Capitalism defined

It cannot be stressed enough: without Capitalism, we’d be living at the level of a subsistence economy, constantly fighting among us for scarce resources, yet there is still incredible resentment towards the very concept of Capitalism, which is not only maligned, but completely misunderstood. So before engaging in any kind of debate about economics, it is essential to define what Capitalism really is.

Every single time people attack “Capitalism”, they attack a straw man. Marx didn’t know or understand Capitalism and totally misrepresented it, which is why 100% of his assumptions turned out to be wrong.

The usual claim is that Capitalism makes the rich richer and the poor poorer, while Socialism is supposed to make everyone equal and well off. But that's not what happens at all. In reality, it looks more like this:

The fundamental problem is that people do not understand Capitalism, as they always hear about it as it is defined by people who try to promote their own favorite ideology. Very few people really understand the genius of Capitalism and why it works so well.

What is Capitalism?

Short definition:

Capitalism is a description of an emergent economic system. It explains what people do when they are free to act and can cooperate voluntarily to produce goods and services while refraining from violence, theft and fraud.

The following are essential elements for a capitalist economy:

• The allocation of resources to produce capital goods, i.e. goods such as tools, vehicles and buildings that help to increase future productivity. The total creation of goods will increase continuously, while a growing number of goods can be used for consumption without limiting production.
• The most important capital good is knowledge, because knowledge allows the creation of everything else. [1]
• Trade supports the division of labor, which is essential, as it is impossible for any individual to acquire the knowledge and skills for more than a small number of tasks. [2]
• Money is a great facilitator of trade, a tool, a symbol, ultimately just information. It works as long as everyone agrees to trade it for goods and services.
• Throughout history, gold was one of the most popular forms of money and it is still considered as extremely valuable; the cost in gold of an average villa in the suburbs of Rome, today, is almost the same as it would have been for an equivalent villa under the Roman empire. This is due to the specific properties of gold that make it such a perfect currency.
• Government currencies are usually only accepted over a limited area and period of time.
• The fact that crypto currencies are now accepted as a form of money for wealth storage and trade shows that money can indeed be nothing but pure information.
• The flow of money allows resources to be directed where they are most needed, priced according to demand and the availability of resources, including labor. All prices are relative to each other and represent subjective value scales of consumers and producers.
• There is no such thing as an absolute or "just" price. A price is meaningful only if it has actually been paid, i.e. just a price tag does not represent a market value, it represents a tentative estimate of what someone else might pay, but that can only be established once a transaction took place.
• Money represents information, but also an incentive for doing that which is most under demand; a seller who is good at anticipating consumer demand will be rewarded.
• A speculator is someone who tries to anticipate consumer demand well into the future; they have a bad reputation because some - a minority - may be highly successful; if they are successful, they are seen as the cause of increased prices, when in fact speculators merely anticipated increased prices and no one pays any heed when they lose large amounts of money due to failed speculations.
• Any system that tries to get around the market has a problem with the flow of information and with motivation: if good work is not rewarded, people have no incentive to work. Replacing motivation with obligations, threats and violence doesn't work well - you will only get minimal compliance, but never full, active, intelligent cooperation.
• That's why slavery and communism are counter-productive. Slave labor is totally inefficient and may cost far more in surveillance than it is worth. It is also totally anti-capitalist, as it represents a crime against the slaves - and crimes against person and property are anti-Capitalist.
• Capitalism works because it is the result of the voluntary cooperation of millions of individuals who constantly correct for changing conditions and past mistakes.
• The only way Capitalism could "fail" is if people repeatedly made the same mistakes, over and over, without taking their experience of failure into account. That is obviously an absurd assumption - people always adjust based on past failures - unless there are legal obstacles that prevent people from responding appropriately to past failures.
• To be highly successful, in a capitalist economy, you have to either attract high value clients, a huge number of one-time buyers or many repeat customers.
• Either way, capitalist entrepreneurs have to please their clients. The greater the capital investment, the more they are bound to listen to their customers. Being large and capital-intensive doesn't make them powerful, it makes them dependent on goodwill. Businesses go bankrupt all the time, even very large companies.[4]

I yet have to find a single anti-Capitalist who actually understands Capitalism. They always assume that Capitalism is about “rich people controlling the world”, about stock markets, shares and billionaires. But Capitalism has nothing to do with “rich people”.

If you create or buy a tool or acquire knowledge useful for the production of goods or services, or if you participate in any kind of voluntary trade, you are a capitalist.

Let me put it bluntly: the second you buy bread from a baker or butter from a supermarket, you are a capitalist.

Capitalism has been a constant throughout human history. We know that human beings made tools 200′000 years ago and traded goods all across Europe 40′000 to 60’000 years ago.

