Definition of capitalism: A political & economic model in which ownership of land & resources can be freely traded between individuals in a free market.

What is capitalism?

Capitalism is an economic system of self-regulation. In a capitalist society, all land and assets have a pre-existing owner. The citizens own the means of production. Most economics book authors would agree that the society we live in is extremely capitalist, although it includes some socialist characteristics.

People provide their labour in return for a wage. This wage can be used to buy goods and services from other people.

Alternatively, people can decide to invest capital to set up a business whereby an individual will organise labour, produce goods and sell these on the market with the aim of making a profit.

This concept of profit is a defining characteristic of capitalism, as it does not feature in the competing ideology of communism.

Under a system of communism, the state owns and controls all resources.

As the state effectively ‘rations’ all land, food and goods, no individual can be said to ‘profit’ from transactions, as the individual enjoys no residual ownership of any items they receive or use. Thus they cannot be said to be richer or poorer as a result.

Why is capitalism the dominant economic system in the world today?

If you study history with an economic lens, you will discover that as soon as humans began living in settlements larger than a family group, the capitalism system emerged in one form or another.

Capitalism is a system which incentivises all citizens to produce as much as possible.

In a free market, you are paid a fair price for what you can supply.

People therefore have a clear incentive to provide as much labour or goods as possible. This will allow them trade for more goods and services in return, which will increase their quality of life.

This strong incentive to be productive means that capitalist villages and towns will have been more likely to produce more food, and support a larger population.

Thus, in a similar way to how effective genes are passed down from generation to generation – early civilisations which adopted capitalism began the dominant civilisations and therefore capitalism self-perpetuated.

The downsides of capitalism

Capitalism isn’t without its flaws or perceived ethical issues.

One thought experiment which exposes several of these is to imagine a child born to a poor mother who is unfortunately orphaned at an early age.

In a mature capitalist economy, all existing land, buildings, machinery and goods are already owned by someone else.

A baby born into such a world begins life with nothing. No assets, no services, no food. It has neither the means to take care of itself, or the money to pay for care.

This puts it at a significant disadvantage to the rest of society who already have a modest amount of money and a stake in the capital or assets of the world.

A baby has nothing to ‘offer’ the free market and therefore would receive nothing in return. If shops provided food for free, they would quickly become bankrupt.

It’s a hopeless and bleak situation. Capitalism feels dynamic and responses to the needs of others, but there’s an absolute pre-requisite, which is that the individual must have something to trade in return.

Where someone is young, disabled, old or ill, they cannot provide labour to the free market. Therefore in a purely capitalist economy, they would starve to death were it not for the kindness and generosity of others (acting outside of the capitalist framework, I would add).

Much is written about the clever ‘invisible hand‘ of the free market. This is the idea that by acting completely in self-interest, markets automatically set prices which ensure the maximum number of people have their needs met.

However, the most effective or efficient market outcome isn’t necessarily a fair outcome in which the basic needs of the poor are satisfied. Without any money, a citizen has no means to participate in the marketplace at all, and thus cannot benefit from it.

This is precisely why modern governments take a socialist role in redistributing taxes taken from those who have, to provide a minimum income for those who don’t. This helps to correct a blatant flaw in the capitalist system, which would see the poor without education, healthcare, accommodation or a means to escape from this trap.

How does the definition of capitalism relate to investing?

Investing in shares is one of the cornerstones of capitalism. By saving some of your wages through a financial adviser or stockbroker of your choice, you are becoming an owner of the means of production. You are seeking profit.

The best property investment books will encourage investors to start small, and gradually build an empire of properties. This clearly shows how you can shift your income source slowly and surely away from labour to capital.

If you can survive off the income from your capital alone, congratulations, you have become a rentier!