Capitalism, Its Characteristics, with Pros and Cons

How It Works Compared to Socialism and Communism

Image by Evan Polenghi © The Balance 2019 

Capitalism is an economic system where private entities own the factors of production. The four factors are entrepreneurship, capital goodsnatural resources, and labor. The owners of capital goods, natural resources, and entrepreneurship exercise control through companies. The individual owns his or her labor. The only exception is slavery, where someone else owns a person's labor. Although illegal throughout the entire world, slavery is still widely practiced. 


Capitalistic ownership means two things. First, the owners control the factors of production. Second, they derive their income from their ownership. That gives them the ability to operate their companies efficiently. It also provides them with the incentive to maximize profit. This incentive is why many capitalists say "Greed is good."

In corporations, the shareholders are the owners. Their level of control depends on how many shares they own. The shareholders elect a board of directors. They hire chief executives to manage the company.

Capitalism requires a free market economy to succeed. It distributes goods and services according to the laws of supply and demand. The law of demand says that when demand increases for a particular product, price rises. When competitors realize they can make a higher profit, they increase production. The greater supply reduces prices to a level where only the best competitors remain. 

The owners of supply compete against each other for the highest profit. They sell their goods at the highest possible price while keeping their costs as low as possible. Competition keeps prices moderate and production efficient.

Another component of capitalism is the free operation of the capital markets. That means the laws of supply and demand set fair prices for stocks, bonds, derivatives, currency, and commodities. Capital markets allow companies to raise funds to expand. Companies distribute profits among the owners. They include investors, stockholders, and private owners.

Laissez-faire economic theory says the government should take a "hands-off" approach to capitalism. It should intervene only to maintain a level playing field. The government role is to protect the free market. It should prevent the unfair advantages obtained by monopolies or oligarchies. It ought to prevent manipulation of information, making sure it is distributed equitably.

Part of protecting the market is keeping order with national defense. The government should also maintain infrastructure. It taxes capital gains and income to pay for these goals. Global governmental bodies adjudicate international trade.


Capitalism results in the best products for the best prices. That's because consumers will pay more for what they want the most. Businesses provide what customers want at the highest prices they’ll pay. Prices are kept low by competition among businesses. They make their products as efficient as possible to maximize profit.

Most important for economic growth is capitalism's intrinsic reward for innovation. This includes innovation in more efficient production methods. It also means the innovation of new products. As Steve Jobs said, "You can't just ask customers what they want and then try to give that to them. By the time you get it built, they'll want something new."


Capitalism doesn't provide for those who lack competitive skills. This includes the elderly, children, the developmentally disabled, and caretakers. To keep society functioning, capitalism requires government policies that value the family unit.

Despite the idea of a “level playing field,” capitalism does not promote equality of opportunity. Those without good nutrition, support, and education may never make it to the playing field. Society will never benefit from their valuable skills. 

In the short term, inequality may seem to be in the best interest of capitalism's winners. They have fewer competitive threats. They may also use their power to "rig the system" by creating barriers to entry. For example, they will donate to elected officials who sponsor laws that benefit their industry. They could send their children to private schools while supporting lower taxes for public schools.

In the long term, inequality limits diversity and the innovation it creates. For example, a diverse business team is more able to identify market niches. It can understand the needs of society's minorities, and target products to meet those needs. 

Capitalism ignores external costs, such as pollution and climate change. This makes goods cheaper and more accessible in the short run. But over time, it depletes natural resources, lowers the quality of life in the affected areas, and increases costs for everyone. The government should impose Pigouvian taxes to monetize these external costs and improve the general welfare.

Some critics say these problems are signs of late-stage capitalism. They argue that capitalism's flaws mean it has evolved past its usefulness to society. They don't realize that capitalism's flaws are endemic to the system, regardless of the phase it is in.

America's Founding Fathers included the promotion of general welfare in the Constitution to balance these flaws. It instructed the government to protect the rights of all to pursue their idea of happiness as outlined in the American Dream. It's the government's role to create a level playing field to allow that to happen.

Difference Between Capitalism, Socialism, Communism, and Fascism

Attribute Capitalism Socialism Communism Fascism
Factors of production are owned by: Individuals Everyone Everyone Everyone
Factors of production provide: Profit Usefulness to people Usefulness to people Nation-building
Allocation decided by: Supply and demand Central plan Central plan Central plan
Each gives according to: Market Ability Ability Value to the nation
Each receives according to: Wealth Contribution Need Value to the nation

Capitalism Versus Socialism

Proponents of socialism say their system evolves from capitalism. It improves upon it by providing a direct route between citizens and the goods and services they want. The people as a whole own the factors of production instead of individual business owners.

Many socialistic governments own oil, gas, and other energy-related companies. It’s strategic for a government to control these profitable industries. The government collects the profit instead of corporate taxes on a private oil company. It distributes these profits in government spending programs. These state-owned companies still compete with private ones in the global economy. 

Capitalism Versus Communism

Communism evolves beyond both socialism and capitalism, according to theorists. The government provides everyone with a minimum standard of living. That's guaranteed, regardless of their economic contribution. 

Most societies in the modern world have elements of all three systems. This blend of systems is called a mixed economy. Elements of capitalism also occur in some traditional and command economies. 

Capitalism Versus Fascism

Capitalism and fascism both allow private ownership of businesses. Capitalism gives those owners free rein to produce goods and services demanded by consumers. Fascism follows nationalism, requiring business owners to put national interests first. Companies must follow the orders of the central planners.  

Capitalism and Democracy

Monetarist economist Milton Friedman suggested that democracy can only exist in a capitalistic society. But many countries have socialist economic components and a democratically-elected government. Others are communist but have thriving economies thanks to capitalistic elements. Examples include China and Vietnam. Some others are capitalist and governed by monarchs, oligarchs, or despots.

The United States is mostly capitalistic. The federal government does not own corporations. One important reason is that the U.S. Constitution protects the free market. For example:

  • Article I, Section 8 establishes the protection of innovation through copyright.
  • Article I, Sections 9 and 10 protects free enterprise and freedom of choice. It prohibits states from taxing each other's production.
  • Amendment IV prohibits unreasonable government searches and seizures, thereby protecting private property.
  • Amendment V protects the ownership of private property.
  • Amendment XIV prohibits the government from taking property without due process of law.
  • Amendments IX and X limit the government's power to those outlined explicitly in the Constitution. All other powers not mentioned are conferred to the people.

The Preamble of the Constitution sets forth a goal to "promote the general welfare." It requires the government to take a more significant role than that prescribed by a pure market economy. That's why America has many social safety programs, such as Social Security, food stamps, and Medicare. 


The United States is one example of capitalism, but it's not the best. In fact, it doesn't even rank within the top 10 countries with the freest markets. That's according to both Global Finance Magazine and The Heritage Foundation, a conservative think tank. They based their ranking on nine variables. These include​ a lack of corruption, low debt levels, and protection of property rights. 

The top 10 most capitalistic countries are:

  1. Hong Kong
  2. Singapore
  3. New Zealand
  4. Switzerland
  5. Australia
  6. Ireland
  7. Estonia
  8. United Kingdom
  9. Canada
  10. United Arab Emirates

The United States ranks 18th. Its weak spots are in business freedom and property rights. Its immense national debt also limits fiscal policy. It's created a future tax burden that will restrict taxpayer freedom