Remember: a single person creating a cabin in the woods and planting vegetables is a Capitalist, as this person creates capital goods - that's capitalism, even without trade. To the extent that this person's property rights are respected by others, trade is always a possibility.

Note that theft, fraud and violence are always possible, in any society. In a capitalist society, such acts have to be treated as crimes and prosecuted, as otherwise the foundation of capitalist wealth creation will be undermined.

Is Capitalism an ideology?

Capitalism is usally presented as "just another ideology", but that's a complete missrepresentation. Caplitalism is descriptive, not prescriptive, i.e. it says what people do, it does not prescribe what they should do, or why:

Capitalism is 100% value-free, i.e. it does not imply any kind of value or goal, which is why it is not an ideology. There's nothing, in a capitalist society, that says: "People should consume goods", as many anti-capitalists suggest. Whether and what you consume is entirely up to you. Capitalism merely ensures that you will have many options for what you need or want.

If you want to help poor children in Africa, apply Capitalism. If you just want a nice home for yourself, apply Capitalism. In both cases, you will achieve your goal faster and with less effort and fewer resources than by any other system.

If you don't want to "consume" goods you don't need, you are entirely free not to. I never understood why anti-capitalists pretend that consumption of what they consider "cheap crap" is somehow demanded.

A typical complaint by anti-capitalists is about how Apple produces a new iPhone every year and how "dumb consumers" keep buying a new iPhone, even though they supposedly don't need a new one. They will then explain how they, personally, don't do that and still use some 10-year old flip-phone from Nokia, thus destroying their own argument.

Anti-capitalists always complain about how other people are "stupid" and "buy stuff they don't need". They fail to realize that maybe other people make their own rational decisions, how they have their own personal needs and how something as supposedly "silly" as social status is actually important for most people's success and happiness.

If it wasn't for consumer demand, Nokia would happily have kept selling the same crappy old phones without any kind of innovation - and that, too, would have been capitalism, if no one else had innovated or people had rejected the proposed innovations.

In fact, it would be entirely consistent with Capitalism if everyone just produced the absolute minimum required for survival and decided to live in mud huts. But that's clearly not a lifestyle favored by most.

Does Capitalism work, in practice to make people less poor? It actually does, miraculously!

How is it different from other economic systems?

The only non-fictional way to not be a capitalist is to live as hunter-gatherer, consuming exclusively food that exists in nature, using only simplistic and mostly natural tools and weapons for hunting and fishing.

A barter economy is still capitalist, just without the benefits of money, so it has to rely on the coincidence of needs.

Socialism and Communism are basically Capitalism with extra steps - they rely on the same methods of production of capital and consumption goods as in a capitalist society, but they remove individual liberty, entrepreneurship and property ownership rights, turning society into a gigantic post office where the post master makes all the decisions.

The difference between Socialism and Communism are purely rhetorical, although leftists can get extremely worked up about totally irrelevant details that will never have any importance in real life, as the utopian socialist societies they hope to implement will never exist.

Communists believe that at some future, unspecified point, through some mysterious, unexplained magic, all the problems of resource allocation will disappear and everyone will live in harmony.

What constitutes real, non-utopian Socialism?

• Socialism is a system of state-run production and implies the enslavement of an entire population. Everyone is supposed to obey the orders of a small number of rulers who are appointed based on political rank, not demonstrated qualities of management and leadership. 
• Individuals do not get to choose what they want to do, they are assigned tasks for which they may or may not be qualified and they get no special rewards for working well.
• Communist planners know next to nothing about either what resources are available or which uses of those resources are most urgent, as they lack any kind of feedback from either the suppliers of resources or consumer demands. There are no price mechanisms. [3]
• “From each according to his abilities” is probably Marx’s most ridiculous idea: no one will ever know what an individual is capable of unless that individual is truly motivated to work to the best of his abilities. No one will ever be motivated without an appropriate reward. If the fruit of your labor is taken by others, people will simply do the absolute minimum they can get away with, as every single socialist experiment has shown.
• "To each according to his needs" was the other absurd Marxist idea, i.e. the assumption that some god-like administrator would know exactly what should be given to every person to be perfectly fair. The only possible outcome is that every person tries to claim extreme "needs", with the least productive mysteriously having the greatest needs of all.

Note that people under Socialism are not free to choose to live in mud huts as hunter-gatherers. Socialism imposes a certain life style and no one has the right to deviate from it. If that life style is "live in horrible concrete bunkers with furniture that would make Ikea blush and eat recycled food", then that is what everyone will have to do. Except the party leadership.

