In the first decade of the 21st century, the world’s economies were buffeted by turbulence of almost unprecedented severity. Plummeting consumer confidence; a collapse in investment and sales; widespread business failures and home repossessions; spiralling unemployment; steep falls in stocks and house prices: the consensus of every financial indicator pointed to a contraction of economies that presaged deep global recession.
At the root of this economic turmoil was a dire ‘credit crunch’ – a massive squeeze on credit available to businesses and consumers. And this crunch was itself the product of an earlier credit binge, which was principally the handiwork of bloated city bankers, insufficiently regulated and addicted to risk, whose apparently boundless hubris and greed had seen over two trillion dollars of ‘toxic’ debt accumulate in the arteries of financial systems worldwide. For greed, read ‘profit motive’; for lack of regulation, read ‘free enterprise’: then it becomes clear that the financial crisis of the early 21st century called into question the most basic principles of capitalism, the dominant economic system in most parts of the world for most of the last two centuries.
‘The inherent vice of capitalism is the unequal sharing of blessings; the inherent virtue of socialism is the equal sharing of miseries.’
Winston Churchill, 1954
Adam Smith and free trade Although use of the term ‘capitalism’ is not attested before the 1850s, the essential dynamics of its operation were fully understood and explained by the Scottish economist Adam Smith in The Wealth of Nations, published in 1776. At this date many of the conditions in which capitalism could flourish were already in place. The expansion of overseas trade had seen the emergence of a merchant class whose entrepreneurial skills had allowed them to accumulate sufficient wealth to invest in the new industries spawned by the incipient industrial revolution. At the same time agricultural workers, displaced from a life of subsistence on feudally managed estates, had begun to form a body of free wage labourers. However, commerce was still widely encumbered by monopolies and other protectionist measures imposed by the state, and it was against the background of such constraints that Smith wrote his seminal work.
Smith claimed that the free market was the most effective mechanism in coordinating economic activity. He recognized that in a free market, where the drive towards personal gain was counterbalanced by the forces of competition, producers would have a natural incentive to provide the goods and services that consumers wished to purchase, at a price that offered a reasonable but not excessive profit on their investment. The market mechanism would thus bring optimal efficiency by closely coordinating supply and demand, and the dynamic relation between these two forces would ensure appropriate levels of cost (in production, wages, distribution, etc.) and profit.
Laissez-faire A crucial aspect of classical capitalism as conceived by Smith and his followers was that it was naturally self-regulating; that is, its proper variables (cost, price, demand, etc.) were determined from within the system, as functions of the system as a whole. For this reason, these variables could be manipulated neither by any single party within the system nor by any party without. The correct price of a product, for instance, was a function of supply and demand within a given market and could not be imposed unilaterally or externally without undermining the system itself. For this reason, probably for the first time in history, the proper realm of economics was conceived as essentially distinct from that of politics.
This division was the theoretical justification for the classical liberal doctrine of laissez-faire – the idea that the state should refrain from attempting to plan or direct the course of the market. Smith allowed that the state had ‘the duty of erecting and maintaining certain public works and certain public institutions’ – facilities, in other words, that private entrepreneurs would have no interest in supplying – and debate over the public or private provision of society’s needs, such as transport and education, would continue till the present day. This aside, the state’s role should broadly be restricted to facilitating commerce, for instance by providing a formal legal framework in which contractual obligations could be made and upheld.
‘Advocates of capitalism are very apt to appeal to the sacred principles of liberty, which are embodied in one maxim: The fortunate must not be restrained in the exercise of tyranny over the unfortunate.’
Bertrand Russell, 1928
Growing pains Advocates of capitalism stress its unparalleled capacity to generate economic growth. Unquestionably, the period of capitalism’s dominance has coincided with a spectacular increase in economic output. Writing in 1848, Karl Marx conceded that in a hundred years of ascendancy the bourgeoisie, or capitalist class, had ‘created more massive and more colossal productive forces than have all preceding generations together’. But this was also a period of massive industrialization, and capitalism’s critics suggest that the ‘subjection of Nature’s forces to man’, by means of mechanization, steam power, railways and more besides, was the main cause of economic growth, not market forces as such.
Adam Smith noted that the urge to accumulate wealth, the central concern of capitalism, tended to encourage entrepreneurs to expand their businesses. This allowed progressive division of labour (splitting of the manufacturing process into smaller, simpler tasks) and other efficiencies that contributed to economies of scale. While such developments undoubtedly contributed to growth – and helped to line the pockets of capitalist financiers still further – critics such as Marx were quick to denounce the kind of growth involved. Smith had suggested that the ‘invisible hand’ of the market would guide individuals acting in their own interests to promote, unconsciously, a greater, collective good, but experience hardly supported any such hope. In the event, the new wealth was anything but evenly shared and the gap between rich and poor grew wider and wider. At the same time the conditions of the working people deteriorated, as they worked long hours in squalid factories at tasks that became ever more tedious and repetitive.
the condensed idea
The unequal sharing of blessings