Capitalism is an economic system where wealth is supposedly accumulated via the ownership of capital. This essay looks at what capital actually is, and whether the return on a capital investment is really generated by the capital itself, or through the cynical exploitation of workers and consumers.
Some basic business economics are touched upon, along with Capital Theory, the Cambridge Capital Controversy, the Labour Theory of Property, and the essay even rounds out with a brief introduction to the Exergy Theory of Value. Everything is presented in very simple terms, and anyone with decent arithmetic skills should be capable of following the thrust of it.
Business Economics
Imagine that you are someone with money to invest in a small business, in exchange for a share of the company, in the hope that this will produce a financial return.
Example
You hook up with a guy called Billy who has £5,000 to start a landscaping business, but who needs a total of £10,000 to purchase the equipment (capital goods). The banks wont lend to him because he hasn’t established a credit rating. However, you view Billy as a good risk, so you invest £5,000 in exchange for a 51% share of the landscaping business. One of the conditions in the shareholder’s agreement, is that the business will pay Billy wages at the market rate for whatever labour he performs, and that any surplus achieved beyond that is divested as profit by way of share dividend.
NOTE – a 51:49% split in favour of investors who are contributing at least half the startup capital is standard practice in order to safeguard their interests. Under the shareholder’s agreement Billy will be reimbursed in wages for any labour he contributes, before the profit is apportioned. If you feel that this is wrong, then feel free to adjust the terms however you see fit, as this largely irrelevant to the matter at hand.
The Return
Here’s what all this means in simple terms: if Billy charges a customer £100 per hour to landscape, which incurs costs of £10 (on stuff like fuel), and sets aside £5 against the business’ fixed overheads (stuff like insurance)… then he can pay himself £50 for an hours labour… leaving a profit of £35 to be split 49/51 between Billy and yourself, netting you a return of £17.85 with Billy receiving a further £17.15 by way of his own dividend in addition to his £50 of wages (meaning Billy receives a combined £67.15 in respect of his wages and share of the business).
The landscaping business averages revenues of £800 per day, 5 days a week, 45 weeks of the year – that’s £180,000 per annum. This provides you with an annual return of £32,130. At a 5x PE (price to earnings) ratio (a basic measure of how businesses are valued) your share capital in the landscaping business is now worth £160,650 – and that’s in the ballpark of what Billy would have to offer in order to buy you out and keep all future earnings for himself.
The Capitalist
This is what it means to be a capitalist. An absentee investor need only stay alive to collect the return on their investment. In order to comprehend the nature of capital, we need to look at what actually funds those returns. Is this money for old rope, or is there actual substance to it?
The (mostly) Orthodox View
All economists agree on three primary factors of production: land, labour, and capital.
Orthodox Neoclassical and heterodox Austrian also advance the existence of a fourth factor – entrepreneurship – which encompasses risk, organisation and coordination (and by the Neoclassical definition intellectual property).
All capitalist economists agree that profit either arises from the supply of natural resources that the capitalist owns, from efficiencies derived from the use of equipment that the capitalist owns, and in the case of Neoclassical and Austrian economists, from the positive action of entrepreneurship. Furthermore they advance the notion that the buyers and sellers must be mutually profiting from any voluntary trade otherwise they would be unable to agree a price.
All capitalist economists argue that profit cannot be attributable to waged labour since said wages compensate each worker for their labour.
Returning now to Billy’s Landscaping, what is the source of your return. Well Billy is the one supplying the labour and you’ve both agreed that he will be remunerated for that prior to the division of profit. You aren’t suppling any natural resources, and in terms of entrepreneurship the funds that you risked were invested in capital goods, therefore your return must arise from the machinery making Billy’s labour more efficient than it would otherwise be. And even though the tools purchased with your original £5,000 stake will eventually wear out, the gross profit generated by the use of those tools will cover the cost of their replacement, meaning that your capital will persist for as long as the business remains solvent.
