What is Capitalism

The newspapers and magazines are full of dreadful news about the economy. Budget crises are causing pain in many parts of the world. Many people are out of work and they are confused and angry about how this mess came about. Some have even gone ahead and declared the current financial crisis as the first step towards the death of capitalism.

So, what is Capitalism? Well, sometimes it is easier to describe something in terms of what it is not. So, let me tell you about the opposite of Capitalism - Commandism.

Commandism says that the people at the top know best. They should be the ones deciding for everyone what should be produced, how to produce it and in what quantities to consume it. How many acres to devote to corn production, what kinds of grapes to grow, how much should be eaten fresh, how many phones, colors of cloth etc. This philosophy underpinned the command-driven economy of Soviet Union, China under Mao and India under the Nehru-Gandhi family. So, what is so wrong about Commandism? Well, for one, there is no one so smart, so prescient, that all these decisions would be flawless. That is not so bad. The worse part is - how would the person on the top know which decision turned out to be a blunder and needs to be fixed? How do the people make sure that the decision making improves over time?

That is where Capitalism has a unique and distinct advantage. Capitalism isn't so much about private property and class tensions and exploitation of labor and resources as it is about pricing. Pricing is the ultimate survey, the ultimate opinion poll, the ultimate discriminator. Capitalism works because people can and do vote with their wallet. If the price of wheat goes up, people would be motivated to change their diets to eat less wheat. Goods tend to flow from low-price areas to high-price areas. Prices, in essence, become signals.

If eggs become popular, their price will go up. This, in turn, would cause certain motivated people to get into the egg business and thus increase the supply (forcing the price down). Others might be motivated invent materials that would help in the egg business, such as egg cartons. Yet others might be interested in promoting other sources of protein which may reduce the demand for eggs. As you can see, none of these actions required any input from the top. There is no "egg czar" to ensure the supply of eggs.

Of course, this also exposes the limits of capitalism. When setting a price, a vendor only looks at costs to itself - not the entire society. For example, if a coal mine is immune from health costs, it can simply ignore that cost. A mine that reduces health risks gets no financial benefit. Similarly, a fishing company doesn't need to fish sustainably if there is no financial benefit to do so. Benefits that cannot be expressed in financial transactions also get the short end of the stick. If the potential financial benefit of an endeavor is too low, or the risk is too large, it too would end up on the bottom of the pile.

The take-home lesson is that while capitalism does have its benefits (and there are many), it also has its limitations. Thinking that capitalism can somehow solve all our problems is a pipe-dream. But thinking that capitalism can somehow die is downright insane. It implies that all human ingenuity and drive and creativity has come to an end. If that is so, it would be best if we cease to exist.