1. Explain the difference between the Christian Paternalism of the European Medieval Ages and the Protestant Individualism that began to dominte Europe in the 16th and 17th centuries.
2. List and explain three changes to technology and institutions that took place in the transition from European feudalism to capitalism.
3. Explain the key institutional features of medieval Europe (the relationship between serfs and lords, as well as the dominant ideology of that era). Elaborate.
4. Explain the difference between the Nightwatchman view of capitalist governments and the Social Democratic view of capitalist governments.
5. Explain the major differences between LME (Liberal Market Economies) forms of capitalism and CME (Coordinated Market Economies) types of capitalism. Name three countries that fall into the LME type, and three countries that fall into the CME type.
6. Starting with the classic circular flow model, derive algebraically an equation showing gross profits as a function of gross investment. This is Michael Kalecki’s famous profit equation. What does this equation say about the relationship between spending and income for the two major classes of a capitalist society, capitalists and workers?
THE PRODUCTION FUNCTION AND GROWTH
In this note I’ll lay out the analytics of a surplus producing economy. The presentation
relies heavily on the ideas of the classical political economists, specifically the insights of Adam
Smith, David Ricardo, and Karl Marx. To keep things simple we’ll imagine a closed economy,
that is, an economy that does not engage in trade with other economies or involved in an
exploitative or subordinate relation with other systems. It is, in short, a self-contained system.
This assumption is commonly adopted in economics because it helps to focus attention on the
factors that are particular to the system and not the result of outside influence. Once the
characteristics of the system are understood, we can enlarge the analysis to include international
trade, imperialism, or dependency, without destroying the principles captured in the simpler case
of a closed economy.
We’ll start by exploring the relationship between work and gross output. With a given
productive capacity and work environment, that is with a given amount and quality of capital and
land and a given set of work habits and expectations, applying more labor to the production
process will cause output to grow at a diminishing rate. Figure 1A.1 provides a visual
representation of this idea.
Gross output (Q) is measured on the vertical axis, while number of workers (N) is
measured on the horizontal axis. The Q curve, also referred to as a production function, shows
how the existence of diminishing returns causes output to grow at a diminishing rate as a result
of adding more workers to production. But rather than thinking of the production function as a
visual image of a growing economy, the proper interpretation is that it represents the range of
production that’s possible given existing conditions. It provides a visual representation of the
relationship between labor usage and output per time period, given existing conditions of
2
production and work. Economic growth, on the other hand, involves additions or improvements
to the system’s productive capacity, causing the system’s productive capacity to grow and the
entire production function to shift over time.
Figure 1A.1
The production function assumes that laborers are working at the same level of intensity.
As a result, the diminishing nature of extra output is not the result of declining effort, but rather
the result of having to interact with increasingly less fertile land. It should also be noted that the
workers measured on the horizontal axis are all assumed to be direct workers; there is no
overhead labor. The graph could be amended to incorporate the role of overhead labor, but it
would complicate the presentation without improving our understanding of basic economic
principles. It should also be noted that all labor is assumed to be productive. There is, in other
words, no unproductive labor.
Given the above production function, let’s say that N’ workers are currently being used
per time period. This would mean that the economy is generating Q’ amounts of gross output per
time period. The worker’s replenishment, socially necessary consumption, is Cn’, depreciation is
Dp (the difference between NP’ and Cn’), and the system’s necessary product is NP’. The
3
difference between gross output (Q’) and the necessary product (NP’) represents the system’s
surplus product. The surplus product represents the amount that’s available for surplus
consumption and/or net investment (not shown in the graph). Obviously, the work force must
generate a surplus beyond its own necessary consumption to provide for the consumption
standards of other classes of people, its own possible surplus consumption, depreciation and net
investment. The extent to which this occurs and how the surplus is distributed and used depends
not simply on the productivity of labor but on the political organization of society.
The historical pattern, for surplus producing systems, is to find one class of people
controlling the laboring activities of another class of people – those who do the work. While
there are variations on this theme and classes of people who fall in between these two categories;
it’s nevertheless the case the surplus producing economies have traditionally been class divided
societies with one class of people, the managing or ruling classes, directing or controlling the
laboring activities of the laboring classes. What’s more, the ruling classes oversees the laboring
effort of the workers to ensure that the surplus that’s generated by the workers is used for their
own consumption and/or invested in more productive capacity. They have a direct interest in
ensuring that the workers generate a surplus that’s sufficient to sustain their lifestyle; as a result,
they will generally be intent on having the workers produce as much of a surplus as they possibly
can.
A numerical counterpart to the above graph is presented in Table 1A.1 (the numbers are
provided for heuristic purposes; they are not intended to capture the actual proportions found in
real economies). For the moment, focus on the first six columns of the table. The columns N and
Q are the numerical counterpart to the production function in Figure 1A.1, showing that, with a
given productive capacity and working environment, more workers will bring about greater
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output, but at a diminishing rate. The Cn column represents the socially necessary consumption
of the various workers (represented as line Cn in Figure 1A.1), while the Dp column represents
depreciation (shown in Figure 1A.1 as the difference between the Cn+Dp line and the Cn line).
The sum of Cn and Dp is the system’s necessary product (NP) and is represented as the Cn+Dp
line in Figure 1A.1. The column labeled SP represents the system’s surplus product and is the
difference between gross output (Q) and the necessary product (NP).
N Q Cn Dp NP SP ap mp cn NP/N SP/N
0 0 0.00 6.00 6.00 -6.00 8
1 14 8.00 6.00 14.00 0.00 14.00 14.00 8 14.00 0.000
2 27 16.00 6.00 22.00 5.00 13.50 13.00 8 11.00 2.500
3 39 24.00 6.00 30.00 9.00 13.00 12.00 8 10.00 3.000
4 50 32.00 6.00 38.00 12.00 12.50 11.00 8 9.50 3.000
5 60 40.00 6.00 46.00 14.00 12.00 10.00 8 9.20 2.800
6 69 48.00 6.00 54.00 15.00 11.50 9.00 8 9.00 2.500
7 77 56.00 6.00 62.00 15.00 11.00 8.00 8 8.86 2.143
8 84 64.00 6.00 70.00 14.00 10.50 7.00 8 8.75 1.750
9 90 72.00 6.00 78.00 12.00 10.00 6.00 8 8.67 1.333
10 95 80.00 6.00 86.00 9.00 9.50 5.00 8 8.60 0.900
Note that as the employment of labor increases, with a given productive capacity and
work environment, the system’s surplus product grows, reaches a maximum, and then declines.