Capital Theory
While that might appear perfectly reasonable, it’s also dependent on capital being an actual thing in its own right, so precisely what is capital? This subject has been tackled by notable economists such as Eugen von Böhm-Bawerk of the Austrian School. Briefly, capital is a factor that facilitates the production of wealth, through the creation of value. Here’s a good summary on the nature of capital from Mises.org, which includes this quote:
“What is capital, then? It is composed of three things:
First, of the materials upon which men operate, when these materials have already a value communicated by human effort, which has bestowed upon them the property of exchangeability — wool, flax leather, silk, wood, etc.
Second, instruments that are used for working — tools, machines, ships, carriages, etc.
Third, provisions that are consumed during labor — victuals, fabrics, houses, etc.
Without these things the labor of man would be unproductive and almost void; yet these very things have required much work, especially at first. This is the reason that so much value has been attached to the possession of them, and also that it is perfectly lawful to exchange and to sell them, to make a profit off them if used, to gain remuneration from them if lent.”
Machines/tools that are used commercially (such as a bulldozer, an oil rig, or Billy’s lawnmower) are termed “capital goods”, but as Ludwig von Mises explains here:
“From the notion of capital goods one must clearly distinguish the concept of capital. The concept of capital is the fundamental concept of economic calculation, the foremost mental tool of the conduct of affairs in the market economy. Its correlative is the concept of income”.
What does von Mises mean by that? Well lets run through how capital is calculated, which is standard across all modern schools of economics:
1. Capital is heterogeneous, meaning that it is encapsulated in many different types of capital good.
- Capital is heterogeneous.
2. Capital is quantifiable, meaning that its value can be measured.
- Capital is quantifiable.
3. The value of capital can be objectively extrapolated from its rate of profit, which is defined as the ratio of net profit to initial investment over time.
- The value of capital can be extrapolated from its rate of profit.
4. Value is measured in money, implying that a specific quantity of capital can be expressed in terms of its monetary value. Money is in fact an expression of capital in and of itself.
- The quantity of capital is measured in money.
5. Since the rate of profit equates to the ratio of net profit to the investment over time, it’s necessary to know the initial quantity of capital invested in order to calculate its rate of profit.
- Calculating the rate of profit necessitates knowing the size of the initial investment.
NOTE – If you’re struggling to fathom why the value of capital is objective rather than subjective, then this essay will help clue you in on how the Subjective Theory of Value works. But briefly… Menger (who devised STV), was quite clear from the outset the value of higher order (capital) goods could be extrapolated from their profitability.
Founder of the Austrian School
Architect of the Subjective Theory of Value
Example: If a machine costs £100,000, has an operational lifespan of 10 years, and incurs £50,000 of running, maintenance and insurance costs over that time period, but its use produces £500,000 of goods or services, then it will produce a profit of £500,000 goods less £100,000 purchase price less £50,000 operating costs = £350,000 profit over 10 years.
Since a machine represents a specific quantity of capital, the rate of profit at any given moment would equate to the net profit divided by the present value of the capital.
Collating each of those points on the nature of capital:
- Capital is heterogenous.
- Capital is quantifiable.
- The value of capital can be extrapolated from its rate of profit.
- Value is measured in money.
- Calculating the rate of profit necessitates knowing the size of the initial investment.
Aah but… there’s a problem…
When we try combining those points on the nature of capital into a cohesive and definitive statement, we arrive at something like this:
The monetary value of heterogeneous capital can be extrapolated from its rate of profit, which is in turn dependent on knowing the quantity of capital that was originally input, as valued in money.
Hmm… that’s spiralling circular reasoning; it seems that capitalists are attempting to calculate the value of capital from its rate of profit, which is in turn dependent on the quantity of capital that was initially input. Given that both are measured in money, it transpires that we’re actually trying to calculate the value of money in terms of how much money it makes!
Capital appears to be an invalid concept, since there doesn’t actually seem to be any way of quantifying it. Given that capital goods are only capable of production in the presence of other factors, in the absence of any way to measure the value produced by a unit of capital, the capital itself cannot be verified as the source of any returns being generated from its use in production. Uh oh…
The Cambridge Debates
This conundrum is known as the Cambridge Capital Controversy. Esteemed economists from the neoclassical and post-Keynesian (aka neo-Ricardian) schools, including Robert Solow, Nobel Laureate Paul Samuelson, Joan Robinson, and Piero Sraffa, spent over a decade arguing about whether or not capital was perhaps analogous to ectoplasm… and failed to resolve the issue. In the end they just gave up, swept the issue under the rug, and carried on as if nothing whatsoever had happened.
