While everyone has a general idea of what economists mean by the term ‘capitalism’ it is important that we now define it more precisely. Fundamentally, capitalism is an economic system founded on the private ownership of the productive assets within an economy. These include land, labor (including your person), and all other tangible property (e.g., cars, houses, factories, etc.) as well as intangible property (e.g., radio waves, intellectual property, etc.). Individuals are free to make decisions regarding the use of their property, with the sole constraint that they do not infringe upon the property rights of others.

The freedom of action given to private owners under a system of capitalism is why the index that ranks states and countries is called the ‘economic freedom’ index. Economic freedom is synonymous with capitalism. More specifically, the key ingredients of economic freedom and capitalism are:

  • personal choice and accountability for damages to others,
  • voluntary exchange, with unregulated prices negotiated by buyers and sellers,
  • freedom to become an entrepreneur and compete with existing businesses, and
  • protection of persons and property from physical aggression, theft, lawsuits, or confiscation by others, including the government.

The concept of capitalism is deeply rooted in the notions of individual liberty and freedom that underlie our country’s founding and are reflected in the Declaration of Independence and U.S. Constitution. Economic freedoms are based in the same philosophies that support political and civil liberties (like the freedom of speech and the freedom to elect representatives). Individuals have a right to decide how they will use their assets and talents. On the other hand, they do not have a right to the time, talents, and resources of others.

Because private property rights, and their protection, are critical to economic progress, it is worthwhile to be more specific about private property rights. Private property rights entail three economic aspects: (1) control rights – the right to do with your property as you wish, even to exclude others from using it, so long as you do not use your property to infringe on the property rights of someone else; (2) cash flow rights – the right to the income earned from the property or its use (i.e. being the ‘residual claimant,’ which is also critical for enabling the property to be used as collateral for loans); and, (3) transferability rights – the right to sell or divest of your property under the terms and conditions you see fit.

A government policy that weakens any one of these components of property rights weakens property rights in general. Taxes, for example, restrict the cash flow rights associated with property and so weaken private property rights on that dimension. Regulations, on the other hand, restrict how owners may use their property, infringing on control rights, and weakening private property rights on that dimension. Outright takings, or other forms of outright expropriation, by removing the property from an owner’s possession (such as eminent domain, especially when allowing the state to remove the property from an owner’s possession and transfer it to another private owner) actually weaken property rights on all of the dimensions considered above, making property a ‘contingent right’ (contingent on the state’s arbitrary will) rather than an ‘absolute right’ guaranteed and protected by law.

In order to nurture capitalism, government must do some things but refrain from doing others. Governments promote capitalism by establishing a legal structure that provides for the even-handed enforcement of contracts and the protection of individuals and their property from aggressors seeking to use violence, coercion, and fraud to seize things that do not belong to them. However, governments must refrain from actions that weaken private property rights or interfere with personal choice, voluntary exchange, and the freedom of individuals and businesses to compete. When these government actions are substituted for personal choice, economic freedom is reduced. When government protects people and their property, enforces contracts in an unbiased manner, and provides a limited set of ‘public goods’ like roads, flood control, and other major public works projects, but leaves the rest to the private market, they support the institutions of capitalism and the resultant prosperity it creates.

This is an excerpt from The Sources of Economic Growth by Russell S. Sobel and J. Brandon Bolen. It was published in Promoting Prosperity in Mississippi.