This can also be seen in Figure 1A.1, by noting that the vertical distance between the production
function (Q) and the necessary product (line Cn+Dp) at first grows, reaches a maximum, then
declines. This behavior is due to the combined effect of both diminishing returns and a growing
necessary product. Adding more workers to the production process, and assuming a stable work
environment, will cause output to grow at a diminishing rate while causing the necessary product
to grow at a constant rate. The interaction of these two trends causes the surplus product to grow,
reach a maximum, and eventually become zero (not shown in either the graph or the table, but
implied in both by the fact that the size of the surplus begins to diminish).
5
Another way of thinking about this is that there’s a maximum amount of surplus the labor
force is capable of generating, given productive capacity and work conditions. That is, given the
amount and quality of capital and land, and existing work habits, the system is designed to
generate a maximum surplus with a specific number of workers. In the table that number of
workers is 7; that is, given the system’s productive capacity and work habits, seven workers will
produce the most surplus. Adding more workers beyond that amount will still generate a surplus,
but not as much as the system was designed for. Of course, a smaller number of workers will
also generate smaller surpluses. In Figure 1A.1, the number of workers which will generate a
maximum surplus is N’.
All of this can be interpreted on a per worker basis. Since the workers are the producers
of the gross product, we can interpret the above relationships by comparing the amount that the
average worker produces to the amount the average worker uses up in consumption. Columns
seven through eleven in Table 1A.1 (from column ap to column SP/N), show these relationships.
The column labeled ap represents the average productivity of labor and measures the
amount of gross output produced by the average worker. Thus, when 5 workers are used and
gross output is 60, the productivity of labor is 12 (60 divided by 5). The column labeled mp
represents the marginal productivity of labor and measures the amount of extra output generated
by using one more worker. For example, when the number of workers increases from 2 to 3 per
time period, gross output increases from 27 to 39 per time period; that is, the addition of the third
worker causes output to grow by 12. The marginal product, mp, of the third worker must
therefore be 12. The column labeled cn represents the socially necessary consumption per
worker, which in this simple example is 8 units of gross output per worker. When this level of
consumption per worker is multiplied by the number of workers we arrive at a measure of
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socially necessary consumption (Cn) for the system as a whole. The NP/N column measures the
system’s necessary product per worker (NP divided by N). Note that as the usage of labor
increases necessary product per worker gradually declines because the fixed amount of
depreciation is spread over a larger number of workers. The SP/N column measures the system’s
surplus product per worker (SP divided by N). Figure 1A.2 provides the visual counterpart to
these ideas.
Figure 1A.2
The ap line represents the productivity of labor. Note that, as in the table, it shows the
productivity of labor declining as more labor is applied to existing productive capacity. Once
again, this is not due to a failing on the part of the workers but rather to the existence of
diminishing returns. The mp line represents the marginal productivity of labor. Note that the
marginal productivity of labor is declining at a faster pace than the average productivity of labor.
Socially necessary consumption per worker is shown as the straight line labeled cn. The
necessary product per worker is shown as a gradually declining curve (cn+Dp/N) that lies above
the cn line; this is the visual counterpart to the NP/N column in Table 1A.1.
7
The marginal productivity of labor has a special role to play in our understanding of the
surplus. In looking over Table 1A.1 it should be apparent that the surplus product, SP, reaches a
maximum when 7 workers are employed. Note that it’s also at that point that the marginal
productivity of labor (mp) is equal to socially necessary consumption per worker (cn). This is an
important principle of economics. The basic idea is that the surplus product will reach a
maximum when the extra output generated by one more worker (mp) is just equal to (or greater
than, but close to) the extra cost of using one more worker (cn). Note that in Figure 1A.2, the
point at which the marginal product of labor line intersects the consumption per worker line is
comparable to using 7 workers in Table 1A.1. In Figure 1A.2, that point occurs when N’ workers
are used; the surplus product is at a maximum at that point.
When N’ workers are used, average productivity is ap’, socially necessary consumption
per worker is cn’ and necessary product per worker is NP/N’. Note that the difference between
the productivity of labor (ap) and socially necessary consumption per worker (cn) represents the
amount in excess of the average worker’s consumption that is used by the rest of society for
depreciation, surplus consumption, or net investment. The proportions in which the surplus is
used for these various purposes depends on the nature of society’s technology and political
economic institutions. But it should be obvious from the graph that, beyond some point, the
excess that’s generated by the average worker will start to diminish and eventually be just
enough to cover depreciation, leaving nothing for surplus consumption or net investment. Of
course, one would not expect society to consciously reach such a state of affairs. Those who live
off the surplus, the ruling classes, would begin to search for new technologies and/or new
productive capacity in the hope of improving the productivity of labor and increasing the size of
8
the surplus. Indeed, the pressure to search for alternative methods of generating more surpluses
will begin to occur when more than N’ workers are employed.
Figure 1A.3 provides a visual image of the impact of capital accumulation on economic
growth. The figure assumes that there are only two eras or phases. The first one, corresponding
to production function Q, shows the relationship between number of workers and gross output
with the initial productive capacity. The second one, corresponding to production function Q’,
shows the relationship between number of workers and gross output with an enhanced
productive capacity due to capital accumulation.
Figure 1A.3
The figure shows depreciation increasing with the process of capital accumulation, both
in absolute terms and as a fraction of gross output. The existence of more capital has had the
effect of increasing the amount of gross product that has to be allocated to capital replenishment.
However, the extent to which this occurs depends on the nature of capital accumulation. We will
consider the types of capital accumulation later on, but for the moment it’s enough to know that
the rate and level of depreciation can vary and need not take the form suggested in Figure 1A.3,
even though it is not uncommon.
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Figure 1A.4 provides the per worker counterpart to Figure 1A.3. Note that, when seen
from this perspective, the process of capital accumulation has the effect of improving the
productivity of labor; the line labeled ap’ represents the greater range of productivity brought on
by the accumulation of capital. The process of capital accumulation would also affect the
marginal productivity of labor. In general, and once again depending on the nature of
technological change, the marginal productivity of labor would increase in tandem with the
average productivity of labor. However, for ease of exposition (to keep the figure relatively
uncluttered), the marginal productivity of labor (mp) is not shown.
Figure 1A.4 also shows, consistent with Figure 1A.3 a greater level of depreciation, and
thus a greater necessary product. But the improvement in labor productivity and thus gross
output is, at a minimum, equal to the growth in necessary product.
Figure 1A.4
Chapter1
Surplus Producing Economies
I. The economic imperative and political economy
If societies are to survive over time they must, at the very least, be capable of reproducing
themselves. The goods needed to keep the system going must be appropriated, produced, or
obtained in exchange, and then distributed in a fashion that insures the system’s continuation.
Humans must be fed and sheltered, buildings and roads kept in good repair, the young trained to
occupy positions vacated by the old, and the myths and ideologies used to provide meaning to it
all, sustained and passed on from generation to generation. Of course, there is no certainty to any
of this, nor is it necessarily the result of some conscious plan. Civilizations have withered away,
and others have been destroyed in wars. Yet, despite this, the fact remains that if societies are to
sustain themselves, they must be capable of reproducing the activities and things needed for their
perpetuation.
