An economy is the wealth and resources that are available in a specific region or country based on the levels of production or consumption of needed goods or services. There are two different types of economy options that can promote capitalism: formal and informal.
The formal economy consists of a market driven by the government or local forces that follow specific rules or regulations that apply to everyone. Informal economies exist without any formal polices that companies or customers must follow to have their needs met.
Capitalism is a form of a formal economy. Businesses must operate within the established limits, monitoring regulations and policies, to stay in compliance with the expectations of the government. Instead of controlling the economy through the use of a central planning authority like the spectrum of socialism-based economies, capitalism focuses on growth, choice, and freedom. These benefits come at the expense of the greater social welfare.
The focus of the economic activities in capitalism are to create profit. These are the advantages and disadvantages to consider with that perspective.
List of the Advantages of Capitalism
1. Capitalism provides consumers with choices.
Under the structure of capitalism, consumers get to choose what they want to consume. It is through the availability of choice that competition develops in the private sector to provide the best possible goods or services. This advantage leads to higher levels of innovation because the typical individual will buy the best possible item that they can afford. You will usually see affordable items of better quality under this economic structure than you would in a socialist economy.
2. There is a greater efficiency to the economics.
Capitalism focuses on goods and services that are produced based on the amount of consumer demand that exists for the item. This advantage allows a company to cut costs because they know what is needed, at a specific quality, and with a particular inventory number in mind. It creates an ability to find new incentives that can cut costs so that price is a competitive factor in the mind of a consumer. Some people can choose luxury items, while others can opt for an entry-level product. Either way, the needs of each person are met – avoiding the waste that can occur in other systems.
3. Economic growth occurs with capitalism.
The GDP increases when capitalism is present in the economy because innovation leads to higher demand, which then leads to more purchasing. When a consumer’s life is better because of the products or services they’ve purchased, then there is an option to improve their standard of living over time. Private enterprise can use economic resources more efficiently than the public sector, which means the profits can go right back into the system to help everyone during each cycle. Over time, this trait leads to expansion, more jobs, and eventually more wealth. Socialism does not provide this advantage.
4. The capitalist approach provides a natural bridge to equality.
What is unprecedented about capitalism is that all members of society get the same opportunity to find their fortune. Although some people may be unable to achieve their definition for a variety of reasons, the fact remains that everyone gets the same starting point in life. It is up to each person to approach the idea of innovation.
No matter what your current economic status is, there is always an opportunity to pursue dreams. Anyone can plot a course where they can achieve financial success. If you’re willing to work hard and be persistent, then you’ve got the same chance as anyone else to pass your wealth to the next generation.
5. Capitalism allows the marketplace to set prices instead of the government.
Instead of having the government interfere with pricing and product availability, capitalism places the focus of goods and services on individual needs. The drive for pricing anything in the economy comes from the demand for that product or service.
Inventories are pushed higher or lower based on the need for a response. That is how capitalism naturally provides opportunities to choose what items a consumer believes they need to solve any problem in the best possible way. The government cannot dictate what households must acquire or how much they must pay.
6. Self-regulation occurs naturally in the capitalistic approach.
Because the rules of supply and demand govern capitalism, creators of products or services must be seen positively by prospective customers. If an organization tries to mislead consumers about the condition of an item, then profits will be challenging to locate. If items or workplace conditions are unsafe, then purchasing activities will not occur.
This advantage encourages self-regulation to occur because the firms which want to continue earning profits must always have a focus on providing the precise needs of their targeted demographics.
7. There are ways to continue being compassionate in a true capitalistic society.
Although there is a work element involved in a society that features true capitalism, it would be incorrect to say that it is entirely without compassion. The goal of this society is to develop innovative products that solve problems. When you can earn a profit by helping more individuals maintain their productivity or hold a job for the first time, then you are encouraging them to stay connected. There will always be a level of self-motivation compared to socialism that cannot be overlooked, but this approach still brings people together in unique ways.
8. You can turn your talents or skills into profits.
Capitalism has a national perspective to it since it is the government who authorizes the approach, but it also has elements of individualism. If you have a specific skill set that is in high demand, then your wages are going to be naturally higher because of the market forces that are in play. High-skill positions are in demand all over the world as well, which means you can move to almost any location to secure a higher-paying job jf you prefer. You can even turn your talents into a meaningful self-employment situation so that your earnings become a reflection of your hustle.
