Capitalism vs socialism is a term that is used while making comparisons and contrast between these two economic systems. The purpose of this article is to outline the similarities and differences between the economic systems. Here, we will clarify the factors that make capitalism and socialism to be similar and the factors that make them differ.
Table of Contents
- What is capitalism?
- What is a capitalist? (Who is a capitalist?)
- Capitalist countries
- Capitalism Pros and Cons
- 1. Advantages of capitalism
- 2. Disadvantages of capitalism
- Higher-income and wealth inequality
- Economic instability
- Fewer advantages for the low-skilled people
- Requirements for successful consumption
- Ignorance of ongoing opportunities
- Consumerism and environmental costs
- Greed while seeking profit
- Monopoly power
- Workforce limitations
- Neglect of social benefits
- Class struggle
- Socialist country
- Socialism pros and cons
- 1. Advantages of socialism
- 2. Disadvantages of socialism
- Capitalism vs Socialism
What is capitalism?
Capitalism is an economic system in which private individuals own and control means of production. Here, private individuals and private businesses own capital goods or factors of production. The forces of demand and supply form the basis for the production of goods and services. This economic system is also known as a free-market economy. In this case, private individuals do not face any form of restraining from carrying out productions.
Private individuals decide what to produce, how to produce, and for whom to produce. They determine the price of goods and services as well as where to invest. The free market or the laissez-faire economy carries out its operations without any form of checks and controls. In other words, there exists a minimum government interference in production activities.
Therefore, capitalism or the capitalist economic system is a system in which basic economic problems are resolved. These problems include the production of resources, distribution, and efficient use of resources. Under this economic system, economic planning takes place through decentralized and voluntary decisions. The reverse is the case under the centrally planned economy (socialism) where the government owns and controls the means of production.
What is a capitalist? (Who is a capitalist?)
A capitalist is someone who uses his wealth to invest in industry and trade according to the laid down principles of capitalism. In other words, the term refers to an individual who has the capital to invest in a business. It can also refer to a person who advocates for or favors capitalism.
Examples of capitalist economies include;
- The United States
- Japan, Canada
- New Zealand
- The United Kingdom
Capitalism Pros and Cons
1. Advantages of capitalism
Efficient resource allocation
Competition leads to the most efficient resource allocation. This is because companies utilize the factors of production. This fosters efficient production. Producing firms adopt strategic means of cutting down their costs as well as improving competitiveness and productivity. If firms become unproductive, they will go out of business.
Capitalism is theoretically is the invisible hand of the market that ensures the distribution of resources based on the preferences of the consumers. Firms do not gain rewards for producing what consumers do not want. In other words, producers produce goods according to the demands of the consumers. Firms that are not efficient will not be able to survive in a competitive business environment.
Utilization of available resources
Under this economic system, there exists an optimum utilization of resources that are available. Producing firms put their scarce resources to the most efficient and economic use to avoid waste as much as possible. In other words, every producer gives in his best in trying to use productive resources at his disposal in the most economical way in order to maximize profit. When this happens, there will be efficient production of commodities and services. Where firms find out more superior production methods in order to derive high-quality products at the lowest possible cost. This is the process of utilization of available resources thereby making methods of production more efficient.
Usually, every business carries out research and development to expand their firms and make sure that they do not go out of business. Entrepreneurs get the motivation to be constantly innovative This happens because companies compete. Producers compete for the consumer’s money by improving the quality of their products. Business firms take risks in setting up businesses. This is because of the large financial rewards that follow. If the scope for private profit is not present, then new firms will not come up. Businesses only produce the goods and services that are profitable.
This economic system is a tool to bring people together and overcome discrimination. It encourages both domestic and international trade. This incentive also works towards breaking down barriers. It also works towards bringing people and countries together. It ignores racial differences, tribal differences, and religious differences. People who hate one another can deal with and help one another. Quoting Gary Becker, profit motive would penalize those firms and individuals who practice racial discrimination.
Raising the standards of living
There is an improvement in the standard of living of the people and the reduction of poverty. When the economy grows, there will be a rise in the standard of living within an economy. We can trace an improved standard of living to a fall in the poverty rate.
