Category: economics

I’m giving myself some permission to provide a definition of capitalism as I understand it, and not the absolute best definition of the word. Books have been written about the subject, and the way capitalism works has shifted a lot since the 1700’s when its foundational treatises were written by Adam Smith and his contemporaries. So the definitions I land on are going to be imperfect, incomplete, and only relevant to the present time–a different definition may be more applicable in, say, 1900 or 2100.

What is an “economy?”

First, we need to make sure we’re on the same page about what an “economy” is. The way it’s discussed can make it sound like a vast, unknowable thing that needs to be handled gingerly for fear of ruining it.

An economy is a tool. It falls into the same broad category as a wrench, a government, a personality test, and an atomic bomb. Specifically, an economy is a tool that helps a collective (a family, a city, a country, a world) distribute the resources available to it.

Like other tools, it’s good for some things and not for others. Like other tools, it can be handled properly or improperly. And like a lot of other tools, it’s possible to improve upon its design–either to make it more useful overall, or to make it better at some specific thing you need to use it for.¹For example: a hammer with a shock-absorbing grip is an overall improvement, while a rubber mallet is a specific type of hammer that specializes in doing particular tasks well.

This definition is important because of language that’s often used around economic questions. For example, it’s often asserted that socialized medicine would lead to “rationing.” However, since medicine is part of the “economy,” it’s already “rationed”–it’s rationed by the market by setting higher price points for more complicated and rarer products, instead of being rationed by someone making a decision about who gets what. Setting a high price for something is a way of rationing that item to people who have the ability to pay for it.²One of the forces changing the economy today is that there are significant resources on the Internet that don’t need to be rationed, including information obtained through searches, social media posts, even video streams to a lesser extent. Since humanity isn’t capable of consuming all of the resources that one company is capable of producing, this results in a winner-take-all scenario that was extraordinarily rare before about 1998. Google receives nearly 80% of search traffic, but you can’t split up Google’s search engine as though it’s a monopoly because after an initial period of confusion, most of those users would settle on one of the two new engines, making it the “new Google.”

Any given economy has many ways to ration out its resources. In the United States, for example, we ration out emergency services based on people calling 911. In principle, we could let the market take care of emergency services, and you’d either have to sign up for a subscription (like an alarm company) or give them a credit card number before they put out the fire in your house, but at some point we decided to pay for emergency services with tax dollars instead, and ration out those services based on who was asking for them. But whether they’re handled by the market or by 911, centralized emergency services are part of how we distribute resources, and so they’re part of our economy.

Isn’t “capitalism” just a fancy word for “free market?”

“Capitalism” and “free market” are different things. Free market just means that anyone is able to sell a new product to compete with others that already exist in the marketplace. It’s the opposite of “monopoly,” whether that monopoly is owned by a single powerful business or a government entity. It’s a pillar of capitalism, but an economy doesn’t need to be capitalist to have free markets.

I’m not convinced there’s any such thing as a “free market economy.” Just like socialism (discussed below), there are different degrees to which an economy’s markets are free. Some items may be completely unregulated, while other items may be sold from only one vendor or handled outside the market.

Some products and services might be handled better by a free market, while other products and services are better handled by a regulated market or a closed market.³John Stuart Mill says in Principles of Political Economy, “Laissez-faire, in short, should be the general practice; every departure from it, unless required by some great good, is certain evil.” This represents the attitude of later “free-market” economists, including Milton Friedman (who, unlike Mill, held to this dogma his whole life). But careful readers will notice that even Mill allows for regulation when required by “some great good”–and as capital markets have become more complex, “good” and “evil” have also taken on complexity. Mill might have changed his mind about some things if he’d seen the financial instruments that brought about the housing crisis in 2008. You don’t have the ability to sign up for a private fire extinguishing service when you buy a home–that’s a market that isn’t free. Your house may be required to meet local building codes, but you can hire any licensed contractor to make sure it does–that’s a free but regulated market. You can also buy whatever decorations you want to put inside your home that are made by anyone, provided they don’t break other laws (e.g., they aren’t filled with cocaine or made with the fur of endangered animals)–that’s a free and unregulated market.

A market completely free of regulation only remains a free market for a short period of time. Markets left to themselves tend to eat themselves⁴Through mergers, acquisitions, or winner-take-all competitions. until only monoliths exist that are capable of either decimating or acquiring all their rivals.⁵Amazon is an example of a company that has been able to acquire or destroy most of its competitors before they came to be big enough to pose a challenge, however, it fails to meet the definition of a traditional monopoly because retailers like Wal-Mart still hold a non-trivial portion of the online market. Regulations are needed to prevent monopolies from forming and to ensure fair competition and consumer transparency (for example, without regulations McDonald’s would never have to tell anyone they’re putting sawdust in their food to make it cheaper).

