Capitalism is the name applied to an economic system in which relationships among people are organized on the basis of individual liberty and private property. Capitalism is thus opposed to socialism, a system in which property is held in common and economic relationships are based on the politically organized compulsion that such common or collective ownership requires. To be sure, the term “capitalism” was coined by Marxists in the latter part of the nineteenth century and was used as a slur word to represent the idea that a capitalist economic system was run by and for capitalists. Such other terms as “market economy” and “free enterprise system” have also been used. But “capitalism” is the predominant term, and it does serve to focus attention on how the development of new ideas and their embodiment in capital goods is the source of material progress.
As a theory, capitalism is based on the conviction that we are social creatures and that it is through an elaborate network of cooperative relations that we are able to achieve the standards of living we take for granted. This complex of cooperative relationships is made possible because of certain institutions that have evolved over the ages. Primacy among these goes to private property, along with the related principle of freedom of contract and association. When people relate to one another within an institutional framework characterized by private property and freedom of contract and association, the result is a coherent, coordinated pattern of economic activity, even though it would be beyond the ability of any person or agency actually to plan that coordination. Economic life proceeds as an uncon-ducted, self-orchestrated symphony. Adam Smith referred to this self-coordination as if it were the result of guidance from an invisible hand.
Through social cooperation it is possible to multiply the common level of material well-being beyond what it would be without that cooperation. Yet how can that cooperation be achieved? The Marxist vision is to achieve such cooperation without market competition. But market theorists argue that this is impossible. As Ludwig von Mises noted: “Even angels, if they were endowed only with human reason, could not form a socialistic community.” The beauty of the market system is that it is not necessary to give the detailed instructions to billions of people that would otherwise be necessary to achieve the degree of social cooperation we actually observe all around us.
The fundamental paradox that economics seeks to explain is how it is that competition, within a framework of private property and freedom of contract and association, is the most effective process ever discovered for organizing social cooperation on a large scale. If each of us were to make up our wish lists of what we would like to have, the aggregation of those lists would exceed many times over our capacity to produce. Some wants will be fulfilled, others will not. Competition among us is inescapable. But competition within a legal and moral framework characterized by private property and freedom of contract and association fulfills those wants more fully than any other form of social organization because it harnesses individual interest to the service of social cooperation.
A market economy is a competitive process for organizing social cooperation. While there are many examples of real, organized markets, for the most part economists use “market” as an abstract noun to represent the network of exchange relationships that form within a society. To refer to the market for oranges is not to refer to some specific place, but simply to the idea that there are some people who grow and sell oranges and others who would like to eat oranges. The market for oranges is simply a representation of the complex network of exchange relationships through which the myriad choices and trades are made that result in oranges being grown, picked, delivered, sold, and eaten.
Market prices play a pivotal role in organizing this cooperative network of exchange relationships. If growers do not produce as many oranges as people would like to buy, prices and profits rise. This encourages existing growers to expand production, while it encourages others to start growing oranges, perhaps partly through shifting out of producing less profitable fruits. Areas of production in which profits are expanding attract new investment, while a contraction of profits discourages investment. Furthermore, a capitalist system encourages the invention and development of new products as part of the same quest to locate and exploit mutual gains from trade. Thus, the washing machine replaced the scrub board, the self-cleaning oven replaced scouring pads, and the bread machine replaced the need to roll and knead dough.
While it is generally granted that capitalism is splendid in encouraging production and the creation of wealth, critics claim that it suffers on moral grounds because of the acquisitive spirit it unleashes. Individual values are stressed to the detriment of communal well-being. Capitalism may enrich people economically but it impoverishes them spiritually. Images of Ebenezer Scrooge abound as the archetypical representative of capitalism. The defenders of capitalism argue that such images are contrary both to reason and to experience. The examples of the communist and socialist nations of the twentieth century have not, to say the least, provided evidence that noncapitalist societies are necessarily more virtuous ones.