9. Capitalism attempts to limit government spending.
The goal of capitalism is to reduce the amount of regulation that occurs in every industry. Although there is a recognition that defense and infrastructure are common needs, the least effective amount possible is the priority with this approach. There must also be accountability for the money being spent to ensure that it is effective. When there isn’t a lot of money being spent on public services and high progressive taxes weighing down on people who make as little as $50,000 per year, then each worker gets to keep more of what they earn. Instead of investing in uncertain government services, then can spend the money on their direct needs.
10. Consumers have more choices available to them.
Because there is an emphasis on innovation in capitalism, consumers win because they have more choices available to them when there are wants or needs to fulfill. Each firm can work to find a specific niche where they can become an expert at meeting the personal needs of each consumer. As long as there is value in the offering that can lead to a profit, then the organization will continue its operations. This advantage results in a society that offers more options, less state interference, and better control over personal finances.
11. It embraces the idea that borders can help the economy.
Even though our economic world is smaller than ever in history, capitalism still places a point of emphasis on national borders. Companies can become multinational juggernauts that financially support communities all over the planet because of the influence of their inventory or provided services. By supporting local businesses, more money stays in the economy to help one’s neighbors. At the same time, large agencies can leverage their scale to provide needed items at lower costs.
12. Supply and demand determine the fair prices of everything.
Capitalism bases its perspective on the free operation of the marketplace. That means supply and demand are what will determine the price of goods and services. This advantage extends to the other elements of investing and money management as well. The price for stocks, bonds, mutual funds, derivatives, commodities, and even currencies is driven by consumer activities and the business response to them. The only thing the government needs to do is enact and enforce rules of fair play that are sometimes necessary.
List of the Disadvantages of Capitalism
1. It must be regulated in some way to be an effective form of economics.
The nature of capitalism is that the most powerful business in every industry will eventually gain control over the rest of its competition. Those with the most money and resources can perform the highest levels of research and development. That means they control more of the production cycle every time expansion opportunities occur. Even when a disruptor can create something better than the largest organization in the sector, the big company can purchase the rights to the product – or buy the new company.
That means there is a chance to have a monopoly of power if regulations are not in place to control outcomes. A firm that has a monopoly can abuse their economic position by charging whatever they want for goods or services.
2. Capitalism eventually leads to inequality.
One of the founding principles of capitalism is that it allows each person the right to pass down their wealth to the next generation. If a small group of families hold a majority of the money in any given economy, then they can pass it to their children to keep the value in the same group over multiple generations. Over time, this disadvantage causes the rich to get richer, while the poor continue to struggle to make ends meet. It allows for money to hold as much power as innovation, leadership, or oversight. If you have enough of it, then you can purchase whatever you need to retain your power.
3. Capitalist economies do not always stay in a pattern of growth.
It can be exciting to live in a society that focuses on capitalism when there is a period of expansion occurring. When the economy decides that it is time to contract, then this recession can cause higher levels of unemployment, more people on social safety net programs, and a decline in revenues for producers. Those who have high levels of wealth withstand this time because they can dip into their reserves to maintain their quality of life. Someone living paycheck-to-paycheck would not have that luxury.
4. It marginalizes the people who are unable to maintain high productivity levels.
True capitalism does not take into account age, wisdom, experience, or health. It expects people to remain competitive to stay active in the economy. If you do not have any skills that are in demand, then there is theoretically no place for you to exist. Social safety net programs are not part of this economic theory. You either contribute or you don’t, and if you choose the latter, then it could be a life-threatening experience.
Capitalist economies will take this advantage to the extreme, providing fewer goods that offer positive externalities. That means there would be less of an emphasis on education, public transportation, infrastructure, and healthcare needs. Each organization and worker would always be looking out for themselves above anyone else.
5. A capitalist economy ignores adverse external outcomes.
Profit is the sole motivation in a capitalist economy. Even though there are higher levels of innovation to consider with this approach, it comes at the detriment of everything else. There is no consideration of the environment unless it contributes to the bottom line in some way. Damage to health is common with this economic approach because organizations can replace one worker with another without much difficulty.
