Capitalism

Part 1 – The definition

Lee Friday

Capitalism entails private ownership of the means of production. The ‘means of production’ are land, labour and capital. Land: in order to produce any good or service, land is required. This should be obvious. Anyone who is producing must be physically situated somewhere. Labour: again, this should be obvious. Production cannot occur without the efforts of human beings. Capital: factors of production, such as money, tools, machines, buildings etc.

If I believe an apple a day keeps the doctor away, I will insist that my child eat one apple each day. I ask her if she ate her apple today. She says yes and shows me the apple core as evidence, but tells me her friend took a bite of the apple before handing it over to her to finish. Thus, neither of them ate an apple. Each of them ate a fraction of an apple. We must think of capitalism in this way. Capitalism does not exist, and never has existed. We have only a fraction of capitalism.

Either we have private ownership of the means of production, or we have government ownership, or ownership is split between these two groups. In Canada, as in most countries to varying degrees, ownership is split between the two groups. However, to the extent that we have private ownership, we must consider this to be fractional private ownership, not pure private ownership. This is a very important distinction.

Pure ownership of an item means that one has the freedom to make use of the item as one pleases. I own my house, and the land on which it sits, or do I? A city by-law says I cannot raise chickens in my backyard. Another law says I must pay money for permission to construct an addition to my house on my land. Another law grants the government the right to confiscate a portion of my house and land each year (property taxes). And the list goes on. My ownership comes with many conditions, restrictions, and confiscations, which means I have only fractional ownership in my house and land, and it seems like the fraction gets smaller each year. This concept applies to businesses and individuals alike.

‘Market’ is the term we use in reference to the voluntary exchanges of individuals and companies. People are constantly buying and selling goods and services: food, clothing, pianos, cell phones, stocks, bonds, money, cars, diamonds, computers, haircuts, video games and anything else you can think of. Whenever you buy or sell something, you are active in the market because you have made an exchange. The essence of capitalism is free markets. Thus, as with capitalism, free markets do not exist.

Capitalism is constantly criticized by university professors, bureaucrats, politicians, and media personalities. They tell us government must act to curb corporate greed in order to protect consumers. They tell us a new government program is urgently required to fill some nebulous need which capitalism ignored because it is not profitable. They tell us a particular bureaucracy requires a bigger budget because market inefficiencies require government solutions, in the public interest of course. Economic intervention by the government always reduces the fraction of capitalism, and our standard of living suffers as a result. More on this below.

CAPITALISM  EFFICIENTLY  ALLOCATES  SOCIETY’S  RESOURCES

Let’s see how capitalism works. We live in a world of scarcity. There is only one free resource – air. In order to survive, we must somehow acquire everything else we need, the bare necessities being food, water, shelter, and beer. Without utilizing the division of labour, each individual, or family unit, must be completely self sufficient. The most efficient way of organizing a civilization based on the division of labour, is through capitalism. Capitalism allocates scarce resources more effectively than any other ‘system’. How does capitalism do this?

The word ‘capital’ refers to factors of production, such as money, tools, machines, buildings etc. But where does capital come from? Quite simply, capital comes from our savings. Savings is the part of our income that we do not consume (spend). John Smith works hard at an ordinary job. He spends little, and after ten years has finally saved enough money to start his own business. Using his savings, he leases a building, buys materials, and hires workers. He is going to produce washing machines, and believes his product will be far superior to anything on the market. He also knows he is taking a huge risk. His plan could fail and his savings could be lost. There are no guarantees.

Smith cannot force consumers to buy his washers. Therefore, his success or failure is determined by profits or losses. Profits would mean that consumers have placed a higher value on the washers than they did on the money which they give Smith in exchange for the washers. This is obvious. Otherwise, consumers would not hand over their money. There are only two possible outcomes for Smith.

Scenario 1 – His business succeeds. He is making a profit. Profits are a signal that Smith has made use of scarce resources in an effective manner, as evidenced by the fact that consumers are buying his product. Smith has taken various factors of production – labour, raw materials, land (the building) – and combined them in such a manner that they are now worth more, as washing machines, than the sum of their parts i.e. more than what he paid for them. The difference is his profit. Smith has created value. He has created wealth. He is better off than before. His customers are also better off, their standard of living having been improved by the new washing machines. All parties benefit. Profits are the market’s way of telling Smith to keep doing what he is doing. He is using resources efficiently.

