Meanings of the Word Capitalism

Idols of Capitalism in front of the Frankfurt Stock Exchange, Germany, a high temple of Capitalism
Wikimedia Commons/Eva K.

Since we looked at the various meanings people give to the word ‘socialism’ in my last post, I should be balanced and examine various meanings given to its antonym, ‘capitalism‘. At least most people consider the words to be antonyms, although some crazy troglodytes who praise the virtues of “state capitalism” might disagree.  Although there might be universal agreement on the technical definition of ‘capitalism’, many people disagree passionately, bitterly, and on some historical occasions violently on the exact implications of that definition. Let us take a look at the dictionary definition from the New Oxford American Dictionary.

Capitalism: an economic and political system in which a country’s trade and industry are controlled by private owners for profit, rather than by the state.

What then are the implications of this definition for human society?

Basic Critiques of Capitalism

What is controversial about capitalism is that the means for producing wealth (industry) and its distribution (trade) are not in the hands of the state, but are controlled by private individuals and groups of individuals (the owners).  Even worse in the eyes of many, this control is exercised for the purpose of making a profit! Aversion to such a social organization appears in part to be generated from the emphasis of many religions on self-denial or self-sacrifice. In preaching the messages from God to his peoples (or if you will, from religious leaders to their followers), religions had truly excellent reasons to emphasize self-sacrifice. The natural motivation for individuals without societal restraints is to look primarily for their own material well being and for their families (and perhaps their friends). It is not for nothing that greed, lust, and gluttony are among the seven deadly sins of Christians.

Similar ideas can be found in many religions, including Islam, Judaism, Buddhism, Hinduism, and Shinto. All civilized societies have an absolute need for constraints on individual behavior to prevent destructive individual behavior from tearing society apart. Historically, such constraints were provided by religions and enforced by both the religions and secular authority, which sometimes were one and the same. One such constraint would be that the elite (or nobility) of a society should not unjustly aggrandize themselves at the expense of their workers (or serfs), but should grant them a comfortable living.

In addition, historical experience includes many periods when a nobility oppressed a majority of people, who were subjugated as subjects of the nobility. It is only natural for socialists to try to map these kinds of relationships, say, from medieval Europe to Europe and the United States during the Industrial Revolution and afterwards. The owners and managers of companies become the new nobility, while the workers become the new serfdom. A sense of oppression where the fruits of the workers’ labor are mostly taken by the owner-nobility leads to a call for the socialization of the means of producing and distributing wealth.

Elites Dominate Economic Output in Capitalism?

One of the first fruits of this sense of oppression during the Industrial Revolution was Malthus’ Iron Law of Wages, often attributed to David Ricardo, which turned out not to be an economic law at all. The so-called law asserted that over time, wages would be driven to a subsistence level. According to Malthus’ demographic theory, population increases when wages are above a subsistence level. [Workers will then breed like rabbits, don’cha know!] If the economy’s output increases slower than the extra subsistence cost for new population, the value of wages for a larger population would have to fall. Clearly, wages could not fall below a subsistence level, since then the workers would starve to death and could not work. As a result the population is driven to a constant number, the maximum that can be supported with all workers at a subsistence wage.

There are at least three reasons why the Iron Law of Wages turns out not to be a law of economics. The first is that workers will not always breed like rabbits if given a wage above the subsistence level. In economically underdeveloped countries this premise of high fertility is in fact true, since in a poor country with high infant mortality, having a lot of children is the poor man’s social security; with high fertility at least some of the children will survive to support the parents in their old age. As countries become wealthier, modern health care and birth control together with retirement plans (government social security, equivalents to 401Ks and IRAs, etc,) greatly reduce the motivation to have large numbers of children. The second reason is technology has greatly increased labor productivity since Malthus’ time, so that economic output has increased faster than the cost of a growing population. Third, the need for skilled labor has caused companies to compete with each other for that scarce resource. Because of the law of supply and demand and the law of marginal utility, wages relative to the wages of earlier times have been driven up.

Recently Thomas Piketty, a French economist, has offered a celebrated theorem that can be regarded as a modern-day equivalent of the Iron Law of Wages. In a best-selling book entitled Capital in the Twenty-First Century, he argued that the return on capital – such things as

property, stocks, and bonds – will rise faster than economic growth over time. Economic inequality would then rise as the economy’s output goes preferentially to the rich owners of capital. Presumably, those who do not own capital will be driven toward subsistence wages as an ever larger fraction of the economy is accumulated by owners of capital. Clearly a new justification for socialism can be seen in Piketty’s theorem.

Piketty’s theorem has been vigorously challenged by a large number of economists and journalists. Three of the most interesting and most widely discussed criticisms were offered by an economics graduate student at the Massachusetts Institute of Technology, Matt Rognlie.

One is not original, having already been made by James Hamilton at the University of California-San Diego and by Benjamin Bridgman of the Bureau of Economic Analysis. This criticism is that Piketty does not note that as capitalists accumulate more machines, buildings, computers, etc., they must also spend ever more on replacement investments to maintain them. Rognlie (and Hamilton and Bridgman) has noticed that this replacement cost has been increasing with time. Because Piketty does not take depreciation into account – that much of the new income to capitalists must be immediately used for capital replacements – he overestimates the new income to capitalists.

