What Is Capitalism? Even Conservatives Can’t Explain It

It is a shame that, in the country that invented capitalism, we can’t explain it. Perhaps that is a reason we are losing it to socialism. Ask any conservative, or even an economist, and they are likely to describe it as “free markets.” Barter societies in the Middle East are free markets and they are mired in poverty.

Capitalism is not simply free markets. It is a designed, self-accelerating economic system that reduces prices and poverty. It was gradually designed, in the United States, from 1793 to 1914. Before we can understand capitalism’s benefits, we must define wealth and poverty in comprehensible economic terms.

The wealth of a nation is its amount of usable goods, just as poverty is a lack of usable goods. Poverty in a society is created by a lack of clothes, food, vehicles, housing, etc. If the supply of these usable goods is low, naturally, there is not enough to go around. This creates the divergence of wealthy and poor. It gets worse; those who can afford the limited supply of usable goods bid up the price, creating even more poor. A large supply of usable goods brings prices down so that more people can afford them. As the supply of usable goods rises, poverty declines.

The United States grew to be wealthy because we created far more usable goods than other nations. But how did that happen?

All usable goods are created by manufacturing. It is not the amount of money that manufacturing employees earn that is of value; it is the millions of shirts, hammers, and cars they produce that create wealth in a society.

In 1793, rural people were paupers, living off the land, building log cabins, growing their own food, and wearing buckskins for clothes.

Eli Whitney’s cotton gin accelerated the production of textiles and brought the cost of clothing down so even the poor could afford it. However, it was Whitney’s other invention that ignited the growth of capitalism. It was his creation of a new technical expertise, mechanical engineering, which led to the next generation’s proliferation of other manufacturing machines.

Cyrus McCormick invented the reaper in 1840, but there was an array of business problems that beset him. He was selling a complicated machine to farmers who did not understand it and were not capable of its repair. Broken parts might cost the farmer his crop during harvest. Sales and service were paramount and McCormick could not traverse the territory fast enough.

McCormick solved these problems by designing a unique system, a network of distributors with whom McCormick shared considerable profit. The distributors took over all sales and service. They stocked parts locally and performed repairs. McCormick wisely turned farmers away from direct factory sales by telling them they had to buy from their respective distributor.

McCormick Reapers throughout farm country helped bring food prices down to supply the poorest of households. It was not the reaper that added structure to capitalism, it was his concept to share his profits with others to increase sales -- the distribution system.  

Rural couples were using mail-order catalogues to buy household items direct from factories. Mistakes in ordering and returns were enormous problems, and single orders added to the cost of usable goods because they limited mass production.

Manufacturers of household goods solved these problems by carrying McCormick’s distribution concept one step further. Distribution centers were given a wholesale price so they became profitable businesses, but the manufacturers added an additional discount and layer of profit to include retailers. This created a unique three-tier distribution system (factory, distributor, and retailer). It worked well for household goods.

Distributors were told to send buyers back to the retailers. Because the distributor provided a nearby stock and a retail discount, retail stores became efficient and profitable businesses.

Sales grew exponentially and prices declined. The retail industry expanded to its full capacity because factories were willing to share their profits with retailers, and to protect those profits. Contrary to popular opinion it was the sharing of profits, not greed, that helped create America’s great wealth.

Factory owners had wisely added another innovation of factory recommended retail prices. The wisdom of this was to provide a structure of profits for all who sold their product. It might seem that this would add to the price, but it did the opposite. The resulting high volume of sales resulted in an overwhelming larger drop in product cost. As manufacturing costs fell, the recommend retail pricing was reduced to protect product sales from competition.

Prior to this, women made their own soap, household goods, clothes, and tended crops. Men planted crops, hand-forged steel tools, and built what they needed. Rather than make their own goods, people began to buy them at a local general store. Rural couples were unshackled from the centuries-old life of paupers.

Rural couples wanted more. Factories could not meet the demand. Enter Andrew Carnegie. He recognized the demand for steel from retail-good factories and built his Pittsburgh steel mill in 1873. At Carnegie Steel, he set up a double shift to produce steel 24/7 and provided incentives to the shift that produced the most. He began by walking the floor and paid his workers well. Production far exceeded other producers.

Over the next twenty-five years, Carnegie Steel alone grew to exceed the total production of any country in Europe. His high production facility brought the price of steel down to about a fourth of its previous price.

Factory owners took advantage of the unrestricted supply of steel to supply our nation with everyday usable goods for millions of households. Poverty was declining rapidly. The assembly of complex products however, took time and quality control was always a problem.  

In 1909, Henry Ford  added the innovation of an assembly line to increase production of his Model T cars. The lines used conveyors to bring chassis and parts to the workers. The assembly line brought order to installation of parts. Each worker became expert at the installation of his part. This improved quality considerably. The Model T was long considered the most reliable car built.

More important, production increased from 12½ man-hours per car in 1912 to 1½ man-hours in 1914. With fixed costs and increased production along with volume discounts of his variable costs, the cost per car plunged. The more he made, the lower the price. The price of Henry Ford’s Model T declined from $850 to $260, putting the price well within reach of the average family.

Because sales volume was so high, Henry Ford was able to reduce prices and increase wages. He raised wages to $5 per day, which was more than twice the national average. His distributors were able to do the same. Workers migrated from all over the country to work for Henry Ford.

Henry Ford, one man, employed 100,000 workers. Untold wealth and jobs were created in related industries.

Elsewhere, people born poor would likely end up poor, as would their children. Foreigners named the United States “the land of opportunity.” Our standard of living had risen faster than any nation. Poverty declined to approximate present-day level. Americans had become the wealthiest people on Earth.

Our unique form of capitalism was not simply free markets. It is a designed structure of shared profits which create a self-accelerating economic system that reduces prices, thus reducing poverty.

James T. Moodey is a retired entrepreneur, author, and economic essayist.  His recent book,  The Ladder Out of Poverty, successfully determined why the poverty rate has not declined since the Great Society promised to end poverty.

Image: Public Domain Vectors

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