Mixed economies

Mixed economies are based on some elements of a capitalist, free market economy and a government sector that is based on tax income, operating on government regulations, not market constraints:

• The government sector operates largely as a socialist economy, based on arbitrary decision making with no real-world feedback.
• Anything government does is inflexible and by design resistent to change, yet reality is constant change. Capitalism is ideally suited to adapt to the chaotic nature of reality.
• Markets respond quickly to changes in demand and supply, while governments try to force people into straight-jackets. This is best illustrated by the constant "reform" of government services. Reforms are basically the government's admission that its "services" do not match demand, are wasteful and inefficient. Reforms achieve little to nothing, if they are not outright counter-productive, but they allow government officials to claim that they are doing "something" to fix what is clearly broken.
• Think of the seller of sunglasses who will immediately start selling umbrellas, if the weather changes. Governments will insist on selling umbrellas until a reform says that they also have to provide sun glasses, at which point they will provide sunglasses together with umbrellas, irrespective of the weather - and insufficient quantities of both, usually of bad quality.
• Governments may fix minimum wages, which automatically produces unemployment, especially youth unemployment. The higher the legal minimum wage, the greater the number of people who are priced out of the legal labor market.
• A classic examples of government planning failure are the social security systems that based on pyramid scams and which are so common throughout western countries. When Hayek pointed out that they required a continuous increase in the number of contributors, Adenauer, the German prime minister, replied: "People will always make more children". 6 months later, the pill was officially announced and European demographics started to collapse, thus ensuring that the social security scam would go bankrupt. Over the last 6 decades, western governments kept increasing taxation to support their failing social security programs, but de facto, they are all bankrupt and will never be able to pay out all the pensions they promised.
• Think of government education: their educational performance keeps decreasing and they complaint that they lack money to properly educate the children, but more money never improves anything, on the contrary it makes things worse. This should surprise no one. Government is the only organization where inefficiency is rewarded - and what you pay for, you get more of.

Ultimately, any mixed economy ends up expanding its government sector - using its inefficiency as justification to encroach ever more on the market-driven economy. If this tendency is not countered by massive opposition from the civil society, it ends in full-fledged socialism, at which point the economy and the society will collapse.

Depending on the length and severity of the socialist "experiment", such a failed society will then either be able to re-build itself based on a capitalist model or it will go through endless cycles of violence and oppression.

Here is a quick summary, for reference:

Footnotes

[1] An illustration of why knowledge is the most important capital good: Germany was able to create the 3rd largest economy in the world within 25 years after WWII, starting essentially from rubble and with no military power, i.e. most of their capital goods had been destroyed and they had no means to rob anyone else, yet they managed to re-create all the material goods that had been destroyed in record time. This was possible because German workers already had all the required knowledge, i.e. the capital good "knowledge".

The assumption that Germany's success was based on the Marshall plan is false: the Marshall plan came and went and changed nothing. It was a drop on a hot stone - it redirected US tax payer money into the pockets of a few lucky Europeans who did nothing to improve the economy. It had the same effect as development aid on Africa, generating corruption without production. It's a mystery why people think that this kind of "aid" would have helped Europe, while being totally useless in Africa for over 70 years now.

The German economic "miracle" only took off for real after Ludwig Erhard abolished all the remaining war-time limitations (maximum prices etc.) that had been imposed on the German economy and that was after 1963.

[2] One of the main differences between a highly developed, wealthy economy and a 3rd world econoy is the amount of knowledge and the number of skills that are available in each society. In Africa, in rural areas, every adult person has a pretty impressive amount of knowlege about common tasks related to agriculture, domestic animals and simple construction jobs, but the knowlege hardly varies, from one person to the next. In a developed country, the people living in a single average city street will have extremely diverse skills, ranging from manual construction tasks and commercial skills to engineering, advanced medicine and scientific research.

One of the greatest delusions, in Marx & Engels, is their assumption that a human being could excel at everything - be a farmer, a hunter, a mechanic, a doctor, a scientist and an artist. It mostly serves as illustration of the fact that neither of them had ever accomplished any kind of meaningful work. Marx lived in filth and broken furniture. Clearly, did not even know how to repair a chair.

[3] One of the first and most important jobs for spies sent to western countries, from the USSR, was to collect and send back lists of consumer prices of various goods, so the Soviet planners could use them as indication of how to allocate their own resources. 

[4] When businesses make serious mistakes, they go bankrupt or they have to downsize substantially. When IBM failed to take into account the extent of the personal computer revolution, during the 1980s, although they had contributed to it, this led to serious consequences for the company: by the beginning of the 1990s, they had to fire 200'000 of their 450'000 employees and they had to revise the way they did business. They could not use their size to force customers to buy from them. The initially much smaller Microsoft, which, around 1987, had only 1/100th the turnover of IBM, was able to win a huge market share in operating systems, although the IBM offer was technical better (OS/2). Size is often not an advantage. It makes businesses inflexible, bureaucratic and expensive to operate. Small startups are typically far more profitable than mature, large businesses. Of course there's a risk in investing in small businesses, but the profitable ones generate huge returns of 20 to 50% on the invested capital, while large businesses are happy with 5-10%.