How Capitalism Works

Real Capitalism: The Idea

The Industrial Revolution brought about the end of true capitalism.
The Industrial Revolution brought about the end of true capitalism.
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Befor­e the Industrial Revolution in the 1800s, countries like Britain and the United States had true capitalist economies. With industrialization, though, came sweat shops, social protest and resulting government intervention in the form of fair labor laws. That's when real capitalism ended.

Today, the economies of nations that are typically referred to as capitalist are in fact mixed economies -- they incorporate certain aspects of capitalism and certain aspects of planed economies. In pure capitalism, things like child labor laws, Social Security, anti-discriminatory hiring practices and a minimum wage have no place. Capitalism rejects all government intervention in economic matters.

The basis of capitalism is individualism. The economic system stems from humanistic ideals of the 18th century European Enlightenment -- beliefs that each human being is individually unique and valuable. This mode of thinking was a turning point. Before the Enlightenment, governments didn't talk about human rights. But in this vision of humanity, a society made up of unique individuals who pursue their individual interests is healthy -- it's characterized by progress, spiritual and worldly wealth, and liberty. Individuals are not just free to pursue self-interested goals; they should pursue self-interested goals.

It's easy to see how this shift in social consciousness became the basis of capitalism. If self-interest is a good thing, and personal wealth is a self-interested goal, then widespread personal wealth is a good thing. And if individual welfare leads to overall social welfare, than individual wealth leads to overall social wealth.

The added philosophical view that turns the social concept of individualism into the economic concept of capitalism came from Adam Smith in the late 1700s. His book, "An Inquiry into the Nature and Causes of the Wealth of Nations," had a profound effect on economic principles. Before Smith, the economic self-interest of the individual was seen as counterproductive -- or at least non-contributory -- to the economic welfare of society as a whole. Smith disagreed with this belief. He suggested two concepts that ultimately became the basis of capitalism:

  • Because self-interest guides producers to create exactly what people want, the pursuit of personal gain eventually benefits society.
  • An economy has a natural design. Left to its own devices -- and removed from politics, religion and all other pursuits -- it will regulate itself. As long as no one throws a spoke in the wheel, the economy will work the way it's supposed to, and everyone will benefit.

­Smith's overall view is that an "invisible hand" guides the economy through the combination of self-interest, private ownership and competition. The end of this natural economic balance is general social wealth. In other words, everybody benefits.

­How can private profit lead to public good? On the next page, we'll learn about the process of capitalism.