The idea pushed by neoliberal (free-market) economists like Friedrich Hayek is that the free market is much more effective at distributing resources than any government could ever be. Some economists including Milton Friedman argue that allowing the market to distribute resources also maximizes efficiency and manages to create more resources where previously there were fewer.⁶A lot of economists believe “efficient market theory” was debunked in the 2008 market collapse. Market pricing itself was thrown off by the irrational behaviors of the actors within the market, proving that market prices could be inefficient for extended periods of time. But there are probably very few people who wouldn’t concede that at least some circumstances require us to offer resources based on need and not the ability to pay, and you won’t find many people who think we should do away with all money and assign resources only based on need either. Most economies will include some elements of free markets and some elements of central planning.

So what is “capitalism?”

Capitalism has a few basic features we’ll be looking at over the next several posts:

1. Pricing: This is supposed to be the real advantage to capitalism. If a government entity tries to decide how much a new product might be worth, they might end up picking a number out of the blue that really doesn’t reflect everything that goes into making that product or what people could feasibly pay for it. But if a business tries to sell that product on the open market and another business tries to sell a similar product, the two competitors will keep adjusting their prices until they both hit a spot where they’re making acceptable profits or one of them has gone out of business.⁷This is what’s called a Nash Equilibrium. It doesn’t actually maximize benefit for anyone, it just describes the inevitable price points for competing products and vendors given what one’s competition will do. (There are a lot of problems with market pricing when rational decision-making is compromised and/or when long-term impact is taken into account. We’ll get into that later.)
   
2. Value: Everything, no matter how abstract or intangible, can be assigned a monetary value. This includes the value of an idea, a policy, or a human life. It suggests that everything in existence, both real and imagined, can be valued in terms of the amount of money that would be paid for it. Items that have complex value (for example, human beings) are simplified to the relevant value–a human being might be valued based on her accounting skills when she’s being hired at an accounting firm, but would be valued based on her public speaking skills if she’s being hired as a diplomat, or valued based on the cost of a wrongful death settlement when a car company is thinking about recalling its airbags, or valued by the total of all the potential money she would have made over the rest of her life if an economist is trying to determine the economic impact of her early death. It’s a simultaneously practical and horrifying way of thinking about the world.
   
3. Means of production: In a capitalist economy, the government doesn’t own assets such as farms, factories, workshops, recording studios, and oil refineries–the means of producing the products we buy. The “means of production,” as they are called, are owned by private citizens, either individually or as corporations, trusts, funds, cooperatives, and similar structures.⁸The line between “government” and “corporation” is much murkier than politicians make it out to be. It’s not inappropriate to think of the market as a de facto fourth branch of American government. Whoever holds the means of production is able to set rules and determine important aspects of the lives of citizens. In this light, it may deserve the same respect as, say, the judiciary, but it should also be treated as limited.
   
   The means of production are the source of all wealth. Labor isn’t important to capitalism–it represents a necessary expense in order to extract the value from assets, and should be minimized as much as possible. Capital–or the means of production–is what’s important. Labor is paid with wages that get spent on products. Capital yields profits that are invested into more capital. Labor is always depleting resources while capital is always accumulating them.
   
   The basic idea put forward by Adam Smith back in the 1700’s is that someone controls the capital–a needle factory, for example–and hires other people to work for him. These employees are able to produce a lot more than they would if they were working alone because they’re able to specialize into the tasks they’re most competent at performing–for example, pulling the wire, cutting the wire, shaping the head, sharpening the tip. Where one person could make, say, 200 needles per day doing every task on her own, four people could make 2,000. In Adam Smith’s ideal world, the workers get more money than they would on their own because they’ve produced more needles, and the factory owner would harvest the excess value–for example, if each employee gets 300 needles worth of wages, the factory owner would still get 800 needles worth of profits.⁹Adam Smith was idealistic in his illustration. The more likely economic reality of this scenario is that the employees get the lowest wages that the factory owner can offer them, because the factory owner is able to price his needles lower than the needles produced by individual craftspeople. That is, the four people who were selling their own needles at 50 cents apiece now have to compete with a factory selling needles for 40 cents apiece, so they will have to lower their prices to 40 cents and get only $80 a day, or work for the factory for $85 a day, where previously they were able to sell their own needles for $100 a day. The irony is that the factory owner’s profits are lower than they would be if he continued to sell needles for 50 cents and paid the employees $110 a day, but because the free market is competitive, this would leave a lot of room for a competitor to come in and sell needles at lower prices. In any of these scenarios, however, the factory owner comes out better than all of the workers, which is the point.
   
