How capitalism differs from central planning

In basically capitalist systems, private decision-makers determine how resources will be used, what mix of goods and services will be produced, and how goods and services will be distributed among the members of society. Capitalism is frequently known as free enterprise or modified free enterprise because it permits people to engage in economic activities largely free from government control. Other names sometimes applied to basically capitalist systems are free market systems, laissez faire systems, and entrepreneurial systems. In systems based on central planning, the government makes most major economic decisions. Government planners tell managers what to produce, whom to sell it to, and what price to charge. Centrally planned economies are often called command economies.

The root of the word capitalism is capital. Capital has several meanings in economics and business. In business, it refers to the money needed to hire workers, buy materials, and pay bills. In economics, capital includes buildings, equipment, machinery, roads, and other assets used to produce things. In basically capitalist systems, most land, factories, and other capital is privately owned. In systems based on central planning, the government owns most of the capital used in production.

History of capitalism

From the 1400's to the 1700's, the major European trading nations used an economic system known as mercantilism. Under this system, governments regulated their economic affairs to ensure that exports exceeded imports. They placed high tariffs on imported goods to make them cost more at home, and gave financial aid to local farms and industries so they could lower the prices of their exports. Nations enriched their treasuries by selling more goods than they bought.

The development of capitalism. During the mid-1700's, a group of French economists known as physiocrats urged governments to stop interfering in foreign trade. Their policy, called laissez faire—a French phrase meaning allow to do—demanded an end to tariffs and other trade restrictions.

Adam Smith also argued that a nation could increase its wealth most rapidly by allowing free trade. He believed that people who followed their economic best interests would automatically act in the economic best interest of society. In The Wealth of Nations, Smith described how laissez faire should work. His ideas first became influential during the early 1800's. During that period, the British government began to remove its mercantilist controls and to develop the first capitalist economy. Capitalism soon spread to other major trading nations.

Changing attitudes toward capitalism began to develop in the 1800's, when new technology in industrialized nations helped create many new products. The increased production brought prosperity to many businesses. But problems also developed. Several depressions occurred. In addition, many workers earned low wages and labored under bad conditions.

As a result of these developments, the German social philosopher Karl Marx claimed that laissez-faire capitalism would be destroyed. He predicted that owners of businesses would become wealthier while their workers grew poorer. Finally, the workers would overthrow the capitalist system. Marx was wrong in predicting that workers in capitalist economies would not share in rising standards of living. However, his ideas influenced the revolutions that led to the introduction of Communism in Russia in 1917 and in China in 1949.

Capitalism faced its most serious challenge during the Great Depression, a worldwide business slump that began in 1929. During the 1930's, many banks, factories, and stores closed. Millions of people lost their jobs, homes, and savings. Many also lost faith in capitalism, and political leaders sought new economic theories. As a result, the British economist John Maynard Keynes gained notice. In his book The General Theory of Employment, Interest and Money (1936), Keynes, though neither a socialist nor a Communist, rejected the traditional capitalists' belief that government should keep out of economic affairs. He said a nation's level of economic activity depends on the total spending of consumers, business, and government. Keynes urged increased government spending to fight the depression. The Great Depression lasted until the early 1940's, when huge amounts of government military spending for World War II (1939-1945) finally stimulated the world economy.

Capitalism in former Communist nations. Communist governments were established in much of Eastern Europe after World War II. But in the 1980's, the centrally planned economies of Eastern Europe and the Soviet Union began to crumble. In 1989, non-Communist governments came to power in several Eastern European lands. In 1991, the Soviet Union broke apart into Russia and 14 other independent nations.

During the 1990's, Russia and the other formerly Communist lands struggled to build capitalist institutions. They worked to lift government price controls, to increase private ownership of business, and to shift economic decision-making from the government to households and private companies.