The origins of capitalism: a privilege with a purpose

The idea of responsible capitalism is topical, and its merits widely debated today, but it isn’t a new concept. Taking a look back at the origins of capitalism shows us that it has roots in a social contract with a sense of purpose. With roots like these, there’s great opportunity for advisers to help their clients embrace healthy and responsible capitalism to address today’s urgent challenges.  

17 August 2022

The pace may have accelerated in recent years, but the world has been in a period of rapid change since the start of the industrial revolution some 200 years ago. The transition to heavy fossil fuel use and electrification has created a scale of economic activity that would’ve been unimaginable then. But none of this would have been possible without the rise of something far more subtle: a legal structure – the corporation.

We take corporations for granted, but this vital ingredient of capitalism — that of a separate legal personality – has a long history. In the UK, it was originally religious orders that benefitted from this separate legal identity, given from concession by the Crown. So from their origins, corporations held a privileged position, and one that was granted for a higher purpose.

By the 18th century, the ability to form a company had become the gift of Parliament, and these corporate entities finally gained a foothold with the passing of the Joint Stock Companies Act of 1844.

But importantly, the risks of these enterprises were still shared. Their members were still liable for all the company’s debts. The logical extension of granting a company legal personality — for example, its own name, capacity to be sued and to make investments — is that everything it makes, profits and losses, should be in its own name also. But then came the crucial development: limited liability.

Increasing freedoms

This was when the world really changed. Not with the discovery of penicillin, nor the invention of the microchip, nor the internet, but with the passing of the Limited Liability Act 1855. This was the moment capitalism really took off.

The granting of limited liability to a wider class of companies in 1855 saw the introduction of labels such as 'Ltd' in the UK — that which we take merely as an identifier was originally intended as a warning label, a caution that in dealing with the organisation, the members’ liabilities were limited. Once its assets are exhausted, those owed money cannot pursue the individual members.

A company limited by shares means each investor has limited their liability to the size of their investment. It’s this limited liability — not being jointly and severally liable for the whole of the endeavour — which delivers the crucial freedom to entrepreneurialism and ambition.

Using private capital for public good

With downsides limited, companies were released to invest in nascent technologies, harnessing private capital to produce public goods. Take for example an electricity network. A sole trader wouldn’t invest in a power station, lay down cables and find enough customers — there aren’t enough hours in the day, nor a lender willing to entrust the large sums required to a one-man band.

But where a partnership might feasibly be able to deliver something workable, for a small proportion of an area, a utility grid for electricity requires a drastically bigger scale of investment, deliverable by corporations. Through limiting liability, you unleash innovation and risk-taking with the result that, in the right regulatory environment, tremendous society-level benefits are achieved.

Great strides have been made in transport, electrification, communication, internet access, hygiene and healthcare, reducing child mortality, lifting people out of crippling poverty, increasing life expectancy and many other areas. They were all made possible by capitalism.

Where do we go from here?

Adam Smith, known as The Father of Economics, was an early proponent of the tremendous gains to be made when individuals specialise, while also recognising that once that happens, they become mutually dependent. So companies play a vital role in coordinating and providing incentives for economic activity.

But Adam Smith also warned that limited liability could enable short-termism and excessive risk-taking if corporate managers didn’t take the same care they would with their own cash. For similar reasons, capitalism today is not functioning as it should; we know it doesn’t always allocate capital to the most useful areas. For example, harmful emissions causing health problems and climate change are allowed to continue because the damage caused is not fully included in the price of the products.

Free market capitalism in its current form is under pressure. The banners at Extinction Rebellion protests call for “system change, not climate change”.

We’re not saying that capitalism is perfect. But we do believe that in its proper form, with due regard to long-term influences and a connection to its societal purpose, capitalism can drive human success and a flourishing planet like no other system.

Yes, it’s messy, but we believe investing in firms with a solid purpose can deliver benefits to society as well as maximising returns to shareholders. Capitalism has a future if it reconnects with this founding purpose – and if shareholders are encouraged to act with a view to the longer term. Societal problems and investment returns are intimately linked; the solutions for society and investors are one and the same.

We have further to go, but we are committed to doing our bit for responsible capitalism. We see this as a crucial aspect of helping clients invest for the future. The Business and Sustainable Development Commission estimates that achieving the UN Sustainable Development Goals will create at least US$12 trillion in market opportunities. We need a responsible investing approach to ensure that we don’t diminish the investment returns of tomorrow, which are intimately linked to the investment decisions of today.

You can find more on the subject of responsible capitalism at our dedicated hub.

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