This process of social reproduction involves the interaction of a number of different
institutions and social processes. The combined interaction of these various processes provides
the texture of life characteristic of a society, its cultural achievements, political ideals, scientific
contributions, and material standards of living. But despite the multiplicity of elements involved
in this process, it can safely be said that economic processes and institutions are fundamental to
the reproduction of societies. They are fundamental in the sense that their function is to provide
the goods and services needed to carry on. This is not meant to imply that the various other
institutions and social processes are unimportant. Military crises do occur and can bring about
the downfall of a system. Likewise, new political regimes have energized decaying societies.
2
Nevertheless, the efficacy of these other institutions and social processes is a moot question if the
economic institutions of a society are incapable of providing the food, shelter, clothing, tools,
transportation, and such, needed to carry on. It is in this sense that the economic component of
any society is fundamental.
The set of institutions through which society appropriates, produces, and distributes
goods and services constitutes what we call the economic system, or the economy. The economy
provisions society with the material requisites of life. It involves that aspect of social life through
which things are appropriated from nature, transformed into various goods, and distributed in
some fashion among the members of society.
Economic institutions evolved out of the need to obtain the requisites of life; they reflect
the history of humanity’s efforts to provide for itself. This becomes self-evident if one keeps in
mind the ultimate purpose of economic institutions, namely, to provide a flow of goods to a
group of people. The fundamental reality is that humans must figure out a way of fending for
themselves, of appropriating or producing the things needed for survival. In a very primitive
setting this is quite obvious and is generally the context in which the survival imperative is
understood. One can envision a family of humans hunting for game with sticks and rocks in
response to the need for food. But even in a modern setting the survival imperative is the
fundamental reality undergirding the economic institutions of contemporary society.
This imperative to survive forces humans to figure out ways of providing for themselves.
Tools, or more broadly technologies, are developed to solve practical economic problems.
Methods of taming nature are invented and easier ways of producing and distributing goods are
devised. At the same time, economic institutions are created to provide a stable environment for
the production and distribution of goods. These institutions coordinate the interaction of human
3
effort and technology to produce and distribute a myriad of goods. They represent the social
relations that evolved to solve the problem of sustenance. In their efforts to overcome the
vagaries of nature, humans create technological and institutional environments that ensure a
steady stream of the goods thought necessary or desirable.
As the technology and institutional structure of society evolves, so do the amount and
type of things thought necessary. The growing complexity and sophistication of society requires
the continued production and reproduction of a growing array of goods and skills just to keep the
system going. Each generation comes to view the existing technology and institutions, and the
amount and distribution of goods made possible by that structure, as the norm. This norm then
serves as the base from which new technologies and new institutions are invented.
Unlike other species, humans cheat nature by creating a social environment that provides
them with a certain, and preferably bountiful, flow of goods. In the process of creating these
social environments they transfer their need to survive from nature to these social structures. The
survival imperative comes to be viewed in terms of the existing institutional environment, and it
is survival within that environment, and not the “natural” one, that becomes the issue. Moreover,
from the perspective of society as a whole, and in particular from the perspective of the
beneficiaries of the existing institutions, it is the survival and perpetuation of these institutions
that comes to be viewed as imperative.
While the survival imperative is the motive force propelling humans to create tools and
economic institutions, the specific manner in which these tools and institutions are used depends
on the values they express. In the process of manipulating and molding their environment,
humans are also assigning meaning to these activities and explaining why this and not that
should be done. The creative capacity of humans is expressed not only in their ability to invent
4
the needed technology and institutions, but more importantly in their ability to create an
environment that expresses their vision of the way things should be. Humans create ideological
systems intended to explain who they are, their place in the universe, and how they should
govern themselves. They invent language as a medium to explain their vision of the world to
each other and their offspring. Social rituals are developed as expressions of their beliefs, and
governments are created to institutionalize their conceptions of the way things should be.
Thus, the quality of life that a society is capable of providing is not simply a matter of
logistics or engineering, it is also a function of the value system, the ideology, of that society. It
is dependent on the set of values that underlie the way in which the people in that system
perceive themselves, their relationship to each other, other societies, and their ecological
environment. It is dependent on the manner in which these values are expressed and
institutionalized in that system’s political and economic structures.
At one level, the ideology of a society is nothing other than an expression of the broad
consensual values that are accepted as normal or natural by the members of society. It represents
the values that are interwoven into what is referred to as culture, providing a common language,
or paradigm, to society. This ideology is expressed in the myths and ideas that are taken for
granted and beyond dispute by the governed and the governors alike. At another level, the
ideology of a society is expressed through the set of beliefs and norms that are sustained and
enforced by its political system. The political system reflects the distribution of power in a
society; and the manner in which that power is used reflects the values which the power structure
views as legitimate and worth enforcing.
The political system is the arena of social life where values are debated and fought over,
laws are established, and penalties are imposed on transgressors. It is through this process that
5
rules are devised to determine who has rightful access to the economy and to the goods made
possible by it, and where disputes over issues of ownership, production, and distribution are
resolved. The political system is the context through which rituals and ceremonies are created to
provide justification for, and acceptance of, the existing distribution of power and privilege.
Thus, what will be produced, how it will be produced, and who will get it, depends, in large part,
on the ideology that is expressed and enforced by the political system of a society.
Because of this, the term political economy is used to underscore the idea that the manner
in which a society goes about producing and distributing the requisites of life is intimately tied
into the value system of that society and the distribution of power that permits that value system
to remain in place. The political economic institutions of a society are structures of power that
coordinate the use of tools, nature, and labor for the purpose of generating and protecting a flow
of goods. The manner in which these goods are produced and distributed depends, given the
existing technology and resource base, on the values that are institutionalized in these structures
of power.
To be sure, during any one era, the technology and resource base available to a society
will impose a constraint on what its economy is capable of producing and how it will go about
producing it. But short of that constraint, it is the existing set of political economic institutions
that determines, through the values they express and support, what will be produced and who
will get it. It is this characteristic of political economic systems that explains why societies with
roughly similar technologies and resources may nevertheless have different standards of living.
Or, more dramatically, why a society endowed with meager natural resources is nevertheless
capable of delivering a higher level of material comfort than a society endowed with abundant
6
natural resources. Over the long-term, it is the set of values institutionalized in the political
economy of a society that will determine the quality of life characteristic of that system.
II. Economic viability
A society is said to be economically viable if it is capable of generating, on a regular
basis, an aggregate of goods and services, a gross product, that is sufficient to maintain the
productive structure of the system in good repair plus provide for the usual needs of the
population. A society that is capable of achieving this will be able to reproduce itself over time.
