Two developments paved the way for the emergence of modern capitalism; both took place in the latter half of the 18th century. The first was the appearance of the physiocrats in France after 1750; and the second was the devastating impact that the id eas of Adam Smith had on the principles and practice of mercantilism.
The Doctrine of Adam Smith
The ideas of Adam Smith represented more than just the first systematic treatise on economics; they were a frontal attack on the doctrines of mercantilism. Like the physiocrats, Smith tried to show the existence of a “natural” economic order, one tha t would function most efficiently if the state played a highly limited role. Unlike the physiocrats, however, Smith did not believe that industry was unproductive or that only the agricultural sector was capable of producing a surplus above the subsi stence needs of society. Rather, Smith saw in the division of labor and the extension of markets almost limitless possibilities for society to expand its wealth through manufacture and trade.
Thus, both the physiocrats and Smith contributed to the belief that the economic powers of governments should be limited and that there existed a natural order of liberty applicable to the economy. It was Smith, however, far more than the physiocrats , who opened the way for industrialization and the emergence of modern capitalism in the 19th century.
The Rise of Industrialization
The ideas of Smith and the physiocrats provided the ideological and intellectual background for the Industrial Revolution—the material side of the sweeping transformations in society and the world that characterized the 19th century. No precise date can be given for this “revolution”; it is generally conceded to have begun in the late 18th century.
The fundamental characteristic of the industrialization process was the introduction of mechanical power (originally steam) to replace human and animal power in the production of goods and services. As the mechanization of production gained momentum in England and gradually spread to other parts of the world, several fundamental changes occurred. Production became more specialized and concentrated in larger units, called factories. The artisans and small shops of the 18th century did not disappear, but they were relegated to the periphery of economic activity in the leading nations, especially in England, the United States, and Germany. The modern working class began to emerge; workers no longer owned their tools, they had little property, and generally they had to exchange their labor for a money wage. The application of mechanical power to production brought with it a great increase in worker efficiency, which made goods abundant and cheap. Consequently, the real standard of living r ose throughout much of the world during the 19th century.
The development of industrial capitalism had serious human costs. The early days of the Industrial Revolution were marred by appalling conditions for large numbers of workers, especially in England. Abusive child labor, long working hours, and danger ous and unhealthy workplaces were common. These conditions led Karl Marx, who spent most of his adult life in England, to produce his massive indictment of the capitalistic system, Das Kapital (3 vol., 1867-94). Marx’s work, which is the intellectual foundation for the kind of Communist economic systems used in the USSR and still in use in China, struck at the fundamental principle of capitalism private ownership of the means of production. Marx believed that land and capital should be owned collectively (that is, by society) and that the products of the system should be distributed according to need.
Capitalism was also beset by cycles of “boom and bust,” periods of expansion and prosperity followed by economic collapse and waves of unemployment. The classical economists who refined the ideas of Adam Smith had no ready explanation for the ups and downs of economic life, being content to view such cycles as the inevitab le price that society had to pay for the material progress experienced under capitalism. Marxian criticisms, along with frequent depressions in the major capitalist nations, he lped to establish vigorous trade-union movements that fought to raise wages, shorten working hours, and improve working conditions.
In the late 19th century, especially in the United States, the modern corporation, with its limited liability and immense financial power, began to emerge as the dominant form of business organization. The tendency toward corporate control of manufac turing led to many attempts to create combines, monopolies, or trusts that could control an entire industry. Eventually, the public outcry against such practices was great enough in the U.S. to lead Congress to pass antitrust legislation. This legisl ation attempted to make the pursuit of monopoly by business illegal, using the power of the state to force at least a bare minimum of competition in industry and commerce. The antitrust laws never succeeded in restoring to industry the competition of many small businesses that Adam Smith had envisaged, but it did impede the worst tendencies toward creating monopolies and restraining trade.
Despite such difficulties, capitalism continued to expand and prosper almost without limit throughout the 19th century. It was successful because it demonstrated an enormous ability to create new wealth and to raise the real standard of living for nearly everyone touched by it. As the century closed, capitalism was the dominant economic and social system.
