How Capitalism Distributes Risk

One of the defining features of capitalism is risk. Risk is starting a new business or investing in somebody else’s. It’s taking out a loan for school or work, betting that you can pay it back. It’s deciding to spend money on a home or a business space, even though the real estate market or severe weather could take it all away. While other economic systems seek to eliminate risk and build safety nets for all, capitalism seems to revel in risk.

But – while not a perfect system – capitalism has developed some rather ingenious ways of managing risk.

Insurance: capitalism’s answer to risk

In other economic systems, people are protected by a government or another large entity holding the money. If property is held in common – as in theoretical communism – or by the government, then you’ll be protected when the house you live in burns down or is flooded. You can move into another one (they all belong to everyone, after all), or the government will give you a new one – in theory, at least.

But capitalism also has an answer to this risk: insurance. As in the other systems, resources are pooled and then doled out to those who need it. In insurance, though, participation is voluntary – and the insurance company makes a profit.

The trick, of course, is that you need to pay for insurance. Nothing is free in capitalism, and the onus is on the homeowner to get insurance that covers mold remediation or fire or flooding, and to keep those insurance bills paid up so that the coverage is there if and when it is needed.

In many Western countries, insurance has become tied up with the law. In some cases, this socializes a capitalist solution: subsidized health insurance solutions in the United States, for instance, or the way that many countries mandate that drivers have car insurance in order to register their car.

In other cases, the capitalist methods have leaked into government regulatory laws. Take, for instance, public official bonds. These bonds are all about government and public officials’ duty to uphold their office. But the solution is a very capitalist one: a form of surety bond, which is essentially a type of insurance.

Other ways of spreading risk

If capitalism shows us a sort of “natural state” of the economy, then it’s encouraging to see that our natural inclinations lead us to share risk. While risk is still a staple of investing, the free market has created ingenious ways to reduce risk. For instance, mutual funds allow us to invest in lots of companies at once, spreading out the risk. Then there are index funds, which behave similarly.

Capitalism is a risky business, but it’s clear that we humans would prefer to minimize risk and maximize gain. Capitalism has its own way of doing this, and through free markets as well as government intervention, our imperfect system has shown an incredible ability to adapt to risks and minimize them.

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