and fire and when.
2. They maintained that the government should not be involved in business. It
should leave them free, alone.

The main principles of liberal capitalism are:

1. Profit-making: Adam Smith aptly said in his book, The Wealth of Nations,
that 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. We address
ourselves not to their humanity but to their self-love, and never talk to them of
our own necessities but of their advantages (638). This is sometimes called
the virtue of selfishness. Smith sees self-interest as the core of human nature.
Human beings seek to satisfy their own needs first.

2. Free enterprise: That people should do business freely at their initiative.

Everyone in society should have an equal chance to start a business.

3. Free market system: (a) Freedom to buy and to sell: This means everybody
is free to produce what he wants, to sell where he wants and to buy what he
wants. The government should not plan the market by forcing factories to
produce certain goods and fix the prices. (b) Supply and Demand: The prices
in the free market are determined by supply and demand. When the supply is
high, and the demand is low, the price goes down and the other way around.
(c) Competition: It should be left to the capitalists to compete for quantity and
quality production of goods even where this will make other business go
down. (d) Private ownership: The capitalist system demands private
ownership of the means of production. When a business is owned by the state,
workers lose interest they know the state will pay them regardless of the
output of the business.

Adam Smith (1723-1790)

According to Smith, human beings are naturally selfish. In doing business, they look
to their own good. But interestingly, within this selfishness, people end up serving the
public good because they bring different goods to others, goods which the others
would never be able to get by themselves. In other words, because we are gifted
differently, we concentrate on what we know best and provide that service to others
through business. There is a natural division of labour which serves the public good
controlled, as it were by an invisible hand (the market). This division of labour
(specialization in areas where we are naturally competent) has the happy unintended
consequence of uniting people in a vast web of cooperative and mutually beneficial
enterprises.

In his defence of capitalism, Smith took a stand that was contrary to religious
morals. In religion, we are encouraged to take care of the poor, the stranger and the
orphan, for example. Smith said selfishness is natural and good. It promotes

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community interest. Ignoring the stranger is central to national prosperity. Free
and mutually beneficial trade does better job of assuring the general welfare than
selfless charity does.

The wealth of a nation

According to Smith, the nations wealth accumulates when successful individuals
herd or hoard capital and then risk it on new ventures. Smiths ideas can be summed
up as: (1) Pursuit of interest, (2) Division of labour (specialization) (3) Freedom of
trade and (4) the invisible hand.

TRAPS FOR THE CONSUMER

1. Free market conceals dangerous traps for the consumer (Give examples).
2. There is danger of being exploited and manipulated by the managers of big
business (Give examples). Advertisement is one such example of
manipulation. Advertisement influences the principle of supply and demand by
creating artificial needs for people to consume an unnecessary extra supply of
goods. As we shall see, Karl Marx underestimated the power of advertisement.
He thought the market was going to collapse by itself, as there would be too
many goods to sell and less people to buy. For example, when everyone owns
a chair, nobody would buy any more chairs and the business of selling chairs
would collapse, so he thought.

MANY FACES OF CAPITALISM:

Collective Capitalism: This is where several business owners pool their

money together to form a group or collective to buy bigger machine and
control the production of certain goods. Sometimes several companies work
together to form a trust. Sometimes different companies have secret
agreements not to charge less for a particular product in order to keep the
prices up. This kind of cooperation gives rise to cartels (interest groups).
Another consequence of collective capitalism was colonialism whose basic
drive was to satisfy the hunger for cheap raw materials from abroad. To do
that, the colonialists had to subdue (imperialism) other nations in order to
establish their own empire (see the immediate connection between politics and
economics).

Controlled Capitalism: This is a situation where governments still exercise

power over business despite the cry for laissez faire capitalism. Capitalisms
can be controlled by two major powers: Government and Trade Unions.

Governments control:

(a) Labour laws and regulations for factory-owners such as:

Minimum wages for workers
Working hours
No employment for children
Safety measures in working conditions
Pension and health schemes
Holiday arrangements

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 No dismissal at random
Relationship to Trade Unions
(b) Taxation
Taxation is when the government collects part of the profit people make and uses it
for the common good such as the construction of roads, schools and hospitals.

Trade Union control:

To safeguard the rights of workers, Trade Unions came into being. In Trade Unions
the workers organize themselves and speak with one voice through their leaders. Such
leaders negotiate with factory owners to demand the implementation of government
labour laws and secure rights for the workers.