Scenario 2 – His business is not going well. He is taking heavy losses. He is not selling as many washers as he had hoped, and low consumer interest forces him to reduce his selling price. After one year, he ceases production and closes the business. Capitalism is not all about profits. Losses are also important. Losses convey an unpleasant truth to Smith – he has taken various factors of production – labour, raw materials, land (the building) – and combined them in such a manner that they are now worth less, as washing machines, than the sum of their parts i.e. less than what he paid for them. Losses are the market’s way of telling Smith to stop doing what he is doing. He is wasting resources.

CAPITALISM  CONSERVES  RESOURCES

Environmentalists talk about conserving the planets resources, but conservation must be considered in proper context. Everyone, including environmentalists, requires resources to survive. If everyone stops using the planet’s resources, we all die. Since we do not wish to die, the question becomes “How can we ensure that scarce resources are directed to their most highly valued uses, thereby minimizing waste?”

The answer is provided in the example of John Smith’s manufacturing business. If Smith’s business is profitable, this means that the resources he uses are indeed being directed to their most highly valued uses. We know this is true because consumers voluntarily trade their hard earned dollars in exchange for washing machines. Consumers are effectively saying “Yes, that is how we want those resources to be used.” Thus, there is no doubt whatsoever that these resources are currently being directed to their most highly valued uses. However, this can change at any point in time. The market is always in a state of flux.

If Smith’s washing machine business is not profitable, then we know with absolute certainty that these resources are not being directed to their most highly valued uses. Once again, this decision is made in the market, by consumers, through their reluctance to purchase enough washing machines for Smith to be profitable. Consumers are effectively saying “That is not how we want those resources to be used.”

That’s how capitalism works. The consumer is in control. The consumer decides how resources will be used. Obviously, consumers do not literally say to a business owner “stop using resources in this manner.” They don’t have to say this. The business owner gets the message when he is confronted with losses. He must either improve the efficiency of his business, or close up shop. No business owner is prepared to absorb ongoing losses. When he shuts down his business, he will sell the assets to the highest bidder, someone who believes they can more effectively employ the resources. That is how capitalism efficiently allocates and reallocates resources to their most highly valued uses. If particular resources cannot be profitably used, then they are not used, thereby conserving them for the future.

THE  STATE  WASTES  RESOURCES

The State constantly obstructs the operation of the free market. This is why we have only a fraction of capitalism. Consider the 2009 bailout of General Motors by the U.S. and Canadian governments. GM (and the union) ignored signals from the market (consumers). Consequently, it sustained heavy losses and would not have survived in a free market. Its assets would have been auctioned off to the highest bidder, thereby providing an opportunity for someone else to make more efficient and profitable use of the resources, to the benefit of consumers. However, while acknowledging the objections of many citizens, politicians assured us that a bailout was critical for the economy. We did not even get a vote on the issue. They make our decisions for us, and the result of this decision is:

Winners: (1) GM retirees maintain their benefits (2) Unions maintain their artificially high wages (3) Politicians maintain their ‘campaign contributions’ from unions

Losers:  Everyone else, because (1) Taxpayers fund the bailouts, which means they have less money to spend on other things, and (2) Bailouts encourage ongoing mismanagement, ongoing inefficiency, and ongoing union coercion supported by government – thus potentially triggering more losses, followed by more bailouts, and (3) Potential ongoing misallocation of scarce resources which the market (if allowed) would re-allocate, is to the detriment of consumers

GM was wasting resources on the manufacturing of cars that consumers did not want. Environmentalists should direct their wrath toward the State for subsidizing this waste. Curious how the State holds itself up as being a champion of the environment, yet virtually every time it obstructs market processes, the wasting of resources intensifies. This is not capitalism! This is State interference with capitalism!

GM jobs should not have been saved with a government bailout. It is not the government’s job to pick winners and losers. The market will decide which jobs to preserve, which means the decision is in the hands of consumers. Consumers express their preferences through their decisions to buy, or not to buy.

Remember dear reader, capitalism entails private ownership of the means of production. However, production for profit is not easy. Those wishing to employ their private property in the marketplace to earn an income are compelled to satisfy the wishes of consumers. If they do not produce goods and services desired by consumers, they will sustain business losses, which may force them to sell their property to someone who can more efficiently utilize these resources. Since we do not live in paradise, capitalism is the only method of ensuring the best possible utilization of labour and natural resources for the attainment of the highest possible level of prosperity for the masses. Government planning, government intervention, is always harmful.

