The Beginnings of Capitalism Theory

A student relying on secondary sources might surmise that the theory of capitalism's dynamism originates in the classical case for competitive markets – a case first made by Adam Smith two centuries ago. This classical thesis was that the presence of many buyers and sellers competing with one another in the marketplace caused wasteful resource allocations to be weeded out “as if by an invisible hand.” Under equilibrium conditions, efficiency in production prevailed. (One person's choice could be expanded only at the expense of another's.) This valuable feature of unimpeded markets, even if not fully realized, could not be matched by a government bureau: there were just too many goods and factors for a central planner to cope with. The point was made against communism by both “market socialism” theorists and capitalism theorists in the interwar years of the twentieth century.

Going farther, Ludwig von Mises, another of the early moderns (and also a champion of capitalism), argued in the early 1920s that market socialism, a new system then beginning to be envisioned, would also fail to match the efficiency of market economies under private ownership. If managers did not receive the profit and bear the risks of their decisions, the resource allocations of socialist competition would be highly inefficient – an argument that effectively founded property-rights theory.