Capitalists are Really Just Energy Vampires

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.

the angel investor

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 no credit rating.  You see 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.

capital goods are used to make money


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 the telephone bill)… 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).

calculating the return

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.

a business is valued on price to earnings ratio

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, whereas Billy has to work for 1,800 hours each year to earn his end. 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?

what is the source of profit?

The basic premise of capitalism is that the substance is the capital itself.  Even though the tools purchased with your original £5,000  stake will eventually wear out, they will have covered the cost of their own replacement, meaning your capital will persist for as long as the business remains solvent.

replacement capital goods

How is the Profit Generated?

There are four possibilities as to the source of your return:

  1. The customers are being short changed because Billy is charging them extra to cover your end, so that he (Billy) is not out of pocket.  Even though the customers agree to this rate, they are essentially paying you £17.85 per hour just to sit at home and do nothing, because you once invested £5,000, or;
  2. Billy gallantly takes the hit by absorbing your share of the profit out of his own income, therefore earning £17.85 per hour less than he is notionally worth to the customer.  Billy is essentially paying you £17.85 for every hour he works, just to sit at home and do nothing, because you once invested £5,000, or;
  3. A combination of 1 & 2, Billy rips off both himself and the customer in favour of you, or;
  4. The tools (capital goods) that Billy uses to landscape, make him more efficient to the tune of £35 per hour (the notional rate of profit on those capital goods).  Since your share of those capital goods is 51% you are entitled to that £17.85 per hour, and nobody is being ripped off.

Which of those do you reckon it is?  Option 1) is unlikely since that would risk pricing Billy’s Landscaping Services out of the market, by rendering it uncompetitive in comparison to other businesses that weren’t charging a premium.  Option 2) is also unlikely since Billy will feel incentivised to maximise his own earnings at the customer’s expense.  Therefore either Billy is carving your margin out at the expense of both himself and the customer, or it’s somehow being generated by the capital goods that your initial investment help to fund.

The (mostly) Orthodox View

Orthodox Neoclassical, Keynesian, and even heterodox Austrian economists all agree that the return on an investment arises from that capital being put to work in the production of goods/services.  In the landscaping example the labour costs are deemed to be fixed, and the tools purchased with the £10,000 of startup capital are perceived to be generating the profit, once the cost of labour has been deducted. This profit is then fairly split between the entrepreneur and the investor, as per the shareholder’s agreement.

do returns really arise from capital?

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.”

defining a unit of capital

Carefully set aside each of the following bulleted points regarding the nature of capital:

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”.

The value of capital can be extrapolated from its rate of profit.  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 (roughly speaking) its rate of profit is £500,000 goods less £100,000 purchase price less £50,000 operating costs = £350,000 profit over 10 years = ~£35,000 per year.

  • The value of capital can be extrapolated from its rate of profit.

That doesn’t mean that the machine should sell for £350,000 – after all even when brand new it only retailed at £100,000. Instead the rate of profit offers a means of objectively comparing that machine against all other machines, including machines that produce different things, because capital goods are heterogeneous (meaning they don’t all produce the same stuff). Two machines with the same rate of profit are deemed to possess the same quantity of capital. Likewise a particular mechanical digger may represent a quantity of capital equivalent to that encapsulated by ten picks combined with ten shovels (thus enabling one man to perform the work of twenty).

  • Capital is heterogenous (like apples and pears).

We measure the value of capital in units of money, so £1 would represent one unit of capital.

  • The value of capital is quantified in monetary terms.

The rate of profit on capital is dependent on the quantity of capital.  This means that £10,000 of capital will produce 10x the rate of profit that £1,000 worth of capital does.

  • The rate of profit is dependent on the quantity of capital.

Collating each of those points on the nature of capital:

  1. The value of capital can be extrapolated from its rate of profit.
  2. Capital is heterogenous.
  3. The value of capital is quantified in monetary terms.
  4. The rate of profit is dependent on the quantity of capital.

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 capital, can be extrapolated from its rate of profit, which is in turn dependent on the quantity of said capital as measured in money.

Hmm… that’s circular reasoning; we’re trying to calculate the value of capital, from its rate of profit, which then turns out to be dependent on the quantity of the aforementioned capital.  Both are also quantified in monetary terms, so we’re left trying to measure money with… money.

capitalism is predicated on circular reasoning

Capital appears to be an invalid concept, since there doesn’t seem to be any way of quantifying it.  Given that capital goods are only capable of production in the presence of labour, 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.

the Cambridge debate raged for a decade

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!

This also has some serious implications when its logic is applied to the aforementioned landscaping business, wherein it becomes clear that capital cannot be generating the return, since the capital is measured by its rate of return, and that rate of return is dependent on the quantity of capital.  There’s simply no way of quantifying the capital beyond the original £5,000 that was invested, so that investment cannot be shown to be “making money” in and of itself. In other words, the notional return is actually being justified by [cue horror music]: circular reasoning.

This leads us to the only other logical conclusion – that the value of the original £5,000 capital investment, was worth just that, £5,000… meaning that someone, either the customers, or the workers, or more likely both, are 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

A mathematically sound theory of capital had already been devised decades earlier by Karl Marx, but since his solution undermined the philosophical basis of Marxism… he chose to ignore his own reasoning.  Here’s a paper detailing this by Australian economist Steve Keen.

Karl Marx ignored his own reasoning

Property is Theft!

Pierre-Joseph Proudhon actually figured all this out even before Marx did (he just wasn’t able to adequately explain the mathematics).  This is why Proudhon proclaimed “property is theft”.

Proudhon had capital sussed

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.

can ancap word salad validate capital?

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.

the rawest expression of 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.

tools increase productivity

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.

better tools mean more profit

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.


Yup – 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.

no… money doesn’t actually make money

We’re still left with the aforementioned circular reasoning: “The monetary value of capital, can be extrapolated from its rate of profit, which is in turn dependent on the quantity of said capital as measured in money.

An Energy Theory of Value

At the root of the Cambridge problem is the notion that money can make money, but let’s look at the actual physics involved.  All energy used in production can ultimately be measured in joules.  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.

the Sun is the source of all our energy

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.

capital violates this

Capitalism is Exploitation

In the absence of any weird ectoplasm, workers and consumers (who are for the most part the same group of people), are being ripped off by the capitalist, who is likely charging more than the value of the good, whilst paying the workers less than the value of their labour, in order to carve out a living from money.  The capitalist is in effect an energy vampire.

yup… capitalists are really just energy vampires

Capitalism is de facto the exploitation of the working class by a dominant capitalist class. 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.

capitalism is exploitation