So, how do we best use private property for production? Leave it to consumers to decide. As the great 20th century economist Ludwig von Mises wrote:

. . . in an unhampered market society the consumers daily decide anew who should own and how much he should own. The consumers allot control of the means of production to those who know how to use them best for the satisfaction of the most urgent wants of the consumers.[1]

PROPERTY  RIGHTS

Capitalism cannot flourish if the right to own property is not protected. This means I must have full ownership of property which I have peacefully acquired, which means that I am free to use this property however I wish, without seeking permission from anyone, so long as I do no harm to others, or to the property of others. Also, since no one owns my body except me, I am also free to use or sell my labour as I see fit. That is all that capitalism is – nothing more, nothing less. It is pretty simple. These are basic human rights. The fact that governments deny citizens the freedom to exercise these rights does not negate the rights. The rights still exist. In his book The Trouble With Canada . . . Still!, William Gairdner writes:

Why is the concept of private property so important to the free world? After all, as long as we have a right to use things, why should we care if we own them? But unless we own them, despite our best intentions, we simply do not care as much about the condition of things we use. That is likely why so many public buildings, university hallways, subway stations, and the like have an unloved and often grubby feel about them. We could even say that when people spend effort on something they own, it’s as if the effort is stored up or invested in the objects cared for. Private family garden plots in the former Soviet Union, which totalled only 3 percent of all cultivated land there, produced an astonishing 27 percent of that country’s total farm output. This also explains why virtually all commune experiments eventually transform into property-based organizations, or fail outright.

What is the point of having a right to own property – books, shoes, a home, or anything whatsoever that could be considered “ours” – if we cannot freely decide what to do with them?

This understanding is the reason so many Canadians were upset when this ancient and hallowed common law right to own private property was intentionally left out of Canada’s Charter in 1982 by Trudeau and all the first ministers. They left it out because the most socialist of them all, NDP leader Ed Broadbent, insisted they do so as his price for signing. He worried that a right to private property would hamper the government’s ability to expropriate private property. Precisely. If Trudeau had not been so socialist himself, he would never have agreed.[2]

PROPERTY  RIGHTS :   EARLY  AMERICAN  SETTLERS

Gairdner notes the superior production of private agriculture compared to communal agriculture in the former Soviet Union. This is not surprising, as the incentives are completely different in these two modes of production. The same theme played out with the early American settlers. In his book How Capitalism Saved America, Thomas DiLorenzo writes (emphasis added)[3]:

The first American settlers arrived in Jamestown in May of 1607. There, in the Virginia Tidewater region, they found incredible fertile soil and a cornucopia of seafood, wild game such as deer and turkey, and fruits of all kind. Nevertheless, within six months, all but 38 of the original 104 Jamestown settlers were dead, most having succumbed to famine.

Two years later, the Virginia Company sent 500 more “recruits” to settle in Virginia, and within six months a staggering 440 were dead by starvation and disease.

. . .the Virginia Company had not chosen a group of indolent and lazy people to settle the Virginia colony. The problem was that all of the men were indentured servants who had no financial stake in the fruits of their own labor. For seven years, all that they produced was to go into a common pool to be used, supposedly, to support the colony and to generate profits for the Virginia company. Working harder or longer was of no benefit to them, and they responded as anyone would, by shirking.

Even men who were generally known to be among the most energetic by nature were derelict. The absence of property rights – and of the work/reward nexus that such rights create – completely destroyed the work ethic of the settlers.

Economic historians Gary Walton and Hugh Rockoff aptly describe how such indolence can occur when workers have no property rights:

Consider 10 workers, who share ownership of the land and who collectively produce 100 bushels of corn, averaging 10 bushels each for consumption. Suppose that one worker begins to shirk and cuts his labor effort in half, reducing output by 5. The shirker’s consumption, like the other workers’, is now 9.5 (95/10) bushels thanks to the shared arrangement. Though his effort has fallen 50 percent, his consumption falls only 5 percent. The shirker is free riding on the labors of others. The incentive for each worker, in fact, is to free ride, and this lowers the total effort and total output.

It is perfectly logical that free riding would be the outcome of such an arrangement. We live in a world of scarcity, and survival requires hard work. Given the opportunity to live one’s life at the expense of others, many take full advantage of the situation, and it becomes contagious. It is a common feature of our so-called modern society. The government creates hundreds of thousands of free riders through its many welfare programs. More than a hundred years ago, when there was very little government welfare, those who were truly in need received aid on the local level. There were thousands of private agencies tending to cases of genuine hardship. Because this was done locally, those seeking assistance had to show real cause. It was not easy to fool your neighbours.

