Category Archives: Economics

Capitalism and Adam Smith

Adam Smith is considered by many to be the father of Capitalism. His “The Wealth of Nations,” is a seminal book that represents the birth of free-market economics, but it’s not without faults. It lacks proper explanations for pricing, or a theory of value and Smith failed to see the importance of the entrepreneur in breaking up inefficiencies and creating new markets.

The basic definition of Capitalism is: “an economic and political system in which a country’s trade and industry are controlled by private owners for profit, rather than by the state.”

History of Free Market Capitalism

Capitalism came about following feudalism, which took place during medieval Europe. Feudalism was a European system where military service is traded for land. This was the primary economic system in Europe in the 16th and 17th centuries.

Then came about the Dutch East India Company, which was founded in 1602. This was the first public company and marked a shift toward capitalism. The major economists that developed theories surrounding capitalism include Adam Smith and Karl Marx.

Adam Smith theorizes that capitalism is part of natural human behavior that is aligned in trade and commerce. Marxism says that capitalism is an unusual system that could be replaced with a superior system. Marx believes that capitalism is essentially powerful people taking control.

Is Free Market the Same as Capitalism?

A capitalist system and a free market system are both economic environments that are based on the law of supply and demand.

They both are involved in determining the price and production of goods and services. On one hand, capitalism is focused on the creation of wealth and ownership of capital and factors of production, whereas a free market system is focused on the exchange of wealth, or goods and services.

Some key features of capitalism include the competition between companies and owners, private ownership and motivation to generate a profit. In a capitalistic society, the production and pricing of goods and services are determined by the free market, or supply and demand, however, some government regulation may occur. On the other hand, a private owner in a capitalist system can have a monopoly on the market and prevent free competition.

A free-market system is an economic system based solely on demand and supply, and there is little or no government regulation. In a free market system, a buyer and a seller transact freely and only when they voluntarily agree on the price of a good or service.

For example, suppose a seller wants to sell a toy for $5, and a buyer wants to buy that toy for $3. A transaction will occur when the buyer and the seller agree on a price. Because a free-market system is based solely on supply and demand, it leads to free competition in the economy, without any intervention from outside forces.

The problem, as I see it, is the polarization that occurs between the proponents of Capitalism and Socialism. What is see are advantages and disadvantages of both economic systems. Communism has failed since it devolves into authoritarianism and creates the abuse of by the elite which is rails against. Some Socialist leaning countries have successfully provided and excellent standard of living for their citizens. Capitalism has served our country well in many regards, despite the recent decline in purchasing power by our middle class.

My preference is what I have termed “Participative Capitalism” where the vast majority of our citizens participate and benefit from the system. For more detail on this concept please refer you to my Book:

Measuring Economic Growth

Measuring Economic Growth

In the past we have judged economic success by the relative increase in “real” GPD. The real part means that the number has been adjusted for inflation. This is also the criteria that most other countries value. However, recently a small number of countries have voiced a different opinion which I find has merit.

The concern is that the end game of increasing GDP, combined with population growth is that eventually we run out of resources, most of which have limits.

What has been suggested is that a more reasonable measure would be per capita GDP which is one measure of productivity and it does not reply on population growth as a measure of economic success and in might encourage reducing populations.

Neither economic growth or GDP per capita tells the entire story of benefit to residents. As vs GDP increases how is that economic improvement distributed? What is a fair return of capital (for dividends and reinvestment) compared to a reward to labor for their contribution? Would a 50/50 split be fair? I’m not at all certain.

What we do know is that real GDP in the USA has increased by about 70% in the past 20 years while the real median family income has only increased by less than 15%.  Is this 55 to 15 ratio a fair redistribution of wealth?

I find it interesting to look at the per capita GDP by country as a indication of how we are doing:

rankCountryGPD per capita
7United Arab Emirates$74,035
10San Marino$63,549
12Hong Kong$61,671
13United States$59,928
17Saudi Arabia$53,893

Per Capita GDP is merely one indication of the how good things are for citizens. There are a couple of other measures worth considering.

The standard of living refers to the level of wealth, comfort, necessities, and material goods available to a particular geographic area. Quality of life is the standard of health, comfort, and happiness experienced by a group.

CountryQuality of Life Rank Quality of Life IndexSafety IndexHealthcare IndexPollution IndexClimate Index
New Zealand8178.2257.8173.8223.5295.46
United States15169.7852.369.238.1776.69
United Kingdom19161.255.4674.8840.6287.77

The other criteria is Quality of Life which is based on eight indices:

  • Purchasing Power
  • Safety
  • Health Care
  • Cost of Living
  • Property Price to Income Ratio
  • Traffic Commute Time
  • Pollution
  • Climate
RankCountryQuality of Life IndexPurchasing Power IndexSafety IndexHealth Care IndexCost of Living IndexProperty Price to Income RatioTraffic Commute Time IndexPollution IndexClimate Index
9New Zealand17681.4457.773.679.18.0930.723.896.4
15United States167102.652.36971.93.9932.938.977.3

I suspect that we were near the top of these three measurements in the early 1950s. What happened?