4. Capital Accumulation: Not only does capital produce profits, it also accumulates wealth. Most of the things money can buy in the world, from cars to computers to carrots, are depreciating assets. They decay over time or are used up, resulting in a destruction of wealth. But there are some assets, such as land, factories, and brand names, that can become more valuable over time. People who own these things get wealthier without having to work (appreciation),¹⁰It wouldn’t be accurate to say that they don’t do any work, but it is accurate to say that the work they do isn’t what makes them wealthy. The capital is what makes them wealthy. Many wealthy people hire an investment advisor to do the work for them and can continue to accumulate wealth while doing no work at all. while people who work and buy things will have to work and buy more things because their things keep getting used up (depreciation). Most people have a little bit of both appreciation and depreciation: you might have a retirement account that holds stocks that appreciate over time, but your clothes depreciate as they wear out and you have to buy new ones. The greater the proportion of appreciating assets you have, the more your wealth accumulates. When defining the valuation of a human being, there are two tiers: People who are valued based on the work they can do, and people who are valued based on the capital they control. A truck driver for McLane Company is valued based on her labor; Warren Buffett, the CEO of McLane’s controlling company Berkshire Hathaway, is valued based on his assets.
   
5. Capital Markets: Once separate pieces of capital are pulled together into a mode of ownership, such as a corporation, you can break up that ownership into pieces and sell them to other people. And because everything can be assigned a value, and because selling it on a market in a competitive environment results in an actual price, you can do this with anything. (That’s what got the United States economy into trouble in 2008: lenders taking a bunch of mortgages, packaging them together and selling them, then taking pieces of those packages, packaging them together, and selling them, then hedging some of those against other packages… etc.)
   
6. Fluidity: The free market isn’t just for products and capital. Unlike feudalism, people can easily move between different employers under capitalism, even without having to pick up and move to another part of the world. The flip side of this is the degradation of community: since people need to be able to move around easily, your bonds with your neighbors are weaker. Everyone is responsible for her own fate, and many more of our interactions are transactional: instead of confiding in your local priest or preacher, or talking things through with your neighbors, you might pay a therapist or life coach to listen to your problems.¹¹This is what sociologist Ferdinand Tönnies called “Gesellschaft,” which represents a broad and anonymous society, in opposition to “Gemeinschaft,” which represents a specific and familiar community.

As I’ve described in a previous post, capitalism effectively decoupled and abstracted political and economic realities as they existed under feudalism. Where feudalism required wealthy people to own land, capitalism enabled wealthy people to maintain and grow their wealth independent of land.¹²This was an important transition with the ending of the Malthusian era–where the total wealth available to a population essentially came down to the ability to produce food. Once we invented better ways to produce food, wealth became disassociated from land. This also means violence takes on a different form under capitalism, and warfare and destruction is less direct.

Why capitalism?

Capitalism is underpinned by a belief in the effectiveness of rational (or enlightened) self-interest: that people make the best decisions for their own needs with the information they have available to them.¹³That people consistently act against their own rational self-interest does not dissuade believers in capitalism. Usually there is a rationalizing belief that irrational actors get edged out of the market, that poor people are either lazy or need to educate themselves, that the “self-interest” part can be irrational but a person will still act rationally to get it, etc. The result is the “invisible hand” of the marketplace moving to fulfill the needs people are ready to pay for: if all of a sudden everybody wants to eat radishes, the price for radishes will go up and more people will grow radishes because they’ll get a better price for them. (In later posts we’ll look at how this breaks down, especially in the age of the Internet.)

Capitalism was originally developed in opposition to the idea of a central regime–usually a monarchy–attempting to make the best determinations about how resources should be used. Under feudalism, a monarchy might grant a certain portion of land to a knight, who would be the caretaker of that land and all the commerce that was conducted on it. As opposed to the visible hand of a ruler distributing resources under a feudal economy, capitalism depended on an “invisible hand” distributing resources based on how much people would pay for a product or service.

It’s helpful to see capitalism as the product of its particular time:¹⁴To put capitalism into perspective next to similar ideas in physics, capitalism is like Newtonian physics. We still use Newtonian physics for some purposes, but imagine if technologies refused to take relativity or quantum mechanics into account–we wouldn’t have inventions like GPS or even modern computers.) the Age of Enlightenment, when philosophers and lawmakers alike saw education and rationality as a way of elevating humanity((Enlightenment rationality has a long and problematic history with the concept of race, in which white Europeans were thought to carry the “white man’s burden” of rationality into the rest of the world and elevate all other races of humanity beyond what they would be capable of achieving without the salvation of white rationalism and scientific progress. This belief has influenced modern politics among both conservatives and liberals, long after it became unfashionable to be explicitly and unapologetically racist. out of conflict, poverty, and all our other problems. If most men¹⁵Enlightenment rationality also has a long and problematic history with sexism, in which for a long time only men were believed to be capable of rationality, and even today women are frequently dismissed as emotional or irrational. On the other hand, feminists such as Mary Wollstonecraft made appeals to rationality as a way of bolstering their arguments. Even so, it’s been argued that rationalism was the language of the time and not a prerequisite for the success of feminism. became educated and rational, the thinking was, they would be able to lead less rational men and women toward a collective social ideal.

