What role does the government play in capitalism?

The proper role of government in a capitalist economic system has been hotly debated for centuries. Unlike socialism, communism or fascism, capitalism does not assume a role for a coercive, centralized public authority. While nearly all economic thinkers and policymakers argue in favor of some level of government influence in the economy, those interventions take place outside of the strictly defined confines of capitalism.

The term "capitalism" was actually made famous by the system's most notorious critic, Karl Marx. In his book Das Kapital, Marx referred to capitalists as those who owned the means of production and employed other laborers in pursuit of profits. Today, capitalism refers to the organization of society under two central tenets: private ownership rights and voluntary trade.

Most modern concepts of private property stem from John Locke's theory of homesteading, in which human beings claim ownership through mixing their labor with unclaimed resources. Once owned, the only legitimate means of transferring property are through trade, gifts, inheritance or wagers. In laissez-faire capitalism, private individuals or firms own economic resources and control their use. (For related reading, see: How are capitalism and private property related?)

Voluntary trade is the mechanism that drives activity in a capitalist system. The owners of resources compete with one another over consumers, who in turn compete with other consumers over goods and services. All of this activity is built into the price system, which balances supply and demand to coordinate the distribution of resources.

These concepts—private ownership and voluntary trade—are antagonistic with the nature of government. Governments are public, not private, institutions. They do not engage voluntarily but rather use taxes, regulations, police and military to pursue objectives that are free of the considerations of capitalism.

Nearly every proponent of capitalism supports some level of government influence in the economy. The only exceptions are anarcho-capitalists, who believe that all of the functions of the state can and should be privatized and exposed to market forces. Classical liberals, libertarians and minarchists argue that capitalism is the best system of distributing resources, but that the government must exist in order to protect private property rights through the military, police and courts.

In the United States, most economists are identified as Keynesian, Chicago-school or classical liberal. Keynesian economists believe that capitalism largely works, but macroeconomic forces within the business cycle require government intervention to help smooth it out. They support fiscal and monetary policy, as well as other regulations on certain business activities. Chicago-school economists tend to support a mild use of monetary policy and a lower level of regulation.

In terms of political economy, capitalism is often pitted against socialism. Under socialism, the state owns the means of production and attempts to direct economic activity towards politically identified goals. Many modern European economies are a blend of socialism and capitalism, although their structure is generally closer to the fascist concepts of public/private partnership with a planned economy.

(For related reading, see: Main Characteristics of Capitalist Economies.)