However, when the government muscled in, impersonal, inefficient bureaucracies proved to be easy pickings for those wishing to scam the system. The result is hundreds of thousands of people who are recipients of various forms of ‘public assistance’, though most of them are perfectly capable of gainful employment, which would increase production and improve the standard of living of everyone. If not for government intervention, capitalism would provide jobs for all who are able to work, and aid for the truly needy.

Returning to the Jamestown story:

In 1611, the British government sent Sir Thomas Dale to serve as the “high marshal” of the Virginia colony. Dale noted that although most of the settlers had starved to death, the remaining ones were spending much of their time playing games in the streets and he immediately identified the problem: the system of communal ownership. He determined, therefore, that each man in the colony would be given three acres of land and be required to work no more than one month per year, and not at planting or harvest time, to contribute to the treasury of the colony.

Private property was thus put into place, and the colony immediately began to prosper. There was no more free riding, for each individual himself bore the full consequences of any reductions in output. At the same time, the individual had an incentive to increase his effort because he directly benefited from his own labor.

The new system produced other benefits as well. The Jamestown colonists had originally implored the Indians to sell them corn, but the Indians looked down on the settlers because they were barely capable of growing corn, thanks to their communistic economic system. After the introduction of private property and the resulting transformation, however, the Indians began coming to the colonists to acquire corn in return for furs and other items. That is, the colonists and the Indians began to engage in peaceful market exchange based on the division of labor. The mutual advantages of such a system are always conducive to peace as well as prosperity, as many of the colonists realized, for it makes little sense to make war on one’s neighbor if one can prosper by trading.

In 1620, the Mayflower arrived at Cape Cod to establish another colony in Plymouth, Massachusetts. “They knew about the debacle at Jamestown in the early years, but they did not immediately make the connection between the starving time and collectivized farming.” Thus, the same mistakes were made – collective land ownership – with similar results, followed by similar remedies.

PROPERTY  RIGHTS :   20th  CENTURY  COMMUNIST  CHINA

Communist China enforced collective land ownership – no personal property. Everyone got the same amount of food, so they did not want to work. Predictably, food was scarce, and children were going hungry. In 1978, in the village of Xiaogang, the villagers decided that desperate times called for desperate measures:

One evening, they snuck in one by one to a farmer’s home. Like all of the houses in the village, it had dirt floors, mud walls and a straw roof. No plumbing, no electricity.

The farmers agreed to divide up the land among the families. Despite the risks, they decided they had to try this experiment — and to write it down as a formal contract, so everyone would be bound to it. By the light of an oil lamp, Yen Hongchang wrote out the contract. Each family agreed to turn over some of what they grew to the government, and to the collective. And, crucially, the farmers agreed that families that grew enough food would get to keep some for themselves. The contract also recognized the risks the farmers were taking. If any of the farmers were sent to prison or executed, it said, the others in the group would care for their children until age 18.

The farmers tried to keep the contract secret — Yen Hongchang hid it inside a piece of bamboo in the roof of his house. At the end of the season, they had an enormous harvest: more, Yen Hongchang says, than in the previous five years combined.

That huge harvest gave them away. Local officials figured out that the farmers had divided up the land, and word of what had happened in Xiaogang made its way up the Communist Party chain of command.

. . .fortunately . . .at this moment in history, there were powerful people in the Communist Party who wanted to change China’s economy. . . . So instead of executing the Xiaogang farmers, the Chinese leaders ultimately decided to hold them up as a model. Within a few years, farms all over China adopted the principles in that secret document. People could own what they grew. The government launched other economic reforms, and China’s economy started to grow like crazy. Since 1978, something like 500 million people have risen out of poverty in China.

CONCLUSION

All governments infringe on the human right to peacefully acquire property, and to exercise ‘pure’ ownership of property. Politicians, bureaucrats, and their friends (the 1%) prosper from this coercive economic manipulation. The result is that 99% of the people are denied a much higher level of prosperity which would most certainly arise in the absence of government intervention (Part 3 will provide details). In other words, less capitalism benefits the few, more capitalism benefits the many. This becomes readily apparent after we demolish popular myths about the early days of the Industrial Revolution. This is discussed in Part 2.

Go to Part 2

 

[1] Ludwig von Mises Human Action, A Treatise on Economics (Ludwig von Mises Institute, 1998) p 679

[2] William D. Gairdner The Trouble With Canada . . . Still! (Key Porter Books Limited, Toronto, 2010) pp 80-81

[3] Thomas J. DiLorenzo How Capitalism Saved America, The Untold History of our Country, from the Pilgrims to the Present (Three Rivers Press, New York, 2004) pp 53-7

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