The two major economic systems in modern societies are capitalism and socialism. In practice, no one society is purely capitalist or socialist, so it is helpful to think of capitalism and socialism as lying on opposite ends of a continuum, as shown below in Figure 11.3 “The Continuum of Economic Systems.”  Societies’ economies mix elements of both capitalism and socialism but do so in varying degrees, so that some societies lean toward the capitalist end of the continuum, while other societies lean toward the socialist end. For example, the United States is a capitalist nation, but the government still regulates many industries to varying degrees. The industries usually would prefer less regulation, while their critics usually prefer more regulation. The degree of such regulation was the point of controversy after the failure of banks and other financial institutions in 2008 and 2009 and after the BP oil spill in the Gulf of Mexico in 2010. Let’s see how capitalism and socialism differ.

Figure 11.3 The Continuum of Economic Systems

Capitalism

Capitalism is an economic system with five key features. The first key feature in capitalism is that the means of production are privately owned. By means of production, we mean everything—land, tools, technology, and so forth—that is needed to produce goods and services. This is due to the second key feature of capitalist societies, a split between the owners, or those who own the means of production and distribution, and the workers, the people who sell their labor to the owners. Next, as outlined by famed Scottish philosopher Adam Smith (1723–1790), widely considered the founder of modern economics, the most important goal of capitalism and its third key feature is the pursuit of personal profit (Smith, 1776/1910). As individuals seek to maximize their own wealth, society as a whole is said to benefit. Goods get produced, services are rendered, people pay for the goods and services they need and desire, and the economy and society as a whole prosper.

One important hallmark of capitalism is competition for profit. This competition is thought to help ensure the best products at the lowest prices, as companies ordinarily try to keep their prices as low as possible to attract buyers and maximize their sales. In the picture depicted above, ads from 1885 for two companies that make ore extractors are side by side, with the lower ad touting the product’s lower price and higher quality in the hope of attracting customers. Unknown engravers – Public domain – Wikimedia Commons

As people pursue personal profit under capitalism, they compete with each other for the greatest profits. Businesses try to attract more demand for their products in many ways, including lowering prices, creating better products, and advertising how wonderful their products are. In capitalist theory, such competition – the fourth key feature – helps ensure the best products at the lowest prices, again benefiting society as a whole. Such competition also helps ensure that no single party controls an entire market. According to Smith, the competition that characterizes capitalism should be left to operate on its own, free of government intervention or control, the fifth key feature. For this reason, capitalism is often referred to as laissez-faire capitalism (French for “leave alone”); terms to describe capitalism include the free-enterprise system and the free market, that is, a market that is ruled by supply and demand where individuals make economic decisions.

The hallmarks of capitalism, then, are private ownership of the means of production, a division between owners and workers, the pursuit of profit, competition for profit, and the lack of government intervention in this competition.

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Socialism

The key features of socialism as an economic system were spelled out most famously by Karl Marx. The first key feature of socialism is that the means of production are collectively owned, usually by the government. Whereas the United States has several automotive manufacturers that are owned by corporations and their stockholders, such as Ford and General Motors, a socialist society might have one government-owned car maker. The second key feature is there is no division between owners and workers; all citizens are both the owners as well as the workers in socialism. The most important goal of socialism, and the third key feature, is not the pursuit of personal profit but rather work for the collective good: the needs of society are considered more important than the needs of the individual. Because of this view, individuals do not compete with each other for profit, the fourth key feature; instead, they work together for the good of everyone. Finally, the fifth key feature revolves around how much government intervention is permitted. If under capitalism the government is supposed to let the economy alone, under socialism the government literally controls the economy.

Many people confuse socialism with communism. To clarify, socialism, discussed above, typically refers to an economic system while communism refers to a system of governance that incorporates socialist principles. The ideal outcome of socialism, said Marx, would be a truly classless society. In such a society all members are equal, and stratification does not exist. Obviously, Marx’s vision of a classless society was never fulfilled, and nations that called themselves socialist departed drastically from his vision.