You can choose the price to pay for a particular product as well as the brand you want to pay for. In other words, consumers choose whatever they want to consume. Competition develops in the private sector. This is to provide the best quality of possible goods and services. Competition develops as a result of these choices. This advantage boosts the level of innovation. The reason is that everyone wants to buy the commodity he can afford at its best quality. Affordable items with better quality always exist under this economic system.
If firms lose their efficiency, they will go out of business. Because of this, short-term problems such as unemployment will result. As a result of this, the capitalists become more innovative in handling factors of production, that is, labor and capital become more innovative and efficient.
Firms under capitalism can respond to changes in consumer preferences. They respond to new consumer trends. It has to do with efficiency in response to changes in consumer taste and preferences.
Minimal government control
Basically, when the government attempts to control the economy, it ends up with problems. These problems include corruption, poor information, and lack of incentives. The economy will be in danger when a corrupt government controls it, it does more harm than good. In this case, the economy can be eroded.
Freedom of Choice
Consumers have the right to choose from the varieties of commodities offered to them by different companies and brands. So you do not have to buy a specific product or brand from a specific company all the time. In other words, there are varieties of consumer goods in sizes, designs, shapes, etc.
Also, every individual has the right to own and retain their properties as well as freedom of enterprise and choice of occupation. A worker can demand higher pay. This helps to channel labor force/manpower into various fields. You do not need to direct people or impose any occupation on them. The freedom of contract also exists. This helps to ensure a flexible operation of various units of production.
There exists economic freedom which as well fosters political freedom. A strong relationship exists between these variables. These rights include setting up new businesses and choosing where to work. This economic system, therefore, fosters political freedom.
Every individual is free to pursue his own interest and satisfaction. This implies that one can do whatever he wants to do without experiencing any form of political and civil pressure. This bases on the idea that the actions of people will help the entire society. Humans are the most productive factors. This happens when they are able to earn money that gives them both political and financial freedom.
Because of the fact that everyone is free to own assets, companies are able to study the demand of consumers and produce commodities that will satisfy their wants. With the growth of demand, businesses go into the market and compete with one another for the consumer’s patronage and money. This is good because firms get more motivation to produce goods of higher quality and sell at lower prices. Companies will also need to hire more labor and pay them better wages.
Invention and innovation
The idea of capitalism encourages businesses to bring up new business ideas. this will as well encourage efficiency in the market environment. Finding new business ideas and applying them to production processes leads to rapid expansion, more employment opportunities, and greater income. Innovators enjoy the benefits of their research as they bring to existence things that never existed before.
2. Disadvantages of capitalism
Higher-income and wealth inequality
As a result of high competition, businesses will not care for the disadvantaged and less privileged. This class of people includes the aged, disabled, and orphans. This deviates focus from the benefits of society leading to higher income inequality. This is because capitalism bases on self-interest rather than the interest of society. Some businesses can exploit consumers.
It is pleasurable to live in a capitalist society during the period of expansion. When the economy begins to contract, there will be a higher chance of a recession occurring thereby increasing the unemployment rate. Those with higher wealth can withstand this period. This is because they go back to fetch wealth from their reserves to maintain their quality of life. Low-income earners will not have the opportunity to enjoy that luxury.
Sometimes the growth rate is slow even though the capitalist economy works automatically. Even as the economy progresses, there is no complete or all-around development. Some industries tend to develop faster than others.
A capitalist economy can be unstable where there is a recurring business cycle. There are times that economic activities experience a slump. There is a tendency that when prices fall, firms may close down thereby rendering workers unemployed. In essence, capitalism does not always stay on the growth pattern.
Fewer advantages for the low-skilled people
Real capitalism expects people to remain competitive. Competition is needed to remain active in the economy. If you lack the skills in demand, there may be no place for you to exist. Social safety and empowerment programs are not part of the theory. It is either you contribute or you do not. You will face life-threatening experiences when you are not able to contribute. Every individual always looks out for themselves above every other person. There will be less emphasis on social welfare and security.
