What Defines Capitalism?

A major topic of debate among economists is whether Adam Smith was a proponent of capitalism.

We argue that he was not, simply because his core ideas are very different from those of capitalism, which is merely mercantilism with superficial changes. The source of the confusion is the unclear definition of the word ‘capitalism’. The most concise definition is:

An economic system based on the private ownership of capital to produce goods and services for profit.

Based on this defintion, can we conclusively answer if the following are capitalist?

Obviously, the above is not a clear definition of capitalism since we do not regard the bakers of 1,000 years ago as capitalists, and the shell companies of today as non-capitalists.

To get a clear definition*, we follow David Hume’s method of breaking down the compound idea of capitalism into its basic parts. The five basic ideas in it are:

1. Private ownership
2. Capital
3. Production
4. Goods & services
5. Profit

We remove the capital*, production, goods & services, as they are common to every economic system. How else can goods & services exist other than by production through capital?

Thus, private ownership and profit remain as the noteworthy basic ideas possibly unique to capitalism.

The Profit Motive

Private ownership alone cannot be capitalism’s defining characteristic since feudal lands and even a whole country like North Korea can be said to be under private ownership of their rulers, yet are still able to produce goods.

This leaves us with the profit motive as its possible defining characteristic. This is strengthened by the fact that rulers earn revenue from rent as taxes, and not from the profits of buying and selling.

However, the problem with this is that the profit motive also defines mercantilism.

In order to get higher profits from commerce, merchants in the 18th century lobbied for:

• tariffs and quotas
• exclusive privileges
• subsidies

The businessmen of the 17th century set up mercantile companies to profit from the production of tea and opium in India, just as Apple funded factories in China to produce iPhones to take advantage of price differences. Then and now, this massive profiteering can only be done through big business organizations.

In Book 5 of The Wealth of Nations, corporations or firms were known as joint stock companies which were big business organizations that ran on the same basic ideas:

Mercantilism = Capitalism (Sort of)

This sameness of essence between capitalism and mercantilism is proven by the fact that Capitalism’s producers and Mercantilism’s merchants actually form a single sub-order of society which live by profits:

But different words exist only to express different ideas. Even if the basic idea of capitalism and mercantilism are the same, there must have been a secondary basic idea to differentiate them. Otherwise, they could’ve been used interchangeably, just as the words ‘automobile’ and ‘car’ mean the exact same thing.

To find this secondary idea, we retrace our steps back to private ownership to see if there is any difference in private ownership in mercantilism and in capitalism.

Outside Private Ownership

The main difference is the prevalence of private regulated companies, as guilds, in mercantilism, and their lack in capitalism.

Thus, the assets in mercantile company are not pooled together as a joint-stock. This makes it more exclusive but at the disadvantage of having smaller capital.

Capitalism, on the other hand, allows assets to be pooled into a joint stock with many owners. This looseness and freedom to accept many outsiders to own the company leads to a much bigger capital.

Thus, we say that ’equity’ is the cause of a very obvious effect of big capital, which we speculate to have led to its naming as ‘capitalism’.

Common equity is essential in Capitalism, but not in Mercantilism

Capitalism: Born Between 1800-1830

Capitalism’s birth in England and/or France can be narrowed down to after Smith’s death in 1790 to before 1830 when its idea was already written about, as explained by Marx:

There were capitalist corporations, such as the South Sea Company, before the 1800s. But they were not so prevalent in industry which were still dominated by guilds in the 18th century.

The steam engine changed things because they allowed non-specialist workers to produce what the specialized guilds were manufacturing by hand.

Capitalism failed to take root in Germany and most other places, but took root in Britain because of:

• the high degree of freedom that the British enjoyed
• the strong support by their government.

The Netherlands and the Hanseatic league had weaker government support. This prevented their mercantilism from evolving into capitalism, allowing the British to take over the world.

In fact, Thomas Mun wrote that the Dutch owed their commercial wealth to the British who empowered them to counteract the strength of Spain:

From Britain, the seed ideas of modern capitalism went to France, as seen in JB Say, a French businessman and proto-capitalist, who wrote A Treatise on Political Economy (1803).

However, the single idea that sparked the growth of those seed ideas was James Mill who, in Elements of Political Economy (1821), defined a capitalist as someone who owns the produce of the work of others, without actually working himself :

Note that in this sense,capitalist can only apply if the workers are ACTUALLY SLAVES:

Both Communism and Capitalism Enslave Humans

Communism lets the state enslave man, whereas Capitalism lets the capital owners do it

Thus, in modern capitalism (Mill’s capitalism), workers are actually slaves in essence, different from the capitalism of Turgot, Say, and Ricardo.

All of the work done by an employee in a modern company belongs to that company’s owners in exchange for a fixed wage. This is different from the original capitalism where the workers were paid by the piece or had profit sharing in co-partneries.

It was Mill who corrupted the word ‘capitalist’, equating it more to ‘owner of someone else’s work’ instead of the proper classical definition of ‘someone who lives by profits’ as used by Smith and the Physiocrats.

Thus, Capitalism is from Mill and not Smith.

Smith’s economic system gave importance to all three classes of rent-earners, wage-earners, and profit-earners. But Mill only gave importance to the profit earners.

This absurdity became fuel for Marx to attack Mill:

Marx’ main description of capitalism as a system where resources are amassed through centralization for private gain is consistent with our definition of a system of pooling resources together through equity:

Nowadays, almost anyone can own stocks and some people, like pensioners and insurance buyers, don’t even know that they are indirectly owning stocks, and are getting a steady revenue from the work of others without working themselves.

More obviously, the most common buzz in today’s business news are stock prices, proving the importance of equity to capitalism. Turn on CNBC and Bloomberg and you will see stock information everywhere.

If the world had stayed in mercantilism, then commodity prices would be shown instead.

The Basic Supereconomic Definition of Capitalism

We thus define capitalism as an economic system that uses outside ownership to amass private profits.

It is through the ownership of stock by people outside or unrelated to the company’s operations that they get rich through the accumulation of profits via:

• retained earnings
• rising stock prices.

By simply making the right bet, a stock trader or investor can multiply his small money into big money without doing much work, just like a gambler.

This is one of the main expedients that fuels inequality, as it allows people to feed off the work of others legally.

When left unchecked, it allows people to increase their nominal value way above their real value. This manifests as bubbles which pop when the nominal value crashes back to its real, natural value.

State Capitalism, Inclusive Capitalism

State capitalism is the state trying to solve the problem of inequality by giving the government the control of private equity so that its profits can be better distributed to society.

However, such a system requires its government administrators to have a high degree of skill and morals to juggle private and public interest at the same time.

Adam Smith says that the government can be in business as long as its people are responsible. This is proven by the success of China’s state-owned corporations:

A well-run state capitalism* leads to less opportunities for private capitalism. This is why liberals say that governments have no business to be in business. They cherry-pick quotes from the Wealth of Nations to advocate deregulation and laissez faire, contrary to the original spirit of the book.

From here we can add other definitions:

• Inclusive capitalism is an economic system that uses outside ownership to let everyone amass private profits, likely through penny stocks or group purchase
• Stakeholder capitalism is an economic system that uses outside ownership to let its stakeholders have a share in the profits of the company or system

Our definition distinguishes capitalism from mercantilism and answers the questions earlier:

By defining capitalism, we can better filter out the economic policies that enslave people and we can adopt those that set them free. The next task is to define outside equity, which will be discussed in future posts.