Multinational Capitalism: This is a case where big companies like Coca-

Cola, own factories and outlets in different countries in the world. In this way,
they have a monopoly in the market. (We shall return to this topic later).

MERCANTILISM
As we conclude this section on capitalism, it is important to point out that capitalism,
as an economic system, was directly opposed to Mercantilism which was itself an
economic theory and practice, dominant in Europe from the 16th to the 18th century;
that promoted governmental regulation of a nation's economy for the purpose of
augmenting state power at the expense of rival national powers. The main goal was
to increase a nation's wealth by imposing government regulation concerning all of the
nation's commercial interests.

It was believed that national strength could be maximized by limiting imports via
tariffs and maximizing exports. This approach assumed the wealth of a nation
depended primarily on the possession of precious metals such as gold and silver. But
this type of system cannot be maintained forever, because the global economy would
become stagnant if every country wanted to export and no one wanted to import. After
a period of time, many people began to revolt against the idea of mercantilism and
stressed the need for free trade. The continued pressure resulted in the
implementation of laissez faire economics in the nineteenth century (which we have
discussed above).

Economic intervention is when a nations government takes action to alter the economy
for political purposes. In a free market economy, individuals and businesses have the
ability to act in their own self interest. Property ownership is protected by the courts so
individuals do not have to worry about the loss of their goods to other individuals.
Copious amounts of economic intervention will result in a mixed economy, where
government agencies will play a larger-than-normal role in the economic planning of the
nation.

Economic planning is when a nation attempts to create a sense of equality among the
citizens within its borders. Types of economic intervention or planning include minimum
wage laws, ability to unionize workers, price controls, tariffs or import quotas and tax
deductions or credits. Governments often use these plans to help create an economy
free from unfair competition, which is the inability of one individual to achieve the same
level of economic wealth as another person. Heavy-handed economic intervention will

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often result in a centrally planned economy, such as in socialist or communist societies.
These economies rely on their government to direct the economy as necessary and
provide the allocation of resources according to specific purposes.

Free market economies often experience a concept known as the business cycle. This is
a natural period of expansion and contraction based on changes in a free market
economy. Expansion occurs when consumer demand increases for particular goods or
services. Large-scale expansion often results in the growth of a nations gross domestic
product, which is the total of all products manufactured inside the nation. Contraction
occurs when demand decreases or resources become scarce, driving down the supply of
goods produced by companies. Although natural, these contractions may incur the most
economic intervention from a government.

Governments often attempt to create policies during economic contractions in order to

soften the blow of economic hardship. However, free market generally will correct itself,
although it may not occur as quickly as individuals may desire. Additionally, policies
implemented during an economic intervention will still exist after the economy corrects
itself, resulting in additional rules for companies and individuals to abide by in the
economy. This falls into the theory of unintended consequences, where a governments
intervention while well meaning will have an effect that hamper the economy in the
future. However, individuals may prefer this intervention if it promotes a more socially
responsible environment regardless of the cost to businesses.

CAPITALISM

TheoryofCapitalism

Capitalism is a system of largely private ownership that is open to new ideas, new firms and
new ownersin short, to new capital. Capitalisms rationale to proponents and critics alike
has long been recognized to be its dynamism, that is, its innovations and, more subtly, its
selectiveness in the innovations it tries out. At the same time, capitalism is also known for its
tendency to generate instability, often associated with the existence of financial crises, job
insecurity and the inability to include the disadvantaged.

There are basic questions about capitalism that have hardly begun to be studied. What
economic and social institutions engender innovation in the more capitalist of todays
advanced economies, and what institutions function badly in this regard? How large are the
benefits of this system both in productivity and more broadly in the rewards to its
participants? How much worse (if at all) is this system with respect to stability and inclusion -
compared with corporatist systems found in continental western Europe and east Asia? What
changes or additions to those institutions and policies could be hoped to improve its
dynamism, stability or inclusiveness? Are capitalist systems more or less prone to financial
crises than corporate ones? The mandate of Columbias Center on Capitalism and Society is to
advance our scholarly understanding of capitalisms workings, its social benefits and costs,
and its place in a democracy.