Recall that societies can be ranked on a continuum ranging from mostly capitalist to mostly socialist. At one end of the continuum, we have societies characterized by a relatively free market, and at the other end we have those characterized by strict government regulation of the economy. Capitalist nations are found primarily in North America and Western Europe but also exist in other parts of the world.

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Comparing Capitalism and Socialism

People have debated the relative merits of capitalism and socialism at least since the time of Marx (Bowles, 2007; Cohen, 2009). Champions of capitalism tout several advantages. They say it produces more economic growth and productivity than socialism, at least in part because it provides more incentives (i.e., profit) for economic innovation. It also is often characterized by greater political freedom in the form of civil rights and liberties. As an economic system, capitalism seems to lend itself to personal freedom: because its hallmarks include the private ownership of the means of production and the individual pursuit of profit, there is much more emphasis in capitalist societies on the needs and desires of the individual and less emphasis on the need for government intervention in economic and social affairs.

Socialism, proposed to counter the faults of capitalism, also has its supporters. Since its greatest goal is to provide for the needs of all people rather than profits, by working as a collective it can make better use of resources, land and labor. Emphasizing meeting the needs of everyone means that, while a significant amount of individual wealth is not accrued, neither is abject poverty as seen occurring with capitalism. This mindset also means that everyone is equal within society and suggests that true freedom comes from such equality. However, this freedom comes at the cost of inefficiency.

Without the law of supply and demand regulating production and prices in socialist economies, a central planning agency is required to make millions of decisions about the production and distribution of goods and services. The complexity of such decisions in modern society is bound to result in the wasteful overproduction of some goods and services, thus squandering resources. Meanwhile, societal needs can also go unmet when miscalculations lead to the underproduction of necessary goods. Moreover, critics state that without the incentive mechanism that the profit motive provides in capitalist systems, socialist systems are less responsive to the needs and demands of society.

Similarly, even its staunchest supporters must acknowledge that capitalism also has its drawbacks, compared to socialism. There is much more economic inequality in capitalism than in socialism. Although capitalism produces economic growth, not all segments of capitalist systems share this growth equally, and there is a much greater difference between the rich and poor than under socialism. People can become very rich in capitalist nations, but they can also remain quite poor. Numerous Western European nations that have more socialist features than the United States have fewer extremes of wealth and poverty and take better care of their poor.

Another possible drawback depends on whether you prefer competition or cooperation. Important values in the United States include competition and individualism, both of which arguably reflect this nation’s capitalist system. Children in the United States are raised with more of an individual orientation than children in socialist societies, who learn that the needs of their society are more important than the needs of the individual. Whereas U.S. children learn to compete with each other for good grades, success in sports, and other goals, children in socialist societies learn to cooperate to achieve tasks. This begs the question, is competition or cooperation a more desirable value for society? What are the pros and cons of each?

The value of individualism in capitalism is said by its critics to encourage selfish and even greedy behavior: if individuals try to maximize their profit, they do so at the expense of others. In competition, someone has to lose. A company’s ultimate aim, and one that is generally lauded, is to maximize its profits by driving other companies out of the market altogether. If so, that company succeeds even if some other party is hurting. The small family-owned mom-and-pop grocery stores, drugstores, and hardware stores are almost a thing of the past, as department stores, followed by shopping malls and then big-box stores opened their doors and drove their competition out of business. On the other hand, one must ask, in a socialist system, would the innovations associated with these newer forms of retail – the efficiency of mass distribution and economies of scale resulting in lower consumer prices – even be introduced without an individualist mind-set and the profit motive driving these innovations?

While inefficiency and limits on wealth creation and innovation are the main critiques of socialism, a counter argument can be made that these very problems are actually the saving grace of socialism since these traits inherently result in lower rates of production and consumption. A growing critique of capitalism is that capitalist systems encourage consumers to spend wastefully and thoughtlessly, as people buy items without considering their true costs, especially to the environment. The environmental devastation wrought by capitalism and its insatiable need to ever increasingly expand, has resulted in our climate crisis, exploitation of non-renewable resources to the point of exhaustion, and pollution of our natural resources, to list a few negative outcomes. To its critics, then, capitalism encourages harmful behavior. Yet it is precisely this type of behavior that is taught in business schools.