Capitalism was successful in its time due to the invention of new technologies and methods of organizing. Today, the invention of new technologies and methods of organizing are among the reasons we need to develop new economic models and methods that leave capitalism behind.

What about socialism?

There’s a lot of discussion about socialism in the political arena these days. To some people it’s a scary word. Others embrace it whole-heartedly. But what is it?

Socialism is a version of capitalism where the government owns a stake in some industries. Depending on how you define “industry,” most economies are socialist to greater or lesser degrees. For example, in the United States, the government owns most of the military industry and the education industry, as well as a significant stake in the amusement and tourism industry in the form of parks, museums, and monuments, and a pretty big piece of the transportation industry in terms of roads, bridges, waterways, and airports. This isn’t the degree to which the United Kingdom is socialist, where the government owns some television and radio broadcasting channels and the lion’s share of the medical industry, but the United States government owns a pretty large portion of certain industries and so can be called a socialist government already. So the discussion isn’t about whether to be socialist, but about which industries benefit from government involvement and to what degree.

To be clear, I intend to look at issues with capitalism itself, which means the solution may not be socialist in nature. It might require a re-thinking of the assumptions of capitalism, which would necessarily challenge socialism as well.

What about communism?

In my view, communism is also a modification of capitalism. The means of production are held in common by the people, but otherwise it’s intended to work more or less the same way.

In its purest form, communism requires the means of production to be owned by a democratic government and made available to the people based on who will make the best use of it. For example, if one person wants a piece of land to build a farm and another person wants to build a factory on it, there would be a rational, unbiased way of determining whether the factory is needed, whether it’s a good location for a factory, whether the soil and rain conditions are good for farming, etc., in order to decide which person should use that piece of land. In practice, centralized decision-making is the sort of outrageous idea that could only be conceived in an early Industrial Age mindset, when it seemed like rationality would take over the world and everything would become quantifiable.

In the capitalist ideal, some profits flow to workers by way of increased wages, while the rest flow to the owners by way of capital accumulation (whether or not that actually works is another question). In the communist model, the state takes the place of the owner. It’s a shortcut to the dark capitalist utopia envisioned by Arthur Jensen in the movie Network: “one vast and ecumenical holding company, for whom all men will work to serve a common profit, in which all men will hold a share of stock, all necessities provided, all anxieties tranquilized, all boredom amused.”

The real flaw in communism is not that it kills worker motivation but that having a centralized decision-making process about who gets to use assets is extremely prone to corruption and the short-sightedness of the central decision-makers.¹⁶Even if it is, in principle, controlled by all the people. In principle, the United States government executes the will of the people, and yet somehow only 17% of people as of the latest Gallup poll approve of Congress. That number hasn’t been above 50 percent since 2003. It’s hard to imagine people would be happier with Congress if it were directly in charge of all the jobs, resources, and products in the country. Put the no-nonsense Jack Welch in charge and you might stifle innovation for a decade, put the visionary Steve Jobs in charge and you will get a tremendous amount of innovation that fits his particular vision but nothing outside of that. Even the perfect candidate would be limited by human decision-making, and let’s be honest when assessing our human tendencies toward rationalizing corruption.

What’s wrong with capitalism?

It’s been my conviction for the past several years that we are seeing a shift that heralds the end of capitalism as a ruling ideology in our world. This isn’t because we’re getting smarter–it’s because capitalism, and its variations including socialism and communism, fail to address our economic realities.

Some people think this is a bold claim, some people think it’s ridiculous, some people might even think it’s anti-American. But to me it’s about as obvious as pointing out that winter is coming: it’s getting colder, the leaves are falling, we all know where that leads. And if capitalism is ending, we’d better get ready to replace it with something.

I don’t have the solution for what replaces capitalism. But this is a conversation I’m ready to have with other humans who want to see a world in which ordinary people can produce meaning and improve our collective quality of life.

What follows will be a series of posts pointing out what I see as some of the key strengths and weaknesses of capitalism, so that we can begin to talk about how we might do better in the future.

If I left anything important out of my definition of capitalism here, please feel free to comment below. Keep the comments on this post to a discussion of the definition here–there are going to be a lot of posts in this series and there will be plenty of time for criticism and theorizing. It will be helpful to have a solid working definition to start.

Talk to you soon, fellow humans.