For most of the 20th century capitalism has been buffeted by wars, revolution, and depression. World War I brought revolution and a Marxist-based communism to Russia. The war also spawned the Nazi system in Germany, a malevolent mixture of capitalism and state socialism, brought together in a regime whose violence and expansionism eventually pushed the world into another major conflict. In the aftermath of World War II, Communist economic systems took hold in China and Eastern Europe. However, a s the cold war came to an end in the 1980s and the former Soviet-bloc nations turned to free enterprise (though with mixed success at first), China was the only major power to retain a Marxist regime. Many of the developing nations, strongly influenced by Marxist ideas in the early postcolonial period, turned to a modified form of capitalism in their search for answers to economic problems. In the industrial democracies of Western Europe and North America, the sharpest challenge to capitalism came in the 1930s. The Great Depression was by far the most severe economic upheaval endured by modern capitalism since its beginnings in the 18th century. Contrary to the logic of Marx’s prophecy, however, Western nations failed to collapse into revolution. Rather, in meeting the challenge of the Depression, these capitalist systems demonstrated remarkable abilities for survival and adaptability to change. Democratic governments began to intervene in the economy to correct the worst abuses inherent in capitalism.
In the U.S., for example, the New Deal administration of President Franklin D. Roosevelt restructured the financial system so as to prevent a repeat of the speculative excesses that had led to financial collapse in 1929. Action was taken to encourage collective bargaining and build a strong labor movement in order to offset the concentration of economic power in large industrial corporations. The foundation for the modern welfare state was laid through the introduction of social security and une mployment insurance, measures designed to protect people from the economic hazards endemic to a capitalist system.
The most important intellectual event in the development of contemporary capitalism was the publication by the British economist John Maynard Keynes of General Theory of Employment, Interest and Money (1936). Like Adam Smith’s ideas from an earlier era, Keynes’s thought profoundly affected the way in which capitalism worked in Western democracies.
Keynes demonstrated that it is possible for a modern government to use its powers to spend money, vary taxes, and control the money supply in ways that can dampen down, if not eliminate, the age-old curse of capitalism cycles of “boom and bust.” Acco rding to Keynes, in a depression, government should increase its spending, even at the cost of unbalanced budgets, to offset the decline in private spending. The process should be reversed if a boom threatens to get out of hand, leading to excessive speculation and inflation. The Keynesian viewpoint became incorporated into U.S. law when Congress passed the Employment Act of 1946. This act, which committed the American government to maintaining high levels of employment and production, is a lega l landmark representing the formal abandonment of laissez-faire as national policy.
Outlook for the Future
For 25 years after World War II the mixture of Keynesian ideas with traditional forms of capitalism proved extraordinarily successful. Western capitalist countries, including the defeated nations of World War II, enjoyed nearly uninterrupted growth, low rates of inflation, and rising living standards. Beginning in the late 1960s, however, inflation erupted nearly everywhere, and unemployment rose. In most capitalist countries the Keynesian formulas apparently no longer worked. Critical shortages and rising costs of energy, especially petroleum, played a major role in this change. New demands imposed on the economic system included ending environmental pollution, extending equal opportunities and rewards to women and minorities, and coping w ith the social costs of unsafe products and working conditions. At the same time, social-welfare spending by governments continued to grow; in the U.S., these expenditures (along with those for defense) account for the overwhelming proportion of all federal spending.
The current situation needs to be seen in the perspective of the long history of capitalism, particularly its extraordinary versatility and flexibility. The events of this century, especially since the Great Depression, show that modified “mixed” or “welfare” capitalism has succeeded in building a floor under the economy. It has so far been able to prevent economic downturns from gaining enough momentum to bring about a collapse of the magnitude of the 1930s. This is no small accomplishment, and it has been achieved without the surrender of personal liberty or political democracy.
The inflation of the 1970s came to an end in the early 1980s, mainly because of two developments. First, restrictive monetary and fiscal policies led in 1981-82 to a deep recession, both in the U.S. and in Western Europe. As unemployment rose, inflation slowed. Second, energy prices dropped as worldwide oil consumption moderated. In the mid- 1980s most Western economies recovered from the recession, but then the stock market crashes of 1987 introduced a new period of financial instability. Economic growth slowed, and many nations—in particular the U.S., where the national, corporate, and personal debt had reached record levels—dropped into recession, with rising unemployment, in the early 1990s.
The elusive goal for capitalist nations is to secure, simultaneously, high employment and stable prices. This is a formidable task, but given the historical flexibility of capitalism, the goal is both reasonable and attainable.