While this seems obvious enough, the proposition needs to be examined in more detail in
order to fully understand its implications. First of all, there is the organizational, and thus
political, problem of insuring that the existing methods of production and distribution remain
relatively stable and secure. In all economic systems work has to be performed and the outcome
of that work distributed among the members of society. This process involves the development
of institutions that coordinate the process of work and determine who gets what and how much.
But, regardless of the specific fashion in which these issues are resolved, a political economic
regime will be relatively stable, and thus viable, if the system of distribution and work
coordination is viewed as legitimate by most of the people in that society. As long as most of the
people, most of the time, accept the existing rules of the game and view the outcomes as more or
less appropriate, the system will be relatively stable and thus viable.
Moreover, this principle holds true regardless of whether the existing regime is explicitly
based on democratic principles. The governance of political economic institutions is always
easier when the governed profess their allegiance to the system. While there are a number of
ways in which this might be secured, it is more readily attained when the governed view the
7
existing structure of production and distribution as consistent with the satisfaction of their
material needs. Thus, the extent to which a viable institutional structure can be created and
maintained is dependent upon the extent to which that structure is viewed, by most of the people,
as capable of providing for their material needs.
An integral part of this political problem of economic viability involves the specification
of the political boundaries of the system. That is, who is viewed as a legitimate member of
society and who is not? Or, in the language of modern democracies, who is a citizen? The
viability of a political economic system is primarily, though not exclusively, dependent upon the
extent to which the “legitimate” members of society view that structure as appropriate. The
opinions of the non-citizens are less important, or irrelevant. The extreme example of this
involves the case of slave-based economies. As long as the slaves are maintained at a level that
allows them to perform their functions, the question of whether or not they are satisfied with
their material condition is irrelevant; they are not viewed as legitimate members of the system.
Instead, what matters is the creation of an institutional framework, namely a police force, that is
capable of keeping the slaves working. Of course, even here, the viability of slave-based
economies will be threatened if the costs associated with the military structures required of such
societies start to outweigh the ability of slaves to generate the gross product; or more
dramatically, if the slaves resist their condition, rebel against their masters, and destroy slave-
based institutions while creating a new, free and more sustainable, social system.
A second requirement of economic viability is that the production of the gross product be
compatible with the technology and resource base of the system. While no one would expect a
society to consciously set out to produce goods it is incapable of producing, it is the case that
societies have sometimes found themselves in such a situation. This dilemma is most frequently
8
encountered when societies unexpectedly find themselves incapable of producing the same
goods because of a depletion in their resource base. Societies that, in some previous era, were
capable of meeting the usual needs of the population might find that, in a new era, they are
incapable of satisfying those needs with the same technology. On a grander scale, the viability of
all modern societies, and indeed the very existence of the human species, has come into question
as the reigning technologies continue to destroy the global ecology. The long-term economic
viability of a society thus requires that it use technologies consistent with the maintenance of its
ecological environment.
A third requirement of economic viability is that the system be capable, at the very least,
of growing at a rate that matches the rate of growth of the population. If the economy were only
capable of producing the same amount of goods and services each year, then, assuming a
growing population, the standard of living of the average person would soon deteriorate. A
growing number of people would have to compete for the same amount of gross product, and
this would bring about a decline in the material conditions of the average person. Therefore,
economic viability requires that, at a minimum, the economy be capable of generating a gross
product that keeps up with the rate of growth of the population.1
It should be noted that economic viability simply means that an economy is strong
enough to reproduce the material conditions perceived as normal by that society. It does not
guarantee that these “normal” conditions will be opulent. A society that generates no more than a
subsistence level of income may be economically viable, though, at the same time, quite poor.
Thus, if a society is to improve the material conditions of its population, its economy would have
to generate a gross product that is large enough to permit the average standard of living to grow
1. Of course, it is also possible to restrict the rate of growth of the population.
9
over time. Each year the number of new goods and services generated by the economy would be
greater than the increase in population, ensuring a growing income, or product, per capita.
Political economic systems that can achieve this result will tend to be more stable, and thus
viable, than those that cannot.
III. Surplus production and economic growth
The production of an economy’s annual gross product involves the transformation of
natural resources into the various goods and services making up the gross product. These goods
and services consist of two very broad categories, consumption goods and capital goods.
Consumption goods refer to the food, clothing, shelter, and such, produced for purposes of final
use, while capital goods refer to all of the machines, tools, factories, and the like, used by
laborers in the production of these same consumer or capital goods.2
If we visualize the economy reproducing itself through time, then we can imagine the
following process taking place on an annual basis: a portion of the newly produced capital goods
is used to replace the capital goods that have fallen into disrepair; at the same time a portion of
the newly produced consumer goods is used by the workers to sustain themselves while
producing another round of goods. If the laborers, machines, and land are maintained and
replenished by consumer and capital goods, and the laborers continue working at the same level
of intensity, then the economy should be capable of reproducing the same volume of gross
product. The system would be viable.
2. Later on, we’ll see that the distinction between consumer and capital goods is not as clear cut as this paragraph
suggests. There are numerous cases where a good might be an item of consumption under one set of conditions, but
a capital good under another set of conditions. But, on the whole the above distinction is good enough to understand
the logic of economic reproduction.
10
The portion of the gross product that is used to replenish the economic system is called
the necessary product. It represents the sum of the capital goods used for purposes of capital
replacement and the consumer goods used to sustain the workers. The replenishment of capital
goods is referred to as depreciation, while the amount needed to sustain the workers is referred to
as socially necessary consumption. There is no one specific term commonly used to refer to the
replenishment of land; but since, like capital goods maintenance, it involves the upkeep of the
means used by labor to produce the gross product, it too will be referred to as depreciation. The
context of the discussion should make clear whether the term “depreciation” is being used to
refer to capital goods maintenance, land replenishment, or both.
The replenishment of the workers is referred to as socially necessary consumption. It is
determined by technology and social and cultural factors. For any one era, or society, the socially
necessary standard of living represents the minimal amount of goods needed to participate in the
political economic system. It includes, in addition to the goods that existing workers must
consume so as to participate in the system, the goods that must be used to provide the training,
education, and skills expected of the young. In the short-term, in the context of a given
technology and culture, this socially necessary level of consumption tends to remain relatively
stable. But, over the long-term, the socially necessary standard will change as technologies and
social traditions change. Thus, the socially necessary level of consumption varies from one
society to another, and within any one society from one era to another.
The portion of the gross product that exceeds the necessary product is called the surplus
product. It can be used to sustain classes of people who are not engaged in the production of the
gross product and/or to increase the consumption standards of workers or other classes of people.
It can also be used to increase the amount and quality of tools and machines (capital goods)
11
and/or to increase the training and education of the labor force. These latter two uses of the
surplus (increasing the amount and quality of tools and machines and/or increasing the education
of workers) are referred to as net investment. This latter use of the surplus product is particularly
important since it increases the system’s productive capacity and, as a result, the amount of gross
product which can be generated.