Requirements for successful consumption
Capitalism is more effective only when consumers spend their money. If consumers decide to save, then there will be struggles to survive as profit is the sole aim and objective. In essence, capitalism requires consumption to be successful to survive.
Ignorance of ongoing opportunities
The capitalist does not define “fairness” the same way as other market systems will. Even though everyone has an equal opportunity to pursue success, some factors can limit this possibility. Those with more money have more chances than those with less money.
Consumerism and environmental costs
We describe the capitalist economic system as the engine of productivity and growth. Though it has pushed the economy to the future, it has led to environmental disasters thereby raising questions pertaining to sustainability. This economic system requires endless production for it to remain stable. It is a true fact that production is highly dependent on consumption. The higher the consumption, the higher the rate of productivity. Higher production is equal to higher sales and this leads to higher profits. Usually, production processes come with effects on the environment.
While capitalism sets one of its goals on cheaper and accessible goods in the short run, it can lead to a long-term impact that is detrimental to the environment. Firms usually ignore environmental pollution and climatic changes in the process of production. while making commodities available at lower prices in the short run, capitalism depletes natural resources in the long run thereby lowering the overall quality of life in society.
Greed while seeking profit
In a capitalist economy, profit comes first but this can lead to greed. Focus on profit tends to make producing firms compete with one another. It does not stop there, they sell their goods at the highest price while keeping their costs low. There is no equal opportunity because the system may not be favorable for those that lack competitive skills.
Therefore, obsession with profits amounts to both social and economic inequality. The group of people controlling production tend to gather more wealth than the employees who contributed to creating that wealth. Workers receive pay that is far below their productivity. Because the rich pass their wealth to their heirs, the rich become richer while the poor get poorer. This economic system widens the gap between the rich and the poor.
It is very possible for a single firm to become dominant in the market since this is a free market. When this thing comes about, a firm can charge any price it wishes to. In this case, consumers will have no other choice but to pay higher prices. This leads to the abuse of monopoly power. When few competitors gain more understanding, they begin to exploit consumers. There are times that larger firms buy over or eliminate the smaller firms. They usually do this in order to establish their supremacy in some specific lines of production. In this instance, when they charge higher prices, they do not face any compulsion or pressure to improve their efficiency in production.
Theoretically, factors of production should be able to graduate from an unprofitable to a profitable business. It is unfortunate that this does not work for the labor force. There usually exists some unemployment. This is because the market mechanism is slow to adjust to changing circumstances. The fluctuations in business have more negative effects on the labor force, resulting in massive unemployment. This usually becomes fatal during economic depressions. In this case, workers will not be able to secure full-time jobs unless during an economic boom.
Usually, capitalists tend not to care about providing social benefits like healthcare and education. Social welfare benefits do not generate profit for the capitalist since profit is his motive. Because of this, the government has to step in to provide these services.
Class conflicts and struggles are inevitable in the capitalist system. The class of people is few while those that do not have are in majority. Because of this, wage earners tend to face exploitation from capitalists. This, in turn, will result in conflicts between the employers and the employees thereby leading to labor unrest. These unrests include strikes, riots, etc. This has a very negative effect on both production and employment.
Socialism is an economic system in which the government is in full ownership and control of all means of production. The economic system is after basic needs rather than being self-centered. Earning personal profits is not the sole aim. Socialism considers basically the needs of society. As a result of this, there is no competition for profit among individuals. They work for the good of everyone. Under socialism, the government has full control over the economy. It is a centrally planned or a command economic system. In a pictorial view, the outcome is classless though not fulfilled.
In a pure socialist economy, the government makes every legal production and distribution as well as other economic decisions.
Under socialism, individuals may possess little property. They do not have the right to own large means of production such as factories or companies. This implies that they cannot employ people to work for them. The attributes of a socialist economy are directly the opposite of capitalism. Since it is a centrally planned economy, the government gives answers to the basic economic problems in the society. That is what to produce, how to produce, for whom to produce, and efficiency in the use of resources. They also decide the price to charge for the goods and services.
