In capitalism, all management, labor and profits are privately controlled. In a socialist economy, however, businesses are owned and run by the government, and the workers are employees of the government. The U.S. national health care system is run based on capitalist principles. However, the Veterans Affairs (VA) health care system is an example of a socialist program. The facilities are operated by the government, and the doctors and nurses who work there are employed by the VA, which is funded by the federal budget.1
How Does a Capitalist Economy Work?
One of the hallmarks of capitalism is that it is dominated by a free market in which companies are permitted to dictate prices, and spending for production and overhead are controlled by the business owners. Public companies are required to have a board of members who provide guidance and oversight, but otherwise, there are no limiting factors. Companies are free to make decisions that will increase profits and determine how those profits are used.
For investors, it’s important to thoroughly vet a company before making a significant stock allocation to a portfolio. Public companies file earnings updates and are required to issue annual reports to their shareholders, but there is still limited transparency as to their operations. In other words, it’s a big job to research each company for investment purposes, which is why it’s important to work with a trusted financial professional. We may recommend specific holdings to match your goals, but we also may recommend broad diversification via mutual funds, exchange-traded funds (ETFs) or other vehicles to help manage your risk. If you’d like to learn more, please give us a call.
How Competition Impacts Capitalism
Within a capitalist economy, a key factor that inherently curbs greedy business practices is competition. When there are many competitors within an industry, businesses must work to generate a quality product, maintain low production costs and charge reasonable prices to compete for customers. When capitalism works efficiently, it is driven by the economic forces of supply and demand. When supplies are plentiful, prices drop. When they become scarce, higher demand forces prices to rise. At that point, companies tend to increase production to take advantage of higher prices, but as the product floods the market, prices decline again.2
Therefore, competition is a key ingredient to capitalism — it keeps corporate greed in check and encourages competitive pricing and responsible management for a company to remain viable.
It is important to note that one way public companies reduce operational costs is through industry consolidation. Merging or acquiring one or more competitors accomplishes two important goals: streamlining operations and reducing competition. Unfortunately, without strong competitors, industry leaders can charge whatever they want for their products — even if they have successfully reduced costs. The lack of competition is what thwarts the inherent principles of capitalism and makes it inefficient for consumers and, in many cases, for employees and even shareholders.
Perhaps the most abhorrent example of capitalism gone awry is the case of Martin Shkreli. As a hedge fund manager who took the reins of a pharmaceutical company, Shkreli raised the price of a $13.50 life-saving medication to $750.3
In recent years, U.S. corporations have been consolidating at a record rate. Presently, more than three-quarters of the nation’s industries are now controlled by a small number of very large competitors. For example, in a small town with only a few employers, it’s nearly impossible for local workers to negotiate higher wages because they have no leverage. Furthermore, since they have few competitors, large companies can charge prices that are significantly higher than the cost of production, thus increasing their profit margins. According to a recent report, the lack of competition in the U.S. has increased consumer prices without a comparable increase in labor wages. The ensuing cost to median households is about $5,000 per year.4
The latest issues related to labor shortages also are wrapped up in the attributes of capitalism. Antitrust law watchdogs say that companies insisting on no-poach agreements (competitors agree not to hire each others’ workers) and non-compete agreements (workers agree not to work for competitors) serve to control the capitalist principles of labor supply and demand. These agreements impede workers’ abilities to negotiate higher wages and lift income standards for the overall labor pool.5
Another problem with industry consolidation is that it hinders innovation, which often emerges among smaller start-ups. However, when entrepreneurs with a new, big idea are unable to compete against larger competitors, they either fail or their inventions are acquired by larger companies. In this aspect, the forces of capitalism may serve to inhibit rather than stimulate new innovation.
Content prepared by Kara Stefan Communications.
1 Trisha Torrey. VeryWellHealth. Feb. 28, 2020. “How Socialized Medicine Works.” https://www.verywellhealth.com/what-is-socialized-medicine-2615267. Accessed Oct. 5, 2021.
2 Kimberly Amadeo. The Balance. Aug. 26, 2021. “What Is Capitalism?” https://www.thebalance.com/capitalism-characteristics-examples-pros-cons-3305588. Accessed Oct. 5, 2021.
3 Andrew Lisa. GOBankingRates. Sept. 30, 2021. “What Exactly Is Capitalism, and How Does It Affect You?” https://www.gobankingrates.com/money/economy/what-exactly-is-capitalism-and-how-does-it-affect-you/. Accessed Oct. 5, 2021.
4 The White House. 2021. “White House Competition Council.” https://www.whitehouse.gov/competition/. Accessed Oct. 5, 2021.
5 Diane Bartz. Reuters. Oct. 1, 2021. “U.S. antitrust official says competition in labor markets a top concern.” https://www.reuters.com/world/us/us-antitrust-official-says-competition-labor-markets-top-concern-2021-10-01/. Accessed Oct. 5, 2021.
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