Does any of this even matter though? Well let’s return to Mises’ description of capital, but replace the word “capital” with the phrase “circular reasoning”:
“The concept of circular reasoning is the fundamental concept of economic calculation, the foremost mental tool of the conduct of affairs in the market economy”. Oh dear… that’s really not a good look!
In the case of the aforementioned landscaping business it becomes clear that capital itself is not actually what’s generating the return, since the value of the capital is extrapolated from its rate of profit, which is initially defined as the net profit divided by the £5,000 investment. In other words we’re continually revaluing the £5,000 investment on the basis of how much money its supposedly making at any given moment in time. Meaning, the notional return on the investment is actually being justified by – you guessed it – circular reasoning.
This leads us to the logical conclusion – that the value of the original £5,000 capital investment, was actually worth just that, £5,000… meaning that someone somewhere is somehow being ripped off in order to fabricate returns for the investor.
Here’s a nice easy to grasp summary of the capital debates (scroll down past the links at the top).
A Dialectic Theory of Value
An alternative theory of capital had already been devised decades earlier by Karl Marx. However, on p308 of “Grundrisse – Foundations of the Critique of Political Economy”, Marx’s own arithmetic alludes to surplus value being created by something other than labour. He shows that the use value of a machine can significantly exceed its depreciation. This implied a source of surplus value that wasn’t labour, undermining the base premise of the Labour Theory of Value. This created a serious dilemma for Marx, since if other inputs could also contribute surplus value then profitability needn’t inexorably fall, and socialism might not be inevitable after all… in other words that Marxian Economics would undermine Marxism.
Marx’s response to his own conclusions, was simply to leave that can of worms sitting half opened, to fester. Here’s a paper by Australian economist Steve Keen, that details this particular episode.
Property is Theft!
Pierre-Joseph Proudhon had actually figured all this out even before Marx did, he just wasn’t able to adequately explain the arithmetic although he did have an inkling that this unidentified source of value somehow stemmed from land. This is why Proudhon proclaimed “property is theft”.
Non-proviso Lockean
Murray Rothbard had an interesting take on capital by reinterpreting John Locke’s Labour Theory of Property weirdly bereft of Locke’s Proviso. He postulated that property was essentially the original labour of the capitalist, which then somehow persisted eternally.
Example
A worker can dig 50KGs of soil each day using just his or her bare hands, this is worth £80 per day. This is the value of that person’s labour.
An entrepreneur spends their £500 of their earnings buying up 10 picks and 10 shovels. This entrepreneur then employs 20 workers to dig on their behalf using those tools. Thus a new capitalist is born. Each pair of workers now manages to dig 500KG of soil each day, which is around a fivefold increase. Since the workers’ raw labour would only amount to 50KG of production, the additional 200KG of production per worker can therefore be attributed to those tools, which remain the property of the capitalist. Thus the £6,400 of earnings each day from this increased productivity must ‘rightfully’ belong to the capitalist.
After 4 weeks the capitalist invests £100,000 in a mechanical digger. The capitalist is now able to dismiss 14 workers, since only 6 workers are needed to operate that digger 24×365. The digger is able to dig through 5,000KG per 8 hour shift, equating to extra production of 4,950KG, for a gross profit of £166,320 per week of operation, from which £16,320 of operating costs are subtracted, creating a return of £160,000 for the capitalist… and so forth.
NOTE – The perceptive will have noted that these figures trend towards the unrealistic. That’s because the example doesn’t account for free market competition from other digger owners driving those prices down. This is irrelevant to the problem itself, but feel free to change the numbers if doing so makes you feel better.
Capital is Just Ectoplasm
Rothbard’s fantastical narrative still fails to navigate around the problem highlighted by the Cambridge Capital Debates. The notion that the value of someone’s ‘original labour’ can be magically multiplied by investing it in capital goods does nothing to alter the ectoplasmic nature of capital – it merely provides a fairytale as the backstory.