The engagement rule under this system is that every individual receives and gives in his effort or contributes according to his ability. This is why individuals in the socialist economy work very hard. When we say that the socialist system works for the good of everyone, it means to take care of people who are not able to contribute to economic development. This set of people includes the children, disabled, less privileged, caretakers, and the elderly.
Examples of socialist countries include;
- Soviet Union
Socialism pros and cons
Absence of exploitation
The government ensures that no one experiences exploitation. Each person receives and contributes according to their potentials. There is guaranteed access to basic necessities for every individual. Those who are not able to contribute especially the disabled also enjoy this access. This, in turn, helps to reduce the level of poverty in the economy. Everyone has an equal right to healthcare and other social welfare.
The fact that those who are unable to contribute also enjoy some level of access to basic needs helps to minimize poverty since everyone is equal. That is, everyone has an equal right to social welfare.
Rejection of discrimination
Since everyone has equal rights, socialism disapproves of discrimination. Under this system, everyone does what he or she is best at with higher pay for those jobs that no one is available to do but yet should be done.
Socialism focuses more on the needs of society. While capitalism bases on production based on the purchasing power of consumers thereby making the poor to be worse off, socialism tries to prevent such happenings. It is a selfless system that bases its production on the basic needs and necessities of the people. The socialist system puts the needs of the people first. There is less reason for people to worry about tomorrow and this leads to an increase in productivity.
Workers under the socialist system are being provided with a conducive working environment to reduce the risks attached to the job as well as creating a comfortable avenue for them. The state takes responsibility for any accident that occurs in the process of one carrying out his job.
Hidden taxes are those taxes on consumer goods. Firms transfer these taxes to consumers without their knowledge. A proper socialist economic system does not have taxes. The government takes everything and pays allowances to the people.
Social justice is of great advantage because it reduces inequalities and facilitates the equitable distribution of national income. Every individual is entitled to his own share of the national wealth as well as equal opportunities. This greatly helps to eliminate exploitation. In other words, there is an equal distribution of wealth and income.
Rapid and balanced economic development
Because this economic system is centrally planned, the state decides promptly and plans the use of resources. By this, the system fosters efficient usage and utilization of resources thereby minimizing wastage. This usually amounts to rapid growth in the economy. A notable example is a development that the USSR made in those early years.
The system makes available balanced economic growth and development. This also means that there is no imbalance in focusing on development. The central planners will not focus on some areas while leaving other areas behind. There is commensurate economic growth and development in all areas.
Minimal exploitation and class conflict
Socialism aims at creating a classless society that fosters equality for every member. The scenario whereby the rich will exploit the poor does not exist. There is no favoritism and discrimination if the government is transparent since everyone is equal. In turn, this eliminates class conflicts and struggles which is prominent in capitalist economies.
Depending on corporate pooling to get things done is a great disadvantage of socialism. Society expects everyone to cooperate without competing with one another. Competitive individuals seem to find ways to cause social catastrophe for their personal interests.
It kills innovation
As a result of the absence of competition, the system discourages innovation. There is no reward for competitors and business ventures under this system. The economic system does not encourage innovation as capitalism does.
No choices and freedom
Unlike capitalism, socialism does not provide choices to the people in terms of the products to purchase as well as the brands. The monopolistic nature of this system coerces people to buy a particular product at a particular price. Also, the system takes away people’s freedom of enterprise and free choice of occupation. It is the central planning committee that assigns jobs to workers and no worker has the right to change his job without the consent of the state.
Lack of incentives
A high progressive taxation rate can cause disincentives to work and set up businesses. Entrepreneurs may have the feeling that the government is taking a high percentage of their profits. This makes most people avoid risk and work abroad instead. Also, for the fact that socialism is against one accumulating wealth for himself, extra efforts will not constitute an added advantage. Because of that, there is no incentive for innovation and hard work.
Though the idea is that the government will succeed in the regulation of every sector in the economy. Government intervention is prone to government failure and inefficient resource allocation. For instance, the regulation of the labor market such as minimizing g or maximizing the working period can lead to unemployment. Lack of flexibility can surface as well. Because the government regulation on firms is high, it discourages investment thereby lowering economic growth and development.
