A comment posted to yesterday’s blog noted that I had not defined capitalism. Fair point.
The following description is from my last book, Talking Politics? What You Need To Know Before Opening Your Mouth, in which I included the following descriptions/comparison of capitalism and socialism.
Capitalism is defined as an economic and political system in which a country’s trade and industry are controlled by private owners for profit. It is characterized by free markets, where the prices of goods and services are determined by supply and demand, rather than set by government. Economists often define the ideal of free trade as a transaction between a willing buyer and a willing seller, both of whom are in possession of all information relevant to that transaction.
Understanding the importance of free trade to capitalism is important, because it defines the proper role of government in a capitalist system—as an “umpire” or referee, ensuring that everyone plays by the rules. For example, Teddy Roosevelt reminded us that monopolies distort markets; if one company can dominate a market, that company can dictate prices and other terms with the result that those transactions will no longer be truly voluntary. If Manufacturer A can avoid the cost of disposing of the waste produced by his factory, by dumping it into the nearest river, he will be able to compete unfairly with Manufacturer B, who is following the rules governing proper waste disposal. If Chicken Farmer A is able to control his costs and gain market share by failing to keep his coops clean and his chickens free of disease, unwary consumers will become ill. Most economists agree that in order for markets to operate properly, government must act as an “umpire,” assuring a level playing field.
This need for government is a response to what economists call “market failure.” There are three situations in which Adam Smith’s “invisible hand” doesn’t work: when monopolies or corrupt practices replace competition; when so-called “externalities” like pollution harm people who aren’t party to the transaction (who are neither buyer nor seller); and when there are “information asymmetries,” that is, when buyers don’t have access to information they need to bargain in their own interest. Since markets don’t have built-in mechanisms for dealing with these situations, most economists argue that regulation is needed.
Economists and others often disagree about the need for particular regulations, but most do agree that an absence of all regulatory activity undermines capitalism. Unregulated markets can lead to a different system, sometimes called corporatism. In corporatist systems, government regulations favoring powerful corporate interests are the result of lobbying by corporate and monied special interests that stand to benefit from them. You might think of it as a football game where one side has paid the umpire to make calls favorable to that team.
Socialism is the collective provision of goods and services. The decision whether to pay for certain services collectively rather than leaving their production and consumption to the free market can be based upon a number of factors. First, there are some goods that free markets cannot or will not produce. Economists call them public goods, and define them as both “non-excludable” –meaning that individuals who haven’t paid for them cannot be effectively kept from using them—and “non-rivalrous,” meaning that use by one person does not reduce the availability of that good to others. Examples of public goods include fresh air, knowledge, lighthouses, national defense, flood control systems and street lighting. If we are to have these goods, they must be supplied by the whole society, usually through government, and paid for with tax dollars.
Not all goods and services that we provide collectively are public goods. Policymakers have often based decisions to socialize services on other considerations: we socialize police and fire protection because doing so is generally more efficient and cost-effective, and because most of us believe that limiting such services only to people who can afford to pay for them would be immoral. We socialize garbage collection in more densely populated urban areas in order to enhance the livability of our cities and to prevent disease transmission.
Getting the “mix” right between goods that we provide collectively and those we leave to the free market is important, because too much socialism hampers economic health. Just as unrestrained capitalism can become corporatism, socializing the provision of goods that the market can supply reduces innovation and incentives to produce. During the 20th Century, many countries experimented with efforts to socialize major areas of their economies, and even implement socialism’s extreme, communism, with uniformly poor results. Not only did economic productivity suffer, so did political freedom. (When governments have too much control over the means of production and distribution, they can easily become authoritarian.)
Virtually all countries today have mixed economies. The challenge is getting the right balance between socialized and free market provision of goods and services.