We’re still left with the aforementioned circular reasoning:
The monetary value of heterogeneous capital can be extrapolated from its rate of profit, which is in turn dependent on knowing the quantity of capital that was originally input, as valued in money.
Which is word salad for:
The value of money is dependent on how much money it makes.
An Energy Theory of Value
At the root of the Cambridge problem is the notion that money can somehow make money, but clearly that’s nonsense, so let’s look at the actual physics involved.
The raw materials used in production, the worker’s bodies, the food they consume in order to replenish the energy being expended as they labour, even planet Earth itself… all these things were ultimately created by, and depend upon, solar energy. The Sun can (as near as damnit) be viewed as the primary source of all energy used in human production, meaning economics is subject to the same laws of physics as everything else (shock horror), including “Conservation of Energy“. Production doesn’t create new energy, it simply repurposes energy originally radiated by the Sun.
Goods & services are in fact repackaged matter and energy, and their value ultimately arises from the Sun, rather than from capital. What economists think of as units of capital are in fact joules of energy, and as such each joule can be assigned a monetary cost/value. The notion of capital as a source of energy that can make more energy, which can be then translated back into money, therefore contradicts the First Law of Thermodynamics. Hence the entire economic basis of capitalism is false.
What Marx’s working actually hinted at was the presence of a hitherto unidentified fourth primary factor of production (in addition to land, capital, and labour): energy. Matter and energy are completely interchangeable. Both workers and machines consume energy. Production is just the transference of energy from one thing to another. When workers produce using machines they’re using up energy to modify materials, both their own physical energy, and whatever is being supplied to the machines. As Steve Keen describes it, “labour without energy is a corpse; capital without energy is a sculpture”.
The Exergy Theory of Value (ETV) is predicated on the joules of exergy (energy input – energy wasted) required to produce something, rather than the calorific value of the end product. It’s about work done efficiently, meaning that any valuation is unaffected by efficiency variations in production.
It could be said that labour in any society (including societies without commodities or markets) involves the expenditure of energy but so too does leisure, love-making and tending to one’s allotment. But none of these latter activities necessarily entail commodity exchange and the production of exchange values. However, while those activities might not entail commodity exchange they are things that people invest their energy in because they consider them valuable. If someone had to choose between turning a strip of land into a parking space vs an allotment, then clearly they’d be making a value judgement. Only ETV properly explains endeavour and value across the entire spectrum of human activity.
Capitalism is not Exploitation
With all this in mind, it’s possible to calculate and assign a notional energy ‘value’ (measured in joules) to a person and also to everything they possess, and thereby to track their energy balance. If they become poorer then that’s because they are experiencing an energy deficit; they aren’t being paid enough to replace the energy they’re using. An extreme example of this would be in a concentration camp where workers are literally being worked to death.
This is problematic for Marxism because should a worker’s energy balance remain neutral, then that would imply that said worker is being reimbursed the energy they are expending, rather than being ripped off. Obviously such a scenario does not offer any actual incentive to the worker… in that they’ve effectively been enslaved (although it does represent the ideal scenario from the perspective of the capitalist).
Capitalism is Energy Theft
In theory the ETV makes it possible to calculate precisely how much surplus can be apportioned to the action of the entrepreneur, the worker, the machine, and the land. In addition to providing full economic accounting, this also highlights the ethical issue around private property. If the primary source of the returns made by the capitalist are predominantly due to the capitalist owning stuff (rather than any energy expended in entrepreneurship), then said returns are mainly derived from class privilege. This means that Proudhon was correct: since the capitalist’s returns are by and large a product of structural coercion then that implies the capitalist is stealing energy from everyone else, in the form of the Earth’s natural resources. That the capitalist is paying his or her workers to strip-mine our planet for profit.
So… in the absence of any weird ectoplasm, capitalism is really just energy theft on an industrial scale, by a dominant capitalist class, who then attempt to justify their actions by way of circular reasoning.
This can be confirmed by incorporating thermodynamics into economics equations, effectively grounding the social science in actual physics, and thus proving that capital itself does not magically generate a return.
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