The Debate Over Capitalism

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The claims for capitalism differ from the classical case for a competitive market economy.
Adam Smiths thesis two centuries ago was that the presence of many buyers and many sellers
competing with one another in the marketplace would cause wasteful resource allocations to
be weeded out as if by an invisible hand. (So, in equilibrium conditions, one persons
earnings could not be further increased except at the expense of anothers.) A central
government bureau could not match this valuable ability of unimpeded markets, as Ludwig
von Mises warned the socialists in the 1920s. But Smiths insights left it unclear how or
whether economic change might be generated. Would competition among firms suffice to
generate change, with or without private ownership? Would private ownership suffice, with
or without competition?

A few central European economies twice became laboratories in recent decades for testing
competition without private ownership. From the late 1960s to the late 1980s they allowed
each state-owned firm to set their own prices, outputs, wages and workforce in competition
with the others. Whether or not efficiency improved, it was clear that economic dynamism
did not ensue. It was said in defense of these state firms that their managers plans for them
were often blocked by the state and that the managers knew they could get their losses
covered by the state so they didnt need to take chances. In the 1990s, the state firms were put
on their own. This time, with their backs to the wall, they began innovating like mad, hoping
that with luck it would be their ticket to survival. But these state firms were not able to
innovate successfully.1 Competition, it appears, is not sufficient for economic dynamism.

More recently, it has come to be argued that the corporatist economies of east Asia, which had
achieved wonders when there was a yawning gap between them and the West, ran into trouble
in the 1990s because state intervention in the corporate sector through permissions, subsidies
and guarantees led ultimately to mass overinvestment and insolvency.2 On this thesis, private
ownership is not sufficient for dynamism either: capitalism, in which capital is free to go in
new directions without a green light from the state, becomes necessary at some point in
economic development if dynamism is to continue.

How does capitalism do it? The mechanism of capitalisms economic advances became the
leading object of economic research early in the twentieth century and remained so for
decades. With the upheavals of the late 19th century still in their thoughts, the German
School, led by Arthur Spiethoff and Gustav Cassel, linked innovations to technological
developments and the opening up of overseas markets and materials. 3 A new discovery
creates new outlets for investment. The investments made express the zeal of employers to
profit by meeting the increased demand of the community for fixed capital.4 This made
macroeconomic sense of big waves of innovation: they are exogenous and markets react
constructively to them.5 But it failed to identify the institutions crucial to fostering early and
decisive responsiveness to the newly arrived opportunity. And it did not provide an economics
of innovations in normal times, when capitalism has to generate endogenous innovations, if
there are to be any at all.

A decade later, Joseph Schumpeter arrived with a new perspective. Innovations are normally
the creation of business people, he said, and do not spring reliably or quickly from recent

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inventions by scientists and engineers. Furthermore, innovations are as a rule embodied...in
new firms.6 Thus the agent of change was the entrepreneur who, hitting upon the
prospective profitability of some unnoticed commercial application, sought to start up an
enterprise to implement the innovative idea. Banksthe venture capitalists of that era
selected which investment projects of these entrepreneurs to finance. The start-ups that met
success inspired other entrepreneurs and together caused the creative destruction of various
established enterprises. However, this mechanism of Schumpeter, for which he became
renowned, is not consonant in an important respect with subsequent understanding of the
essential nature of innovative ideas, and it doesnt apply to a large sector of capitalist
economies in the present age.

European theorists uncovered the essence of capitalisms innovations in the interwar period.
Friedrich Hayek saw it as a core feature that, under capitalism, entrepreneurs are self-
selected, aided by their particular experience and driven by their distinctive visions. For this
reason capitalism will generally draw on richer experience and wider knowledge than any one
central planner could draw on.7 John Maynard Keynes added that entrepreneurs (and
others) may also have opposing notions about the macro forces and mechanisms in the
economy, which complicates predicting their investment activity.8 Lastly, Michael Polanyi
argued that entrepreneurs, like discoverers generally, take creative leaps and invariably these
leaps involve some tacit or personal knowledge, which is outside of objectively recognized
knowledge and which goes beyond what can be communicated in explicit terms. 9 For this
reason; a state investment bank would not be well-suited to select among entrepreneurs
projects: being accountable to the central government for its mistakes, it would avoid all the
very innovative proposals because of the ambiguity of the evidence for them and thus the
uncertainty of their profitability. This modern view of capitalism, however, poses a difficulty
for Schumpeters model as well. In supposing that lenders and investors selecting among
entrepreneurs projects were capable of discerning the talent of every entrepreneur and the
worth of very project, Schumpeter was attributing information and knowledge to financiers
that is incongruent with the modern view of entrepreneurs ideas. In reality, financiers must
also act on intuition, taking an initial and limited chance on an applicant in spite of the
ambiguity of the evidence. Since an innovative project is in part inherently difficult to
articulate, the success of bankers and venture capitalists in selecting among them hinges not
so much on their knowledge of the project as on their ability to enter into a sequential and
provisional relationship with the entrepreneur that leaves the latter leeway to experiment and
prove himself.10