Because the production of the gross product involves the payment of income, it’s
common to refer to a society’s gross product as its gross income. Likewise, the necessary
product can also be referred to as necessary income, while the surplus product can be referred to
as surplus income. When viewed from this perspective, the process of producing and distributing
the gross product can be seen as the counterpart to the process of receiving and spending income.
As already mentioned, the necessary product represents the amount of gross product that
must be used to provide for the socially necessary consumption of the workers plus the
maintenance of the system’s productive capacity (depreciation). It represents the minimal amount
of gross income that must be generated to keep the system viable. Economies that can only
produce this minimal amount, or worse, fall short of this minimal amount, are always in danger
of becoming nonviable. On the other hand, economies that can generate a level of gross income
that exceeds this amount (i.e., can generate a surplus income) will have greater discretion in the
kind of material life they can provide. Depending on how decisions over the allocation and use
of income are made, any surplus income that an economy might generate can be used to improve
the quality of life of some or all members of society.
In the short run, a society can improve the material conditions of its members by having
its surplus income used for consumption purposes. This can involve providing for the
consumption of classes of people not engaged in work or for the increased consumption of some
12
or all of the workers. But in the context of a growing population, using surplus income
exclusively for consumption purposes will eventually lead to a decline in the average standard of
living. If the entire surplus is always consumed, there is, by default, nothing left over to improve
the productive capacity of the system. And if productive capacity remains unchanged the
maximum amount that workers can produce will also remain unchanged; leading to a decline in
per capita income as population grows.
Over the long run, the only way an economy can provide for a growing level of per capita
income, and thus per capita consumption, is to refrain from consuming all of its surplus and
allocate a portion of it to net investment; that is, creating new productive capacity. A society
wishing to provide a growing level of per capita income will need to have its gross product grow
at a faster pace than its population. One of the more secure methods of ensuring this is to
increase the amount and quality of capital goods available to the work force. More and better
machines increase the productivity of labor and thus the level of per capita output. But, in
addition, a better educated workforce increases the development and adaptation of new and
better technologies, increasing the productive capacity of the system, and thus the level of per
capita income. As long as a portion of surplus income is continually set aside for more tools,
better technologies, and an increasingly educated workforce, the productivity of labor will grow
and so too will the level of output.
Attention must also be paid to the quality of economic growth and to the manner in which
it is distributed. After all, an increase in per capita output does not necessarily mean that real
consumption standards, either quantitatively or qualitatively, will be greater for most of the
people. The increased output made possible by net investment may consist of goods, such as
military hardware, that do not directly improve the real consumption standards of people.
13
Likewise, even if net investment did increase the output of consumer goods, these goods might
be distributed so unevenly that most people are unable to partake in their consumption. In short,
even if per capita output is increased through net investment, the composition of that output
might be inappropriate to the needs of the people and/or the output might be distributed in a
highly unequal fashion.
Finally, the quality of life depends on much more than whether a society can provide a
growing, and equitably distributed, level of per capita consumption. It also depends on the kinds
of freedoms that it guarantees, the respect which it displays towards its ecological environment,
the extent to which the individual is empowered to realize his/her potentialities, and the extent to
which it cultivates the aesthetic and spiritual dimensions of the human experience. A society that
worships mammon at the expense of these other virtues is a very poor, if not retrogressive,
environment for the development of the human character. Nevertheless, unless a society
satisfactorily resolves such fundamental issues as how to feed, cloth, and provide for its
members, the above virtues will always remain a distant concern or the avocation of a privileged,
sufficiently well fed, minority.
IV. The means of production
The inputs that go into the production of the gross product of any economy can be
grouped into two very broad categories: the means of production and labor. The means of
production represents the land and the capital goods used by the laborers, while labor represents
the physical and mental efforts that are expended in the creation of the gross product. We will
now examine these fundamental inputs. This section will outline the principle characteristics of
land and capital, while the next section will examine labor.
14
In addition to the surface upon which buildings are located, land represents all of the
various gases and minerals, the water, oil, animals, sunlight, heat, trees, and so on, provided by
nature. The resources that fall into this category are, in general, non-reproducible, and if used in
an immoderate fashion can seriously impair the ecological environment, and thus the quality of
life that a society might be able to provide.
Economists have traditionally thought of land as the ultimate constraint to the amount of
output that can be generated by an economy. One of the fundamental principles of economic
theory, the law of diminishing returns, expresses this idea by claiming that, with a given
technology and a given amount of land, the extraction of greater amounts of output from nature
will eventually reach an upper limit. For example, in the cultivation of wheat one would expect
farmers to start out by using the most fertile plots of land. As the demand for wheat increases,
farmers will increase production by extending the area of cultivation. But since the most fertile
plots are already being used, this will force farmers to cultivate wheat on less fertile plots of
land. If the inputs of labor and capital are the same on both the fertile and less fertile plots of
land, then output from the less fertile plots of land is bound to be less than what’s generated from
the more fertile plots of land. That is, total output of wheat will indeed grow as the area of
cultivation is extended. But it will be growing at a diminishing rate as a result of having to use
increasingly less fertile plots of land. Another way of saying the same thing is that the
productivity of labor will be gradually declining as a result of having to interact with
increasingly less fertile land. Or a third way of saying the same thing is that the amount of labor
and capital needed to extract an extra unit of output from land will increase at an increasing rate
as the area of cultivation is extended.
15
In short, land imposes a limit to the rate at which goods can be extracted from nature.
What’s more, while our example assumed an extension of cultivation, the same result would
occur if instead of extending cultivation, the farmers decided to cultivate their existing plots
more intensively. In both cases, output would eventually start growing at a diminishing rate
while the productivity of labor declines and unit cost increases. This principle is said to apply to
any productive process that relies directly on nature, such as agriculture, mining, forestry,
fishing, and so on. But, it’s important to note that this principle assumes that the technology of
production remains unchanged. That is, so long as technology remains unchanged, then applying
greater amounts of labor and capital to land will eventually result in diminishing returns.
Luckily, improvements in technology can increase the amount of output that might be
extracted from any one plot of land, thus counteracting the negative implications of the law of
diminishing returns. New technologies can be devised that replenish nature’s ability to continue
providing the basic ingredients of production and consumption. Additionally, political economic
systems can be created that manage economic growth in a fashion that is consistent with the
maintenance of the biosphere. Economic growth can be managed, despite the law of diminishing
returns, through improvements in technology and political economic institutions.
Capital goods refer to the various tools, such as machines, factories, trucks, fertilizers,
dyes, computers, and so on, used by laborers in the process of production.3 They differ from land
in that they can be produced in varying amounts and quality, and as such cannot be viewed, over
the long-term, as a fundamental constraint to production. Unlike land, they are reproducible
inputs. The economic history of humanity can be viewed as a prolonged attempt to overcome the
constraint imposed by nature by creating tools that allow for a greater amount and variety of
3. Capital goods also include the inventory of goods completed or in various stages of completion, that have not
been used in the current time period, but might be used at some future date..