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A final critique of capitalism is that, as capitalists began to dominate the economies of many countries during the Industrial Revolution, the tenets of capitalism allowed the rapid growth of businesses. The resultant and tremendous profits gave some owners the capital they needed to create enormous corporations that could monopolize an entire industry. Many companies controlled all aspects of the production cycle for their industry, from the extraction of raw materials to the production of finished products, to the stores in which they were sold. These companies were able to use their wealth to buy out or stifle any competition. John J. Rockefeller of Standard Oil and J.P. Morgan of U.S. Steel, among others, earned their fortunes in the early 1900’s by creating monopolies.

In the United States, the predatory tactics used by these large monopolies caused the government to act. Starting in the late 1800s, the government passed a series of laws that broke up monopolies and regulated how key industries—such as transportation, steel production, and oil and gas exploration and refining—could conduct business.

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The United States is considered a capitalist country. However, the U.S. government has a great deal of influence on private companies through the laws it passes, and the regulations enforced by government agencies. Through taxes, regulations on wages, guidelines to protect worker safety and the environment, plus financial rules for banks and investment firms, the government exerts a certain amount of control over how all companies do business. State and federal governments also own, operate, or control large parts of certain industries, such as the post office, schools, hospitals, highways and railroads, and many water, sewer, and power utilities. Debate over the extent to which the government should be involved in the economy remains an issue of contention today. Some criticize such involvements as socialism, while others believe intervention is necessary to protect the rights of workers and the well-being of the general population. (Griffiths, et. al., 2015)

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Social Democracies

Some nations combine elements of both capitalism and socialism fairly equally and are called social democracies. In these nations, the government owns several important industries, but much property remains in private hands, and political freedom is widespread; extensive programs are in place to help the poor and other people in need. Although typically these nations have high tax rates to help finance their social programs, their experience indicates it is very possible to combine the best features of capitalism and socialism while avoiding their faults.

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The five Scandinavian nations of Denmark, Finland, Iceland, Norway and Sweden differ in many ways, but all are social democracies. Their governments are elected by the people and at the same time own important industries. Social democracies such as these are often called controlled capitalist market economies because their governments either own industries or heavily regulate industries they do not own. According to social scientist Tapio Lappi-Seppälä of Finland, a key feature of these social democracies’ economies is that inequality in wealth and income is not generally tolerated (2007). Employers, employees, and political officials are accustomed to working closely to ensure that poverty and its related problems are addressed as much as possible and in as cooperative a manner as possible due to each country’s commitment to universalism.

All citizens, regardless of their socioeconomic status or family situation, receive various services, such as childcare and universal health care, and primary, secondary and college education, that are free or heavily subsidized by high taxes that citizens generally accept as normal and necessary. The benefits for individuals are manifest, from young adults who don’t start their independent adult lives buried in a mound of student loan debt to families who have access to high quality daycare for their young children and who don’t risk bankruptcy paying medical bills. While efforts to provide full employment and equality have not been entirely free of difficulties, these Nordic nations have been very successful, as they rank at or near the top in international comparisons of health, education, economic well-being, and other measures of quality of life. Social democracies in these Scandinavian countries show us it is possible to combine the best features of capitalism and socialism and still retain political freedom.

Social Movements and the Economy

The outsize influence the economy has on all facets of life has made it a keen setting for social movements within society, typically involving the political system as well. Indeed, we can see how closely politics and the economy are integrated by examining historical and current social movements in the U.S. For example, in the late 1800’s the modern labor movement emerged as both the industrial revolution and a population surge occurred in the U.S. Factories needed the labor and new immigrants needed work. However, men working in the skilled trades feeling both threatened by this competition and abused by companies that employed them joined forces to form the first union; their first demand was to limit the workday to eight hours, and members of the union held strikes in support of this initiative. Company owners employed sometimes brutal techniques to break the strikes, and the government often actively or passively backed the companies.

