Capitalism Requires Government

Without a whole host of government rules, capitalism could not exist. Even regulations and social programs help sustain a market economy by fixing many of its serious social and economic problems.

One of the most common and misleading economic myths in the United States is the idea that the free market is “natural” – that it exists in some natural world, separate from government. In this view, government rules and regulations only “interfere” with the natural beneficial workings of the market. Even the term “free market” implies that it can exist free from government and that it prospers best when government leaves it alone. Nothing could be further from the truth. In reality, a market economy does not exist separate from government – it is very much a product of government rules and regulations. The dirty little secret of our “free” market system is that it would simply not exist as we know it without the presence of an active government that creates and maintains the rules and conditions that allow it to operate efficiently.

Government Rules Make Markets and Capitalism Possible

Markets, like governments, are very much social constructs. The market is a set of behaviors that is structured by rules, and many of the most important rules have been developed and enforced by government. Without these rules, our prized free-market economy would be a stunted and feeble version of what we see today. To see how this is the case, lets looks at these essential “rules” – the vast infrastructure of laws and policies that make a modern capitalist economy possible.

  • Limited Liability Laws. Capitalism requires capital – lots of it. But without limited liability laws, investors are unlikely to risk investing their money in businesses. In the 19th century, before the passing of laws that limited the liability of investors, anyone who put money into a business that then went under could be held liable for the debts of the company. They could have their personal assets seized and could be financially ruined. Needless to say, this discouraged investment. Without limited liability laws, the economy would not have access to the capital it needs to grow and prosper.1
  • Property Rights. Without the right to own property and dispose of it as you wish, capitalism as we know it could not exist. These legal rights are created and protected by the government. Moreover, in the U.S., the federal courts have extended to corporations the same property rights given to citizens. Corporate property rights – one of the main legal instruments that insulate business from government power – can be created and maintained only by government.
  • Law and Order. A market system cannot work well without a functioning criminal justice system. Otherwise, organized crime would easily take over large sectors of the business community. Extortion, bribery, kidnapping, and murder would become the reigning corporate model. Without the rule of law, our economy would resemble the “mafia capitalism” that Russia has suffered from in its transition to capitalism.
  • Bankruptcy Protection. Business is inherently risky and one of the largest risks is business failure, particularly during recessions and depressions. In the 19th century, before the creation of bankruptcy laws, business failures would usually saddle entrepreneurs with large and ongoing debts, making it impossible for them to make a fresh start and often putting them in debtors’ prison. Investors and creditors also often failed to get any of the money due to them. Bankruptcy laws protected otherwise healthy businesses that were temporarily short of funds. And these laws allowed entrepreneurs to be eventually freed from crushing debts. Along with limited liability, bankruptcy rules formed a crucial financial safety net for entrepreneurs. It is important to note, however, that bankruptcy laws were passed not simply out of concern or sympathy for failed entrepreneurs, but also as a way to lessen economic risk and therefore encourage more investment and economic growth.2
  • A Stable Money Supply. Without reliable money, markets would be based primarily on barter and thus be extremely limited. In the U.S., before the Civil War, almost all paper money was issued by private banks – not the government. This was an unreliable and incredibly chaotic system. Sometimes merchants would not even accept certain currencies. It also meant there was no real control over the money supply – which has a crucial impact on inflation and economic growth. Widespread commerce and a stable economy both require a stable and dependable money system – one in which consumers and merchants have faith. This can only be provided and maintained by the federal government.
  • Patents and Copyrights. Large portions of our economy would grind to a halt if the government did not grant patents and copyrights. Without this massive intervention into the free market, the drug, music, publishing, and software industries could not exist. Bill Gates likes to think of himself as a self-made man, but he would not be one of the richest men in the world if the government did not make it illegal for anyone but Microsoft to copy and sell Windows.
  • Banking Regulation and Insurance. As we have seen recently, a capitalist economy depends heavily on stable banks to finance growing businesses. But banks are inherently vulnerable to “runs” – where worried depositors all seek to take out their money at the same time. Banks cannot survive runs because they have loaned out most of the money deposited with them and therefore cannot pay it out to a large number of depositors at once. Before the passage of banking regulations and federal deposit insurance, banks regularly had runs and failed. The main reason that we had no disastrous runs on banks (and money market funds) during the financial panic of 2008 was that government was there to guarantee those deposits.
  • Corporate Charters. Capitalism today is corporate capitalism. But the corporation itself is a creation of government. Corporations can come into being only through charters: the legal instruments by which state governments allow businesses to incorporate. These charters and state business laws define what a corporation is, how it is organized, how it is governed, how long it may exist, who has a say in decision making, the rights of stockholders, the extent of its liability, and so on. Most states also retain the right to revoke the charters of corporations that break the law or harm the public interest, though this power is seldom used these days.
  • Commercial Transaction Laws. Businesses could not operate effectively without laws governing commercial transactions. Few would risk doing business on a wide scale unless there was some way of making and enforcing contracts. Who would sell goods if they couldn’t be sure they would be paid, and who would buy goods if they couldn’t be sure they would receive them? The Uniform Commercial Code is a set of legal rules that determines, among other things, what a valid contract is, how contracts can be enforced, and various remedies for fraud, default, etc. It is over 800 pages long and covers every aspect of commerce in great detail, including laws governing the sales of goods, payment methods, receipts, warrantees, titles, shipping of goods, storage of goods, how sales are financed, and the leasing of goods. It is the legal infrastructure that allows business to be conducted smoothly and reliably.


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