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goods than could ever be provided freely by nature. Of course, in the short run the amount and
composition of capital goods cannot be changed with enough speed to alter the amount and
composition of the gross product. But, over the long term the only real constraint to the creation
of more and better tools is the ingenuity of humans, the capacity of humans to generate better
technologies.
Technology represents the application of knowledge to the resolution of practical
problems of production and distribution. The productivity of labor, the amount of product that
laborers generate on average, is dependent on the nature of the tools available to them and, of
necessity, the level of knowledge necessary to produce and operate the tools. During any one
period of time, the level and kind of technology available to a society will constrain the kind of
capital goods it can create, and thus the productivity of its labor force. However, over the long
term, as the technology of a society improves so too will the quality of its capital goods, the
knowledge and productivity of the labor force, and the amount and variety of goods it can
produce.
V. Labor
Labor represents the human effort that sets into motion the capital and land used in the
process of production. It involves not simply the muscular and mental effort expended in directly
producing a good, but the effort expended in maintaining the institutional and technological
context of production.
When viewed from this perspective, the labor exerted in the production of the gross
product can be broken down into two very broad categories: direct labor, and overhead labor.
Direct labor represents the efforts of that category of workers who are directly engaged in the
17
production and delivery of the gross product. These are the people who work with the means of
production to generate and distribute the product, such as assembly line workers, truck drivers,
farmers, and so on. Increases in the amount of direct work has the effect of increasing the
amount of gross output, while decreases in such work reduces the amount of gross output. In the
short run, when the technological and institutional environment of the system is unchanged, the
only way an economy can generate more output is to increase the number of direct workers, or
their intensity of work.
In contrast, overhead labor represents the efforts of a category of workers whose
activities primarily involve the maintenance, oversight, or improvement, of the productive
structure of the economy. These are the managers, accountants, teachers, scientists, and so on, of
society. Overhead laborers, while engaged in work, are not directly producing or delivering the
gross product. Instead, they attend to the context within which others directly produce the output.
Their labor is indirectly responsible for the gross product. Moreover, in the short run, increasing
or decreasing the number of overhead workers, or the intensity of their work, will not directly
alter the amount of gross output the system can generate.4
Societies intending to provide a growing level of per capita income will have to allocate a
portion of their labor to the investigation and creation of new technologies, to researching and
developing new ways of producing and distributing goods. Labor of this sort is a form of
overhead and, as such, is not contributing to the production of current output. Nevertheless, it is
contributing to future levels of gross production and to the composition of such future output.
Since it is undertaken for the purpose of improving future material conditions, this type of
activity is a form of investment. Societies that allocate a significant fraction of their labor to such
4 There are, however, indirect effects in the form of consumption.
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investment activities will tend to generate technologies at a faster pace, and attain higher per
capita incomes, than those that do not. We will refer to this type of overhead work as investment
activity or investment work, the workers engaged in this activity will be referred to as investment
workers.
Now, the only way an economy can allocate portions of its labor force to investment
activity is to have the direct workers generate enough output to sustain themselves, the
investment workers, and the productive capacity of the system. In the short run, when productive
capacity is given, investment workers are sustained by the productivity of the direct workers.
Over the long-term, however, when that environment is improved through the efforts of
investment workers, it is this type of overhead labor that provides the extra output. Thus, when
taking a long-term view of the system, both direct labor and overhead, investment, labor is
productive.
The distinction between direct and overhead labor should not be confused with a long-
standing and controversial distinction that economists have often made between productive and
unproductive labor. Productive labor is thought of as work that is necessary to the production of
the gross product, it can be of the direct or overhead variety, while unproductive labor is thought
of as work that is not necessary to the production of gross output.
Perhaps the easiest way to think of this distinction is to imagine that society consists of
two components: the economy, and everything else. The activities within the economy are
considered productive because they sustain and/or improve the material conditions of society.
The activities outside of the economy are unproductive because they do not alter the material
conditions of society. The workers within the economy are productive because they generate an
output that is used by those who work within the economy as well as by everyone else; they
19
generate the surplus that permits the rest of society to carry on. In contrast, those who work
outside the economy are unproductive because they do not generate an output that can be used to
produce the gross product.
For example, imagine a hypothetical economy producing capital goods, K, consumer
goods, C, and luxury goods, LX. The workers use K and consume C in the production of K, C,
and LX. The ruling class is the sole consumer of LX. Moreover, this class does not directly or
indirectly contribute to production. Instead, the management and oversight of production is
carried out by the supervisors, governors, or managers, chosen by members of the ruling class.
The productive structure of this economy can be depicted in the following terms:
𝐾 + 𝐶 => 𝐶
𝐾 + 𝐶 => 𝐾
𝐾 + 𝐶 => 𝐿!
During each cycle, the workers consume C while using K in the production of C, K, and LX.
Note that while K and C are needed in the production of everything in this economy, LX is not. In
fact, the gross output of this economy can be thought of as consisting exclusively of C and K; the
amounts of C and K directly produced during the productive cycle, plus the amounts of C and K
implicit in the amount of LX produced during that same cycle.
The workers in industries C and K would be viewed as productive because they generate
a surplus that is used by the rest of society. The workers in industry LX would be viewed as
unproductive because their output is not used, either directly as a capital good or indirectly as a
consumer good, in the production of the economy’s gross product. The unproductive workers do
not generate a surplus, instead they alter the composition of the surplus already generated by the
productive workers. They transform the surplus amount of K and C produced by productive
workers into a product, LX, that remains within the system’s surplus product.
20
In general, though not always, unproductive labor is thought of as involving activities
that maintain, or improve, the position and privilege of those who control the political economic
institutions of society. In virtually all societies there are groups of people whose primary task is
to defend, justify, or aggrandize the privileges of those who govern, and/or benefit from, the
existing set of political economic institutions. The priestly classes of ancient empires, court
jesters, sycophants, the police and military, government lobbyists, corporate lawyers, financiers,
marketing specialists, and portions of government, are the classic examples. These workers
divert surplus income to themselves and/or their masters without contributing to the production
of the gross product.
While unproductive labor has some superficial similarities to theft and fraud in that, in
both instances, the net effect is to divert surplus income toward those engaged in these activities,
the work of the unproductive laborer is generally viewed as socially appropriate. The efforts of
unproductive workers are seldom viewed as illegitimate or illegal. In fact, some of the more
highly rewarded workers are often unproductive. After all, unlike the cheat, the unproductive
worker does generate an output even though it is usually in the form of a service. Moreover, this
output is often viewed as necessary by the beneficiaries of the existing political economic
structure, in particular the ruling class.