The other shortcoming of Schumpeters mechanism is that, in centering on the entry of start-
up firms, it does not encompass the innovations that come from the sector of established
firms. The innovation is there: the heavy research and development expenditure in the sector
of established firms is circumstantial evidence that many large firms are oriented toward
innovation.11 Besides, we have the direct evidence of radical innovations made by established
firmsfrom Bang & Olufsons designs to Sonys Walkman to the Swatch to Bert Claeys
rethinking of cinemas. But the entrepreneurship differs: in contrast to Schumpeters theory,
the big corporations do not usually have a principal lender or core investor and even the
entrepreneur can barely be identified, if at all. In this sophisticated sector, other institutional
mechanisms are evidently at work but their functioning is not well understood and their

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effectiveness is not yet estimated with much confidence. The thesis of Amar Bhid is that
small firms have a role in innovation since they can better tolerate ambiguity while large firms
have a role since they can better manage and finance projects with high capital costs.12 The
specialization between the start-up and the established firms, and also the possible interplay
between the small-firm sector and the large-firm sector, are obviously areas ripe for further
research.

Thus the system of innovation is the great black box in research on capitalism and it will be
the most central of the Centers interests. Yet innovation is not the only aspect of capitalism
on which there is not yet much fundamental understanding. The influence of capitalism on
fluctuations is not addressed in standard monetary macroeconomics or in the real business
cycle literature. It is obvious that jobs are far more precarious in the relatively capitalist
economies than in the corporatist ones, where governments try to avoid any rocking of the
boat and to backstop with assorted job protection laws.

Capitalisms proponents respond that the right both to hire and to fire freely helps to
embolden firms to take the risks of job creation and thereby serves to raise the average level of
wages and perhaps employment too. However, the impression also exists that, in fact,
capitalism exhibits long swings in economic activity, as measured by employment and
unemployment rates, of far wider amplitude than those detectable in the more corporatist
economies. Here too a reply is conceivable. It may be that when contractionary forces strike,
the prompt restructuring that firms in the relatively capitalist economy are generally
permitted to do serves actually to dampen the size of the slump that follows while the rigid
posture maintained by firms in the relatively corporatist economies, with their strictures
against layoffs, entails a much deeper as well as longer slump. Another of the fluctuation
issues is the justice of regarding long booms as no better than long slumps. A more radical
position raises questions about the justification for blocking or moderating long slumps,
provided they are purely or mainly structural rather than the result of monetary
malfunctioning.13 The subject of long swings is only now beginning to enjoy a revival of
attention in the economic literature, and there is much to be done in this area.

The last of the great questions about capitalism is whether it is best only for the elite of more
able and advantaged participants, who can find rich rewards from its stimulation and
challenges, or whether ways can be found to integrate the less able and less advantaged into
capitalisms sphere. This is the question of economic inclusion. Quite possibly, there is little
cost from a failure of highly corporatized or highly socialized economies to include the less
advantaged; in those economies a low rate of inclusion is often deemed acceptable and, in
some of them, only a minority are in the labor force. Far more may be at stake in the
inclusion of the less advantaged where the business sector is predominantly capitalist. If
these capitalist business sectors offer relatively good job satisfaction and personal growth on
the whole or offer relatively high wages in comparison with the pay in underground and
domestic activities, then an appreciable deficiency in inclusion arising from a wide gap
between low-end wage rates and the median wage, with the consequent demoralization and
decline of employability, may be deemed unacceptable and may impose high social costs on
virtually everyone.14

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Even more difficult than the task of measuring these social effects of capitalism is the problem
of finding solutions to them, if such exist. And that problem is now more difficult since the
West has grown aware of how fortunate it was to have had the capitalist engine driving its
development over the past two centuries and how valuable this engine can be again. So the
West is faced with a conundrum: How does society respond to the social defects and
deficiencies of capitalism without choking off capitalisms potential dynamism? Among the
issues are whether retraining can address job losses, whether long booms are to be treated,
and whether employment subsidies are cost-effective as a remedy for a deficiency in inclusion.