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Capitalism, first used as a term by Werner Sombart around the beginning of the twentieth century, is a social system dominated by economic relations, particularly market relations. The institution of private property is elaborately developed and well secured, and property owners derive income from the sale of output made with labor hired for wages or salaries. The income of property owners can appear as profit, interest, or rent, depending mainly on the kind of property involved. Workers have little or no income-earning assets other than their capacity to labor, which they contract to sell to property owners (capitalists) for a definite period of time but not for a definite intensity. Property income may be increased by getting workers to increase the intensity of labor, that is, to work harder, faster, or smarter.
Although markets existed in a great variety of social systems, appearing back to the furthest extent of recorded history, capitalism is unique in the degree to which market relations affect every aspect of the social order. According to Karl Polanyi in The Great Transformation (1944), the rise of capitalism represents a major institutional reversal. Precapitalist societies often provided for markets within an elaborately structured cultural framework, in which social status and social roles were already established, such that markets played a decidedly subordinate role. Trade and traders had their place, often clearly delimited in time, space, and permitted function. Under capitalism, in contrast, the market itself increasingly provides the framework for the determination of social status and social roles; market relations increasingly determine the time, space, and function of every other aspect of the culture. Cultures are modified and subordinated to global markets, creating a world system beyond any single culture’s design.
Resource Markets: Land and Labor
Specifically the rise of capitalism involves legal developments allowing for efficient markets for land and other natural resources. The sovereign rights of the state and the blood rights of family, clan, and tribe—whatever these may include—become limited and clearly distinguished from modern property rights, so that real estate and rental markets as well as more esoteric markets in mineral rights may thrive unencumbered by ambiguities and restrictions of tradition.
Similarly efficient labor markets are developed to accommodate wage labor on a massive scale that transcends or escapes human relationships based on tradition, intimate acquaintance, or direct coercion. In practically all precapitalist societies, there are some kinds of “subsistence” activity—perhaps in hunting, gathering, farming, fishing, or herding—to which almost anyone could turn for a living in default of any more exalted assignment or organized function. In developed capitalist societies, there is no default living. Access to requisite land or natural resources is not free and not otherwise institutionally guaranteed. Significant property ownership is neither universal nor necessarily even widespread in the population. In fact in the long actual history of the establishment of legal private property in its modern form in many countries, the bulk of property, through force and fraud, came into the hands of old elites and entrepreneurial upstarts, leaving most people without property and without legal access to resources or means of production. Hence involvement in market relations and in social networks becomes inevitable, and that presents a distinct set of challenges to the propertyless, more or less forcing many of them into the labor market and into a weak bargaining stance vis-à-vis the owners of property rights in the means of production.
An essential insight in Karl Marx’s Capital (1867) is that the captive excess supply of labor, or in Marx’s vivid terms the “reserve army of labor,” creates a competitive environment in which workers can be expected to be compliant and wages are negotiated down to subsistence level. Specifically wages are not expected to bear any particular relation to the value of goods produced and sold by the employer-owners, and that provides a nonfleeting source of profitability. Thus Marx demonstrated that regular profit can come from property ownership in the means of production, even if those means of production are themselves produced entirely by workers.
Naturally the state of the capitalist labor market presents some glorious opportunities to employers, but it also presents challenges. Mere biological subsistence turns out to be quite distinct from maintenance of healthy, reliable, motivated, and skilled employees. To the extent that employers scan their labor supply for quality as well as quantity, they seek a labor market different in structure from that envisioned by classical and Marxist economists. As the experience of industrialists from Robert Owen in the 1820s to Henry Ford in the early 1900s repeatedly illustrated, it can be profitable under certain circumstances to invest more in the labor force, paying workers more than is customary or appears necessary in terms of current labor market conditions. This insight gave rise to the concept of human capital, according to which investment in workers can yield a return as readily as might investment in any other kind of productive equipment; to human resource management, including elaborate segmentation and structuring of the labor market; and finally to a variety of state-sponsored programs socializing the cost and standardizing the practice of basic education, sanitation, health care, and other basic investments in the population thought to improve the overall efficiency and productivity of labor. In short, actual labor markets fail to correspond to the classical vision to the extent that labor power cannot be merely “reproduced” in families outside the market, as in the Marxist model, but requires capitalist or socialized investment for its construction and maintenance.
Another challenge facing employers is to manage workers and the work environment so that the potential for profit is actually realized. Employees rarely work at peak productivity on their own initiative based on their own organizational efforts, so investment in human capital does not in itself suffice to maximize productivity and profits. Hence the need for management to organize and supervise on behalf of the enterprise owners, and hence the constant struggle at the work site between management and labor.