Although this approach creates cheaper products for consumers, there is a long-term cost that everyone will pay. Mining companies that strip the land of resources and leave behind toxic residues have no incentive to clean the air or help the local population. The cost of removing these items would be left to those who want them gone, leaving the firm free and clear of their responsibilities.
6. Capitalism requires consumption to be successful.
Capitalism only works as it should when consumers decide to spend their discretionary money. If they decide to save it instead, then this approach struggles to survive because profit is the primary motive. When there are no buying or selling activities happening, then a business can no longer continue its operations. By making a purchase, each member of society contributes to the employment of everyone else.
Capitalists don’t like the idea of income redistribution because it feels like some people get to have their needs met without the obligation to work. This disadvantage redistributes wealth more by corporate choice than government mandate.
7. The capitalistic approach doesn’t consider ongoing opportunities.
What capitalism defines as “fair” is not the same as other market systems. Although everyone gets the same initial chance to pursue success, there are several factors in play that can limit how much progress is possible. Someone with more money will have more opportunities than those who have less. Poor schools tend to underperform, while wealthy schools meet or exceed educational expectations.
Some families are working 2-3 jobs to make ends meet, which means the children have less time with their parents for mentoring, homework assistance, and companionship. There are plenty of people who work hard and still scrape by each pay period with barely enough.
8. Governments use taxation as a way to fund their operations.
Since the government in a capitalistic society stays out of the marketplace, taxes are necessary to fund its operation. Businesses and individuals pay their “fair share” to have access to public resources. Since the primary expense for most agencies is labor, there is always money being directed toward innovative concepts while the expenses of the workforce are trimmed whenever possible. That means workers receive the lion’s share of risk in this approach. One wrong spending or investment decision could create a decade of financial hardship if a bankruptcy becomes necessary.
9. Capitalism bails out the business, but not the consumer.
If a company becomes overly influential in society, then its failure could drag down everyone else with it. This disadvantage is why the U.S. government distributed bailout funds to numerous organizations to help them continue their operations. These investments came through taxpayer dollars. Small businesses don’t receive that luxury, and individuals wouldn’t even get unemployment protection under a true lens of capitalism. When a monopoly exists and then disappears, the hole that it leaves in the economy can create a massive recession that could require a recovery of several years.
10. Wages creep lower as more capitalism tendencies appear.
Your status as an individual in a capitalist society is based on your ability to be productive. If there is a worker who builds cars at $20 per hour, but an unemployed person with the same skills is willing to do the labor for $18 per hour – guess which option the company will choose? Capitalistic idealism pushes people to balance the value of their productivity with the overall wages they need for survival. This disadvantage causes economic decline over time because most positions have someone who is willing to work for less than a current employee.
This process is one of the reasons why the federal minimum wage in the United States is still $7.25 after nearly a decade of not being updated. It’s also the reason why the real value of wages has been stagnant since the 1980s.
11. Capitalism can create more segregation.
People tend to stick to the neighborhoods where everyone makes about the same amount of money. If you are affluent, then you wouldn’t voluntarily have an apartment in the projects of an inner city. Middle-class families can’t afford the mansions that are in a luxury neighborhood. Every social and economic class segregates itself in a capitalistic society because these groupings are the only way people can relate to one another.
Verdict of the Advantages and Disadvantages of Capitalism
Even though many people see the United States as one of the most capitalist countries in the world, the Heritage Foundation, an educational and research institution that promotes conservative public policies, ranks the U.S. as the 12th-best country for this economic idea as of 2019. Countries that Americans think of as being socialist, such as Canada and the United Kingdom, rank higher.
There are positives to consider with the capitalist approach, including the options for innovation, freedom of choice, and competition. It can also be problematic in the fact that a free economy will not invest in itself unless there are profits to be made.
That is why the most successful economies in the world tend to be a mixture of different approaches. By taking the best concepts of socialism with capitalist idealism, the advantages and disadvantages of capitalism can help us focus on its strengths while reducing the impact of its weaknesses.
Keith Miller has over 25 years of experience as a CEO and serial entrepreneur. As an entrepreneur, he has founded several multi-million dollar companies. As a writer, Keith's work has been mentioned in CIO Magazine, Workable, BizTech, and The Charlotte Observer. If you have any questions about the content of this blog post, then please send our content editing team a message here.