Answer by Balaji Viswanathan:
When you want to buy milk you go to a shop. You provide a bunch of currency and the shopkeeper gives you a bottle of milk. You end up with something you like [milk for your stomach] and the shopkeeper ends up with something he likes [money to buy other things]. Whole of capitalism is centered around making this transaction easy.
At the heart of capitalism that all capitalists hold dear is the concept of "free trade". People should be able to trade freely so that all participants benefit in the transaction.
What should be done for free trade?
- Rule of law: What happens when the shopkeeper cheats you with substandard stuff or in quantity? What happens when the customer cheats with fake money? Legal system in capitalism revolves around contracts and trust.
- Standards: Shopkeeper and you should be able to agree on things. Thus, government standardizes a lot of things – including measurements, currencies and so on. They also make sure no one cheats on these measurements. Thus, a shopkeeper can just look at $1 symbol in the paper the customer gives, while the customer can just take a look at 1L written in the milk can. Neither would need to spend too much time verifying [that would slow the trade].
- Market: When only two people trade stuff, it is very hard to know if you are paying the right amount. When thousands of people trade that way and those transactions are transparently reported, customers could know what others pay and traders would know what others pay and together the price will be fair to both.
- Security: A trader often deals with insecurity as there are elements that would try to steal the stuff. Historically empires grew up to protect traders & trade. To this day, superpowers such as the US war in places like middle east because they are in key trade routes.
- Enable competition: When there are only few traders/businesses, competition will be quite less and customers will be charged more. To avoid customers getting ripped off, capitalism seeks to make trade easy so that anyone could become a trader.
- Private property: Trade happens only when there is a property to be owned. If the shopkeeper doesn't own the milk can and neither can you, there cannot be a trade. You can trade with only what you own.
- Risk taking: The trader has to keep thousands of milk cans and other things so that he could serve a number of customers. That requires huge element of risk taking – also called enterprise.
- Capital formation: As the trader generates profits, he/she would invest most of it in further growth of the business – most of which would benefit both the customer and the owner. Thus, the shop could grow bigger, better lit, with more variety, quality etc.
What about welfare state then?
The core belief in capitalism is that the win-win game that trade enables creates wealth for everyone. Again none of this precludes a welfare state. Nothing in core capitalist works like Adam Smith's "Wealth of Nations" is against the concept of a welfare state.
A state could have a reasonable level of taxation so that no one goes homeless or hungry. This way there is better security for traders and more customers to trade with. As long as that tax level doesn't break trade and doesn't restrict private ownership of property, a welfare state is perfectly fine with the tenets of capitalism.