Entrepreneurship and the Business Firm
Unlike in precapitalist cultures, the organizing principles of capitalism are abstract and general. Law is highly formal, aspiring to universal reach, and markets involve stereotyped interactions among anonymous participants. It is no coincidence that capitalist processes are often comprehensible as games, as witnessed by the elaboration of game theory and its rapid extension beyond political science to economics and sociology. This creates an environment uniquely amenable to entrepreneurship.
Of course entrepreneurship even as currently understood is omnipresent in all social orders. History is full of accounts of military adventurers, poseurs, prophets, travelers, and merchants who preceded the arrival of the modern capitalist epoch. Presumably no society could be so structured, so rigid and predetermined, existing under circumstances so regular and predictable, as to provide no space for the restless and adventurous to innovate through that recognizable yet undeterminable combination of design and accident. Yet modern capitalist society was the first to recognize entrepreneurship as a regular rather than extraordinary function in a wide variety of fields of endeavor. It is even encouraged.
Two aspects of entrepreneurship deserve particular attention for purposes of understanding capitalism. The first is risk taking; the second is innovation. A certain amount of risk taking is encouraged under capitalism simply through the institution of property. Legally welldefined property rights allow an unprecedented expansion of the credit system by allowing enormous amounts of value to be put at its disposal in the form of collateral without the items constituting that collateral having been withdrawn from current productive use.
Even more space for purposeful investment in potentially risky ventures is provided by the modern corporate structure of business firms responsible for the large majority of the value of goods and services produced each year. This structure has evolved to spread and limit risk and thus to encourage voluntary contributions of funds. The spreading of risk is accomplished by selling shares, each of which is typically a miniscule fraction of the firm’s total outstanding value and often fairly liquid—meaning that it can often be quickly sold if the need for cash arises. Limitation of risk is accomplished by the legal device of “limited liability.” The maximum an investor can lose, unlike in a sole proprietorship or normal partnership, and the maximum an investor can be held legally liable for by virtue of that kind of participation is the total value of shares he or she holds. By allowing small, limited bets on the future, the corporation encourages risk taking and provides resources for entrepreneurship.
In most societies innovation—anything new that disrupts or undermines traditional ways of doing things—is vigorously rejected, and that rejection is overcome only by enormous endurance and determination or by forcible imposition. Under capitalism, this resistance is diminished. Property is protected, but its market value is not guaranteed. According to Joseph Schumpeter in Theory of Economic Development (1911) and Business Cycles (1939), economic growth comes in waves of innovations, often revolving around some central innovation, such as alternating current, the internal combustion engine, or the microchip. The initial innovation may be accompanied by a flurry of activity amid limitless hopes and give rise to a boom, but then follows disappointment and more importantly the destruction (“creative destruction”—another term first used by Sombart) of value in now obsolete goods, equipment, technologies, and skills; this tends to lead to depression. Eventually the further spread of economic activity based on the innovation helps lead to a recovery, but these innovation-led developments would perhaps never occur were the way not first cleared during the depression by “creative destruction.”
Economists have come to view capitalism in three major ways. The classical and neoclassical schools emphasize the spread of market relations and describe efficiency gains expected as a consequence. Marxist and related schools (e.g., that inspired by Henry George’s 1879 Progress and Poverty) focus on power relations and class structures implied by the prevailing system of property rights and emphasize how those hamper the achievement of many of the goals typically viewed as part of social progress, such as greater equality, more democracy, and more security. The Austrian school, including Schumpeter, deemphasizes efficiency and instead promotes the innovative potential of decentralized knowledge and action. Though property rights are formally protected, the value of actual property is freely created and destroyed in the course of progress.
- George, Henry.  1912. Progress and Poverty: An Inquiry into the Cause of Industrial Depressions and of Increase of Want with Increase of Wealth: The Remedy. Garden City, NY: Doubleday.
- Marx, Karl.  1992. Capital: A Critique of Political Economy. Trans. Ben Fowkes. New York: Penguin.
- Polanyi, Karl.  1957. The Great Transformation: The Political and Economic Origins of Our Time. Boston: Beacon.
- Schumpeter, Joseph.  1949. The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle. Cambridge, MA: Harvard University Press.
- Schumpeter, Joseph. 1939. Business Cycles: A Theoretical, Historical, and Statistical Analysis of the Capitalist Process. New York: McGraw-Hill.
- Schumpeter, Joseph.  2005. Capitalism, Socialism, and Democracy. London: Taylor and Francis.
- Sombart, Werner.  1987. Der moderne Kapitalismus. Historisch-systematische Darstellung des gesamteuropäischen Wirtschaftslebens von seinen Anfängen bis zur Gegenwart. Munich: DTV.
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