One of the implications of this distinction is that unproductive laborers are not necessary
to the reproduction of the gross product. While they may be necessary in some other political,
cultural, or social sense, they are not necessary in a strictly economic, productive, sense. Their
output is not used, either directly or indirectly, to maintain the socially necessary consumption of
productive workers or to maintain the system’s productive capacity. Their output is not a part of
the system’s necessary product and is, therefore, not necessary to the continued reproduction of
21
the gross product. As a result, the efforts of unproductive workers can be reduced or eliminated
without affecting the volume of gross output. What would be affected instead is the composition
of the surplus and the use to which it would be put.
The inverse of this proposition is that increasing the activities of, or numbers of,
unproductive workers, will (other things equal) bring about a decline in the economy’s rate of
growth. As the proportion of unproductive workers is increased the fraction of the surplus they
use as inputs or for consumption also increases. This causes the amount available for net
investment to fall and consequently the rate of economic growth to
decline.
The productive/unproductive distinction makes the most sense when the gross product is
viewed in terms of the strictly technical relations that must exist for its reproduction to take
place. In the example above, it is obvious that good LX is not used either directly or indirectly in
the production of the gross product. As a result, the workers engaged in its production can be
defined as unproductive. But while these workers may not be necessary to the reproduction of
the gross product, they very well may be necessary to the reproduction of the institutional and
cultural context of society at large.
If the gross product is defined to include not only the material goods generated by human
effort and used to sustain or reproduce the material conditions of society, but in addition all of
the amorphous and intangible goods that make up what is commonly referred to as culture, then
the productive/unproductive distinction becomes more difficult to sustain. If what is being
reproduced is an entire style of life, a culture, then all of the human activities that are
characteristic of such a culture, including its military, priests and ministers, legal workers and
financiers, are necessary to its reproduction. We could, of course, argue over the relative merits
22
of this or that type of culture, but we could not claim that the activities typical of a specific
culture are unnecessary to the reproduction of that culture.
In terms of the above hypothetical example, if good LX represents the legal effort
involved in the resolution of disputes over property, and the structure of property rights is an
integral component of the institutional setting in which production takes place, then the workers
generating LX are not necessarily unproductive. They could instead be thought of as a type of
overhead, productive labor that attends to the institutional setting within which production takes
place. While the output from these lawyers is not used for production, it is used in the resolution
of claims to the gross product. To the extent that claims to property affect production levels, the
efforts of legal workers would have to be viewed as productive.
The point is that the productive/unproductive distinction must be used with considerable
care. In fact, because of the difficulties that can be encountered in its use, it is frequently
avoided. Nevertheless, this distinction does have the virtue of drawing attention to the fact that
certain types of work are more important to the reproduction of the gross product than others.
Indeed, the productive/unproductive distinction is frequently employed in the context of a
discussion over the viability of economic systems. The implicit argument in such discussions is
that the declining material condition of a society is the result of an overreliance upon
unproductive workers. The idea here is that unproductive work, because of its essentially
parasitical nature, is feeding off the productive capacity of the system, chewing into portions of
the surplus that could be used for investment, thus causing the material conditions of society to
decline.
Before closing, it must be noted that if the productive/unproductive distinction is to be
used, then the meaning of socially necessary consumption has to be altered. From this
23
perspective, it is not the consumption of all workers that is at issue, but rather the consumption of
only those workers that are essential to the reproduction of the material conditions of society,
namely the productive workers. Thus, socially necessary consumption would have to be
redefined to refer exclusively to the socially determined minimal amount of consumption
required of productive workers. The consumption of unproductive workers, regardless of
whether it happens to be at, below, or above the socially necessary level is irrelevant. By
definition, their consumption is a component part of the system’s surplus. Given this, the
necessary product would thus be defined as the sum of the socially necessary consumption of
productive workers plus depreciation. The surplus product would then consist of the remainder
of the gross product; namely the consumption of all unproductive workers, the surplus
consumption of productive workers, the consumption of non-workers, and net investment.
The Evolution of Capitalism
The Evolution of Capitalism
The transition from feudalism to capitalism
Not just about industrialization, also about property rights
From usufruct to private property
Interest as usury to interest as market price
Just price to market price
Enclosure movement (16th to 18th century)
The putting out system
From guilds to factories
From serfs to free working class
Technology – crop rotation, carts, horses
Long distance trade
The Evolution of Capitalism
Adam Smith’s Theory of History
Hunting
No private property, primitive technology, communal
Pasturage
Domestication of animals, emergence of private property, surpluses and government
Agricultural
Domestication of plants, landed estates, surpluses used to maintain retainers
Commercial
Emerges from burghers, trade is extensive, cities hub of economic activity
Evolution occurs as a result of trade, “propensity to truck, barter, and exchange.”
Leads to specialization and division of labor
The Evolution of Capitalism
Karl Marx’s Theory of History (Historical Materialism)
Economic base
Forces of production
Relations of production
Superstructure of ideas
Forces of production always advancing, sometimes slowly, other times quickly
Conflict between emerging new technologies and new social classes and privileges and ideas of old social order.
Modes of Production: Primitive communism, Slavery, Feudalism, Capitalism
In general, a linear, progressive view of history (similar to Smith)
The Evolution of Capitalism
Thorstein Veblen’s Theory of Social Evolution
Society structured by habits of thought (institutions).
Two types of institutions:
Technology – problem solving
Workmanship, parental bent, idle curiosity
Ceremonial – conservative
Predatory, invidious,
No guarantee of progress, stagnation and regression is possible
Surplus leads to predation and class divided societies
Work is denigrated
Conspicuous leisure is exalted
Waste encouraged
The Evolution of Capitalism
Karl Polanyi’s Theory of Capitalist Evolution
Prior to the emergence of capitalism, the economy was submerged in the social fabric of life
Reciprocity – symmetrical exchange
Redistribution – centralizing institutions
Householding – autarchy
Under capitalism, the social fabric of life gets submerged under the economy
The economy stands above society
The economy (market system) regulates itself
The self-regulating market a product of the nation state
The double movement
The Evolution of Capitalism
Ellen Wood on the Origins of Capitalism
Capitalism did not emerge as a result of giving vent to exchange and self-interest
Capitalism emerges out of the changed property relations, in particular over land, that begins to take place in England in the 15th and 16th century.
The concentration of land ownership (enclosure movement) lead to competition on the part of farmers (peasants or freemen) to rent land from nobility
This also leads to competition on the part of landlords to find productive tenant farmers
Economic coercion first appears in the countryside. Its origins are agricultural, not industrial
Chapter 4
The Evolution of Capitalism
In this lecture we’ll focus on the most well-known theories of history and social evolution
that shed light on the process by which capitalism came into being. Such an investigation will
help us discern those features of capitalism that distinguish it from other political economic
systems and provide insights into the processes that have made it grow and become a global
system. The theorists we will be exploring are Adam Smith, Karl Marx, Thorstein Veblen, Karl
Polanyi, and Ellen Wood.