It is difficult to remove subsidies/government benefits.
No suitable basis for calculating cost
Under capitalism, market forces (demand and supply) determine the cost of production as well as the subsequent prices of commodities. Under socialism, this is not the case. The government owns and controls everything, that is the role of an entrepreneur. This means that the means of production do not have a market price. So because of this, there is no suitable basis for calculating the cost of production as well as the price of goods and services.
Capitalism vs Socialism
The basic factor that makes capitalism and socialism similar is the fact that they consider labor and capital as the primary forces of an economy. They both agree with the fact that the world is endowed with diverse natural resources that human labor activates.
Another thing that makes them similar is that they both involve ownership and control of means of production. They both believe in production as a mechanism for improving the standard of living of an economy.
Capitalism and socialism are both economic systems. Despite their differences, they both have a share in promoting economic growth and development.
The opposite of capitalism is socialism and in the political economy, capitalism is preferable against socialism. The basic difference between capitalism and socialism is the ownership as well as the control of the means of production. While under capitalism, private individuals own and control all means of production, under socialism, it is the state/government that owns and controls all means of production. These means of production include property and businesses. We can also look at some visible differences in the aspect of equity, efficiency, and employment. It is
The capitalist economy does not place its concerns on equitable arrangements. Here, the argument states that inequality is the force that drives and encourages innovation thereby pushing economic development. Socialism places its concerns on redistributing wealth and resources from the rich to the poor. This act is out of fairness in order to make sure that there is equality in opportunity and of outcome in place. Socialism values equality above high achievement. Also, the system views the collective good and welfare of the people above the opportunity available for individuals to advance.
Under capitalism, the profit incentive is the factor that drives firms to be innovative and bring in new ideas. Doing this has to be according to the desires of the consumers as well as the demand in the market. On the other hand, many have argued that when the state owns and controls the means of production, there will be inefficiency in the use of resources. This is because workers, management, and developers tend not to put on more effort into bringing in new ideas and products when there is no motivation to earn more money.
The state does not directly hire labor under the capitalist economic system. AS we have seen in the disadvantages, this can lead to unemployment in an event of a recession or economic depression. On the other hand, the state is primarily the employer under the socialist economic system. In cases of economic hardship, the state will be able to order hiring in order to foster full employment. There also seems to be a stronger safety net or protection under socialism for the injured and permanently disabled as well as a conducive working environment. Those who are no longer able to work under the capitalist economy have fewer options available to them.
Under capitalism, there is freedom of consumer choice as well as the freedom of choice of occupation. Also, private individuals have the right to own properties and assets. On the other hand, these features are absent under socialism.
Frequently asked questions
Capitalism is an economic system in which private individuals own and control all means of production. On the other hand, socialism is an economic system in which the government owns and controls all means of production. Basically, the differences lie in who owns and controls all means/factors of production as well as who determines the solutions to the basic economic problems. These problems include what to produce, how to produce, where to produce, for whom to produce, and efficiency in the allocation/use of resources. Also, capitalism permits private ownership of the property while under socialism, this is usually not the case.
Why is capitalism the best?
Capitalism is good because it leads to a more efficient allocation of resources due to competition. Companies want to utilize factor inputs/resources thereby fostering efficient production. There is an incentive to be more innovative and it tends to bring people together to overcome discrimination. Under this, there is freedom of choice, that is consumer choice and choice of occupation. This is because of minimal government control.
People tend to be overdependent on the government since it is the government that controls everything. As a result of the fact that no individual has the right to own resources, the system discourages innovation. No competition and this tends to lead to inefficiency in allocating resources. It does not provide for consumer choices and other choices, it is more restrictive in nature. A suitable basis for calculating cost tends to be absent under this system.
The United States is not a socialist economy, it is a capitalist state. This country is highly entrepreneurial in nature with large industries. This has amounted to rapid growth in their GDP thereby fostering economic growth.
Chyou is a published author who focuses on the field of international business. After an established career facilitating mergers and acquisitions for medium to large corporations, Chyou turned to writing to help students better understand international business concepts.