A second criticism is that much of the new income for capitalists comes from capital gains in the stock market, rather than from company incomes paid out as dividends or increases in the book value of the company. This makes new income from the economy’s output much more modest.

The third criticism is the most interesting of all. One of the forms of capital is the land a capitalist owns, and over the period of Piketty’s study (around 250 years!), Rognlie has noticed almost all of the returns to capital have come from the increasing value of land. This reduces Piketty’s estimate of increasing income to capitalists from economic output even further.

Yet another criticism for Piketty is that as ordinary workers gain increasing wealth in their 401K accounts, they themselves become capitalists gaining  the increasing returns from capital.

Why Capitalism Is Not Guilty of the Socialist Accusation

While I find it hard to dispute the origins of capitalism from the roots of medieval serfdom, one can certainly disagree that employer-employee relationships are fundamentally oppressive and feudal in nature. Of course this is precisely what modern day socialists such as Bernie Sanders claim. In a recent Democratic Party debate last October, he declared, “Do I consider myself part of the casino capitalist process by which so few have so much and so many have so little, by which Wall Street’s greed and recklessness wrecked this economy? No, I don’t.” On another occasion he said

Ninety-nine percent of all new income generated today goes to the top 1 percent. Top one-tenth of 1 percent owns as much as wealth as the bottom 90 percent. Does anybody think that that is the kind of economy this country should have? Do we think it’s moral? So to my mind, if you have seen a massive transfer of wealth from the middle class to the top one-tenth of 1 percent, you know what, we’ve got to transfer that back if we’re going to have a vibrant middle class. And you do that in a lot of ways. Certainly one way is tax policy.

A criticism of Sanders’ statistics is surprisingly difficult, given such facts as there is no such thing as the 99% and the 1%; the membership in both groups is highly fluid. A study by sociologists Thomas Hirschl of Cornell University and Mark Rank of Washington University has shown that Americans on average reside in many different income brackets during different parts of their lives. For example 70% of the population will be within the top 20th income percentile for at least one year; 53% will be within the top 10th percentile of income; and 11.1% will be in the much-discussed 1% for at least one year of their lives. In terms of income, ours is a highly mobile population! For now I would just note Sanders believes that in our semi-capitalist country, a capitalist minority oppresses the feudal masses.

In making such a claim socialists have to ignore a great amount of intervening history from medieval times to the present, especially the Enlightenment, as well as social changes generated by the Industrial Revolution. The Age of Enlightenment in Europe was marked by values of maximizing liberty for the people in general, with the understanding of the meaning of liberty as given by John Locke (1632-1704).

In his book Two Treatises on Government, Locke writes

In the state of nature, liberty consists of being free from any superior power on Earth. People are not under the will or lawmaking authority of others but have only the law of nature for their rule. In political society, liberty consists of being under no other lawmaking power except that established by consent in the commonwealth. People are free from the dominion of any will or legal restraint apart from that enacted by their own constituted lawmaking power according to the trust put in it. Thus, freedom is not as Sir Robert Filmer defines it: ‘A liberty for everyone to do what he likes, to live as he pleases, and not to be tied by any laws.’ Freedom is constrained by laws in both the state of nature and political society. Freedom of nature is to be under no other restraint but the law of nature. Freedom of people under government is to be under no restraint apart from standing rules to live by that are common to everyone in the society and made by the lawmaking power established in it. Persons have a right or liberty to (1) follow their own will in all things that the law has not prohibited and (2) not be subject to the inconstant, uncertain, unknown, and arbitrary wills of others.

While Locke leaves open the limitation of a person’s freedom of action through the lawmaking power of the state, the individual should otherwise not be limited in his actions, and the extent to which the individual was bound by law, all others should be limited to the same extent. Nevertheless, the spirit of the time was to limit government and maximize personal liberty. One of the most important products of the Enlightenment was the American Revolution giving birth to the U.S. Constitution.

It is this aspect of the Enlightenment that influenced the development of capitalism in the eighteenth and nineteenth centuries, where everyone was to be allowed maximal freedom to make their own economic decisions. This freedom implies the existence in free-markets of Adam Smith’s Invisible Hand.

As opposed to this freedom, socialism promises greater economic equality; and outside of the ruling elite socialism does seem to deliver more equality. (For some reason, even in socialist states, the ruling elite always lives much better than the masses!) However, as Winston Churchill once famously warned, “The inherent virtue of socialism is the equal sharing of miseries.” Free-market capitalism offers individuals more choice on their economic path through life. If individuals want to escape the role of serfs underneath the ruling elite, they would be better off in a system where they have maximal choice.

The Practical Problems of Making an Economy Work

As I have written in a number of posts, free-market capitalism also is the only known way to coordinate the choices of suppliers and consumers in a practical way. The balancing of supply with demand for every good and service offered by the economy is The Economic Problem that must be solved by every economy. If supply and demand are significantly out of balance, economic output is reduced, jobs are lost and the economy is in recession/depression.  Historically, every incarnation of socialism has failed the test of solving this basic problem. To see a discussion of the reasons for socialism’s failure, read the posts Why Socialism Does Not Work, Central Planning for Chaotic Social Systems, and How to Solve Problems in Chaotic Social Systems.

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