Capitalism

Capitalism – The 5 Pillars Of A Free Market Economy

In this post, we’ll unpack all you need to know about Capitalism, defining exactly what it is, the 5 pillars that form the foundations of Capitalism, its relation to government, socialism and evolution and more.

What Is Capitalism?

Capitalism, also known as free market economy, is a socioeconomic system whereby the means of production and distribution are controlled by private actors rather than by the state.

The 5 Pillars Of Capitalism

There are 5 core pillars that support the effective functioning of capitalism. They are: Private Property, Private Enterprise, Market Competition, Profit As Incentive and Consumer Sovereignty. The extent to which these pillars operate distinguishes the various forms of capitalism.

In free markets, markets operate with little or no regulation. In mixed economies, free markets play a dominant role. However, they are regulated by government to maintain law and order, correct market failures, promote social welfare and strengthen national defense.

Below we’ll unpack each of the 5 pillars in more detail.

  • Private Property

Private property allows people to own tangible and intangible assets.

Private property promotes efficiency by giving the owner of resources an incentive to maximize its value. The more valuable a resource, the more trading power it provides the owner of that resource.

  • Private Enterprise

Private enterprise allows individuals to control businesses independent of the state.

Private enterprise allows customers to determine the success of a business, provides employees with wages and salaries and ensures investors are responsible for providing capital to entrepreneurs.

  • Market Competition

Market competition allows individuals to compete to provide superior goods and services.

Market competition promotes innovation and forces individuals to maximise efficiency and offer the best products and services at the best prices which maximises the welfare of both producers and consumers.

  • Profit As Incentive

Profit allows individuals to benefit financially from their endeavours.

Profit operates as the financial incentives for individuals to produce goods and services. It promotes innovation, increases efficiency and motivates individuals to take risks and seek new opportunities.

  • Consumer Sovereignty

Consumer sovereignty allows individuals to freely buy and sell.

With consumer sovereignty, a market economy gravitates to equilibrium — a place where supply and demand are equal. Prices settle where producers and consumers are satisfied.

Capitalism & Government

Paradoxically, the forces that lead to the success of capitalism can also lead to its failure.

Free markets can only flourish when governments set the rules that govern them — for example, laws that ensure property rights — and support markets with proper infrastructure — for example, roads and highways that allow the transportation of goods.

Governments, however, may be influenced by organized private interests. These actors may try to leverage the power of regulations to protect their economic position at the expense of the public interest. For example, by repressing the same free market that bred their success. This is termed crony capitalism.

Consequently, society must, to borrow a phrase from Raghuram G. Rajan, “save capitalism from the capitalists.” That is, take appropriate steps to protect the free market from private interests that seek to impede its efficient functioning.

Capitalism & Socialism

Believers in capitalism tend to hold the view that it’s human nature to be primarily greedy, self-interested, and competitive.

Believers in socialism tend to hold the view that human it’s nature to be primarily compassionate, group-interested and cooperative.

The truth, however, is that human nature contains elements of both systems. People are both self-interested and group-interested.

What distinguishes capitalism from mere market activity is that in a capitalist society social relations are embedded in the economy rather than the economy being embedded in social relations.

A free market system effectively provides a perpetuating cycle of innovative entrepreneurs breaking monopolies and then creating new ones.

Capitalism & Evolution

Evolutionary theory supports the idea that capitalism — in a broad sense and in its true form — is a system that best fits our evolved psychology.

Furthermore, just like evolution, capitalism is also an optimizing process. Specifically, it optimizes for profit, with consumers exerting the selective pressure instead of the environment. Thus, the result is that every niche in the market is filled with a product or service suited to that particular consumer desire.

Below are just a few features of human nature emphasized by evolutionary psychology that align with the characteristics of capitalism.

  • Humans Are Coalitional Free trade encourages market participants to see members of unfamiliar groups (other businesses) as partners, not enemies as us, not them.
  • Humans Are Hierarchical Free trade motivates market participants to create the best products and services in return for status.
  • Humans Are Self-Interested — Free trade motivates market participants to create the best products and services in return for personal gain.
  • Property Rights Are Natural Free trade encourages our innate desire to acquire, possess and control our own property.
  • Mutually Beneficial Exchange Is Natural Free trade encourages our natural proclivity to navigate skilfully through the world of personal exchange.
  • The Division Of Labour Is Natural Free trade encourages the separation of tasks and allows individuals to specialize in productive endeavours.

The moral justification of capitalism lies in the fact that it is the only system consonant with man’s rational nature, that it protects man’s survival qua man, and that its ruling principle is: justice. — Ayn Rand Lexicon

Summary

Capitalism is a socioeconomic system whereby the means of production and distribution are controlled by private individuals instead of the state.

Capitalism exemplifies personal freedom, ownership of one’s self, ownership of one’s property and the right of self determination. All these combine for the purpose of easing our burdens and improving the individual quality of life as we see fit.

While not perfect, capitalism seems to be one of the most effective systems humanity has come up with that best aligns with human nature and our evolved psychology.

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