Capitalism - The Best We've Got?

Capitalism is flawed. I'll be the first to admit that the world's predominant economic system is far from perfect. It unfairly rewards those who start off in better circumstances to continue to build wealth, drives companies towards profits over the greater good, and creates a substantial wealth gap across the spectrum of citizens. However, I'm convinced it's truly the best system we have, and with additional provisions to mitigate the negatives of capitalism, it can be a powerful force to help every citizen find financial success. You may be wondering why your favorite personal finance and career advice blog is seemingly deviating from its core topic. However, capitalism is at the root of both your financial and career aspirations - and having a basic understanding of how it works and impacts your daily life is critical. There's so much to cover, I'm turning this topic into a series. Without further adieu, let's dive into some economics!

The first results of my image database for "capitalism" is this guy. Sure, works for me.

Modern Economic Systems

In the modern world, there are really two main economic systems: market-based or command-based. Market-based is capitalism, where citizens (including companies) own assets (capital) and have the freedom buy and sell goods or services without government intervention. Command-based systems include socialism and communism, with the governments either reallocating capital (socialism) or owning/distributing capital (communism) to citizens. Capitalism allows citizens to generate wealth by producing goods or offering services, or working for citizen-owned companies that do so. Additionally, capitalism can operate across borders - citizens of one nation can conduct commerce with those of another.

Of course, no countries are purely capitalist. Governments own many resources that are built and maintained for the common good - roads, parks, etc. Citizens and corporations pay taxes and abide by regulations set by various layers of government. On a global scale, countries place tariffs on goods from other countries meant to stifle imports that compete with their own products. Extreme measures, like economic sanctions, can fully restrict commerce with another nation. There is a spectrum of capitalism in practice across the world. Below is a map of economic freedom as rated by the Economic Freedom of the World Index, with the lighter colors (orange) being rated as most free, purple as least, and gray as N/A. For my American readers, the U-S-of-A comes in ranked 6th in the world. Hong Kong takes home #1, however recent laws imposed will most likely impact this ranking.

To illustrate how the degrees of capitalism play out, let's compare how nations utilize their natural resources. Oil has been drilled across the world, but each country handles this asset differently. In the U.S., there's a complicated system of ownership; depending on the state, the property owner can claim the oil under their property, or the "mineral rights" may be separately held by another individual or company. Norway has their Oil Fund, in which the Norwegian government manages the national oil rights and uses profits to pay for government programs. While both nations have relatively high economic freedom scores, they have very different approaches to their natural resources.

Why Capitalism Works

One of the best measures of the economic success of a nation is its gross domestic product (GDP) per capita. GDP estimates the value of products and serves created within a country over a set period of time (usually one year), and is a standard indicator of the magnitude and growth (or stagnation) of a country's economy. Using the Purchasing Power Parity (PPP) metric to normalize the buying power within each nation, the countries can be ranked side-by-side to show the relative wealth of its citizens. To show how this measure coincides with economic freedom, you can refer back to the economic freedom index above. You can run the numbers for yourself, or you can look at the pretty graph I created!

As you can see, the United States has both the highest GDP per capita using PPP methodology and the highest economic freedom score. As you look from left to right, you'll notice that the decreasing GDP per capita tracks closely to the drop in the economic freedom index scores. Coincidence? I think not.

This is why capitalism works! We, as a whole, have more because we are free to produce more and realize the benefit. It's not just quantity, either. It's generating quality, with the consumer acting as the ultimate judge. If a company or individual doesn't produce, someone else will do it and reap the reward. It's why we have phones with three camera lenses that can take pictures with greater resolution than most cameras. Apple is trying to outdo Samsung, and we are the beneficiaries. New products and services are created, job opportunities arise, and we earn money that can be spent on the things we want. More wealth is created, which spurs more innovation in products and services, and the cycle continues. Communism and socialism tend to view wealth as zero-sum, where wealth is a fixed amount and it needs to be split amongst citizens. Capitalism is not zero-sum: wealth is not fixed, it's a byproduct of the efforts of citizens.

With all the praise of capitalism in this blog, let me be perfectly clear. Capitalism alone is not a perfect solution for the economic woes of a nation. Citizens that either need a helping hand to fully participate in the free market, or can't contribute whatsoever, need to be considered. Can we use our the massive wealth generated by capitalism to provide a safety net for those less fortunate and help people work out of difficult situations? Next in this series, I'll focus on how capitalism can be massaged to serve all citizens, and try to find the right balance. Until next week, be good to each other!