How Does Capitalism Work?
by Dr. Doug Cardell
Capitalism is part of the economic system called Free-Market Capitalism. It consists of two main components; entrepreneurs, and investors called capitalists. An entrepreneur is a person who has an idea for a product or service that he believes will be of enough benefit to consumers to allow them to market it to those consumers for a profit. A capitalist is a person who provides capital, that is, money, to the entrepreneur to fund their attempt to start their business. The entrepreneur is risking his time and effort while the capitalist is risking his capital.
A television show illustrates the principles really well; Shark Tank. The "sharks" are capitalists looking for promising entrepreneurs to help get started, as long as they believe the product or service will be valuable to consumers and succeed. They are tough, self-made, experienced investors searching for the best services and products to serve America. They give budding entrepreneurs from all walks of life the chance to pursue their version of the American dream. According to ABC, "The Sharks are billionaire Mark Cuban, owner and chairman of AXS TV and outspoken owner of the 2011 NBA champions, Dallas Mavericks; real estate mogul Barbara Corcoran; "Queen of QVC" Lori Greiner; technology innovator Robert Herjavec; fashion and branding expert Daymond John; and venture capitalist Kevin O'Leary. The guest Sharks include founder and CEO of Stitch Fix, Katrina Lake; founder and CEO of KIND, Daniel Lubetzky; international tennis star and creator of Sugarpova, Maria Sharapova; and co-founder and CEO of the personal genomics company 23andMe, Anne Wojcicki. Recurring Shark Rohan Oza, iconic Smartwater and Vitaminwater brand builder, and serial entrepreneur Matt Higgins, co-founder and CEO of RSE Ventures." If you want a crash course in entrepreneurial capitalism, this may be for you.
So far, we've only been discussing the startup phase of a business. Once the company is up and running, the original capitalists that helped get it started usually sell their ownership share to what we might call second-level capitalists. Most Americans are second-level capitalists. They invest in shares directly and through IRAs, retirement plans, mutual funds, buying insurance, and putting money in the bank.
Many Americans imagine that business ownership is still in the hands of the financial elite as it was in the late nineteenth century. However, if they read about who owns IBM in the "Ownership Summary" on NASDAQ's website, they would see how public ownership of corporations works. The Vanguard Group is the largest holder of IBM stock. It is a mutual fund company with more than twenty million investors in one hundred seventy countries. Those twenty million investors include numerous pension funds and insurance companies, making it likely that most Americans are part owners of IBM.
Furthermore, if they were not, they could buy shares in a Vanguard fund for $1000 and thereby own stock in IBM and hundreds of other companies. All these investors share the corporate wealth of this country equitably. All of that capital creates new products and services, and the investors, the capitalists, are rewarded with profit. In the case of stockholders, the child who received one share of IBM as a Christmas present receives exactly the same percentage of profit as the largest shareholder. That child is one of the capitalists that own IBM.
Ironically, most economic problems blamed on free-market capitalism are government failures. These failures come in three flavors; government intrusion into the market, failure to ensure a fair marketplace, and cronyism. We'll cover each of them separately and in greater depth in upcoming articles.
Government intrusion takes many forms, including the Federal Reserve's manipulation of interest rates and money supply. It also includes government programs that transfer control from the market to the bureaucracy, using government spending to compete with private enterprise and many more. These are cases where virtually all the evidence shows that the market would perform better independently.
Government neglect is the government's failure to regulate a free and fair market. Many of these neglects involve what economists call rent-seeking. Rent-seeking is the attempt to derive profit without providing any benefit. This behavior includes asset flipping, like that which caused the 2008 housing bubble and the Great Recession and allowing monopolistic practices.
Cronyism is often called crony capitalism, but once cronyism becomes involved, it is no longer true capitalism. Some of the most common types of government-granted privileges given to individuals and businesses providing them an unfair advantage are:
Bailouts refer to the government providing funds to companies or industries to prevent them from failing due to poor decisions.
Loan Guarantees are when the government grants loans to companies or industries to allow them to borrow money more easily than their competitors.
Monopoly Advantage happens when the government directly protects particular firms or industries from competition by limiting other firms' entry into the market.
No Bid Contracts occur when the government gives certain companies government contracts without competing firms undergoing a bidding process.
Occupational Licensing is a means of restricting competition by requiring businesses or individuals to be licensed to engage in commerce.
Regulatory Capture is when corporations and industries gain a competitive advantage by lobbying for regulations that benefit them and/or restrict competitors.
Subsidies or "Corporate Welfare" exists when the government provides money directly to a business or industry.
Tariffs and other measures to restrict Foreign Competition are the government's restraint of trade to benefit specific industries or companies.
Tax Privileges exist to attract businesses to their community by state and municipality governments.
Laws Benefiting Industries are used to grant unreasonable freedoms to companies or industries. For example, Arizona is an 'open range' state. While no single law defines the open range, nine statutes on the books pertain to livestock and fences. County Boards of Supervisors usually exempt urban areas by designating those areas as No-Fence Districts. Outside of those areas, it is up to the property owner to fence out livestock with a "Lawful Fence." They must have posts no further than 30 feet apart and at least four strands of barbed wire spaced 18, 28, 38, and 50 inches above the ground. Only if you have such a fence and the livestock break through it or if the livestock owner willfully herds his cattle onto your property is that owner responsible for damage done by the livestock. Furthermore, without a lawful fence, if the land owner harms or harasses the livestock or allows their dog to do so, the owner is liable for any damage to the livestock and can be charged with a misdemeanor. These laws apply on private property and anywhere on 'open range,' including public roads. For example, if a driver strikes and kills livestock on a public road and is killed in the collision, the driver's heirs will be held liable for the cost of the livestock killed. The Arizona government implemented these laws to save ranchers the expense of fencing their land to keep their livestock contained but they unfairly transferred the fencing burden to rural landowners.
All of the above are examples of contaminated or corrupted capitalism. They are a better argument for less intrusion into markets than an indictment of capitalism. Free-market capitalism polices itself very well when the government's involvement is limited to ensuring a level playing field.
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