Over time though, as more unions formed and became more organized and larger, they accumulated enough power so that by the 1930’s laws protecting workers’ rights to shorter workdays, shorter work weeks, higher wages, and the regulation of child labor were passed. The communist revolution marked a decline in American support of labor unions, and the administrations of the 1920’s generally hands-off approach to governing meant company management again had the upper hand. The Great Depression of the 1930’s resulted in renewed interest in the potential of the union and membership grew and continued to expand through WWII.

A larger membership also resulted in growing coffers since union membership required dues. By the 1960’s, unions were diligently using their funds and their power to support politicians who supported the unions and encouraging members to vote for the candidates who were pro-union. Unions were thus able to see laws pass that kept workers safer on the job. Even as union membership has declined in recent decades, labor unions continue to have a positive impact by increasing wages for all workers. People in unions on average have better benefits while working and better pensions when they retire (Walters, 2003).

A different, but related, social movement, Occupy Wall Street (OWS), began as a local protest in New York City in September 2011 in response to the Great Recession and the U.S. government’s use of tax dollars to bailout large banking, insurance and automobile corporations, while at the same time, approximately four million Americans lost their homes to foreclosure (Dharmasankar and Mazumder, 2016). People gathered in Zuccotti Park near Wall Street to bring attention to income inequality, corporate corruption and a sense of injustice to the governmental response, as noted above. They stayed for months and introduced the terms “the 99%” and “the 1%” to describe the majority of people in the U.S. versus the wealthiest portion of the population, and said of themselves, “We are the 99%.” In the two months camping in Zuccotti Park, thousands of people participated to some degree, the movement grew, and participants started to occupy other spaces such as banks, corporate headquarters, foreclosed homes and college campuses across the U.S.

One of the key elements of Occupy Wall Street was its decentralized leadership; everyone was a leader, and all decisions were made by group consensus. Goals of OWS were both wide ranging yet similarly amorphous, as issues as varied as student loan forgiveness, bank reform, reducing corporate influence and halting house foreclosures were included. Reactions to OWS ranged from a general support of the premise of the movement to criticism of its methods. Occupy Wall Street tapped into the frustrations of the average American, but its inability to transition to a sustainable organization with clear goals sounded its end. After the police evicted the protesters from Zuccotti Park and other venues, the movement largely dissipated without having any discernible impact.

Some dispute this assessment, saying instead that the many goals outlined initially prompted the creation of several smaller movements that did target specific issues such as student loan debt forgiveness and monitoring the U.S. Securities and Exchange Commission (SEC). Occupy the SEC, which works to ensure that financial regulators focus on the interests of the American public rather than the interests of Wall Street, even helped shape policy. OWS is also credited with revitalizing the idea that social protests are worth the effort they take, perhaps evidenced by the protests against the Muslim ban, racism, sexism and police brutality in the years following 2011.

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Section 11.3 References

Smith, A. (2002) The Wealth of Nations. Oxford, England: Bibliomania.com Ltd.

Bowles, P. (2007). Capitalism. New York, NY: Pearson/Longman. 

Cohen, G. A. (2009). Why not socialism? Princeton, NJ: Princeton University Press.

Environmental Justice Foundation.  (2007, August 20).  Cotton – Environmental Disaster & Lethal Pesticides. YouTube. Retrieved from https://youtu.be/nlSQevNPBd4.

Lappi-Seppälä, T. (2007). Penal policy in Scandinavia. Crime and Justice, 36, 217–296.

NeoMam Studios.   (2020, April 20).  Fast fashion: Drowning in clothes. YouTube. Retrieved from https://youtu.be/YFPnqjSXEAc.

Walters, M. and L. Mishel.  (2003). How unions help all workers. Economic Policy Institute. Retrieved from https://www.epi.org/publication/briefingpapers_bp143/. 

Dharmasankar, S. and B. Mazumder. (1970, January 1). Have borrowers recovered from foreclosures during the Great Recession? Chicago Fed Letter. Retrieved from https://econpapers.repec.org/article/fipfedhle/00059.htm. 

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Gonzales, Chachi.  (2020, January 10).  Amazing Finnish baby box for newborns!: Unboxing. YouTube. . Retrieved from https://youtu.be/HIIssQX2brk.

CC licensed content, Shared previously and Adapted

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