Before addressing these broad theories of history, we’ll first explore, in a very brief
fashion, some of the most salient characteristics of the transition from feudalism to capitalism, as
well as some of the most well-known theories regarding that transition. To begin with, its widely
known and accepted that capitalism emerged in England sometime during the Mercantilist era.
Elements of feudal political economy persisted alongside the new emerging capitalist forms for
several centuries, from roughly the early 16th century to the late 18th century, but it wasn’t until
the industrial revolution of the late 18th century and early 19th century, that capitalism came to
the fore.
The first thing to note about this characterization is the close association that’s frequently
made between the industrial revolution and capitalism. Indeed, it’s common to imagine that
capitalism and industry – specifically the widespread use of machines in the production and
distribution of goods – are two sides of the same coin. And while it is true that the introduction
of mechanized techniques of production emerged alongside the development of capitalism, it’s
also true that capitalism is a form of social organization, a structure of property relations, and not
simply the mechanized production of industrial capitalism. After all, the Soviet Union managed
to introduce mechanized techniques of production, large urban centers, and smog producing
factories, but no one would define that system as capitalist. So, while it’s true that the industrial
revolution seems to have coincided with the full flowering of capitalism, it’s also true that the
formal rules of the game, the property laws which set capitalism apart from previous political
economic systems, had been developing for several centuries before the industrial revolution.
While there’s no way that we can explore all the ways in which notions of property
changed from the medieval ages to the current era of capitalism, we can draw attention to two
2
broad currents that help to explain that transition. The first has to do with the notion of usufruct,
which was widespread during the medieval era, but which is now largely, if not completely,
absent. This idea is best understood when thinking in terms of the manors, which were the
centers of political economic power during the feudal era. These were vast swaths of land which
were under the control of a lord (a duke, baron, prince, or king). The lord and his entourage lived
off the surplus product generated by the serfs that lived and worked on these estates. But the
serfs that worked the land or generated artisanal goods, were not considered employees and the
lord could not simply dismiss them (“fire them” in the language of contemporary capitalism).
The serfs were thought of as being a part of the manor, literally tied to the land, and were
expected to provide allegiance to the lord and a surplus, over what they retained for themselves,
in the form of agricultural or artisanal goods and/or labor. Indeed, the serfs had control over their
small parcel of land and owned enough means of production to provide for themselves. In return
for their allegiance and surplus to the lord, the serfs received military protection, and religious
and civil oversight, from the lord.
For their part, the lords didn’t really own the land in the sense that they could freely sell
it, or demand that all those who live on the land, such as the serfs, leave the manor unless they
could pay a rent of some sort. The lords had a right to the use of the manor, a right to the output
of the land and the laboring services of the serfs, so long as they did not abuse that right and
provided allegiance to their overlord (another, generally more powerful, lord that in turn had
obligations to the lesser lords in return for military and political allegiance). The lords, in short,
didn’t own the land, they instead had a right to its use, so long as they adhered to the medieval
traditions of reciprocal obligation.
Gradually, over the course of several centuries, this way of viewing landed estates
gradually changed, leading eventually to the abolition of the usufruct and the acceptance of
private ownership. By the time we get to the 17th century, these landed estates, formally
medieval manors, had been converted into huge chunks of private property owned by
descendants of landed nobility, but also by wealthy merchants who had acquired enough wealth
to purchase these estates. The rights that came from owning this land now exceeded the rights
that had been associated with usufruct and, what’s more, carried far less obligations than had
been thought customary during the medieval ages. It was understood that the “landlord” could
sell that property and/or demand rent from those who lived or worked on his land. What’s more,
3
it was understood that the landlord no longer had obligations to those that were renting the land.
If the rent could not be paid, the landlord could evict the tenant (an attitude or practice that was
viewed as sinful during the medieval era).
In addition to the emergence of private property over land, displacing the medieval notion
of usufruct, the transition from feudalism to capitalism also saw the growing acceptance of
charging interest on the lending of money. In general, the charging of interest on monetary loans
was viewed as sinful by the Catholic Church during most of the medieval era. The fallback
position was that one should not charge interest on the lending of money to a fellow human, a
fellow Christian. This was particularly true for loans that might be taken out to purchase
necessities. The church viewed the charging of interest on consumer loans as sinful and did its
best to outlaw it (after all, how could a Christian charge interest to a fellow Christian in dire need
of money to buy necessities?). But in practice, the church did make exceptions, particularly in
the case of loans intended for commercial purposes. So, for example, the church did not think it
was wrong to charge interest on the lending of money to a merchant or artisan who intended to
use that money for commercial purposes, so long as the interest rate was not usurious (beyond a
level that could be thought of as reasonable or Christian). What’s more, if that loan was paid
back within a specified time, often 90 days, then the borrower did not have to pay interest on that
loan. It was only after that initial grace period that interest could be charged on the loan. And
even then, the interest rate could not exceed some reasonable limit, it could not be, in short,
usurious.
It should go without saying that such an era is far behind us. Indeed, it was already
receding by the 15th and 16th centuries. By the mid-18th century, it was commonly accepted that
the charging of interest on loans was a normal part of business for a commercial society. Now-a-
days the interest rate is whatever the market will bear and there’s no limit to what it might be,
other than the limit imposed by the pressures of demand and supply. What’s more, interest is
charged on all kinds of loans, consumer or commercial.
Along with the growing acceptance of private property in land there also emerged a
tendency, on the part of the emerging new landlords, to enclose acreage that previously, in the
depths of the medieval ages, had been part of the commons or greens. During the medieval ages,
it was common throughout Europe to find vast expanses of land that were considered the
common property or usufruct of all. These were often forests that weren’t owned by any one
4
person and were viewed as spaces to which people could go forage, hunt, graze their animals,
gather wood or wild fruit, and live, so long as they did not abuse that right and allowed others to
do the same. But as feudalism gave way to capitalism, that tradition came under assault as
landlords began to enclose tracts of land that previously were not part of their estate but which
had been part of a commons. These enclosures often involved the literal fencing off of a landed
estate, expanding the boundaries of the estate beyond its original border to include acreage that
had previously been thought of as common. But, more often than not, the erection of a fence was
less important than the claim, on the part of an aggressive landlord, that x acreage of land, which
previously had been a part of a common, now belonged to him and could thus now extract
payment for its use, that is, charge a rent. The humble peasant could no longer flee to that portion
of the commons to eke out an existence, unless he/she paid the fee or rent demanded by the
landlord.
The enclosure movement took place over several centuries, but in the case of England,
one of the most disruptive episodes occurred in the 16th and 17th centuries, though it continued
on into the 18th century. During that era, the enclosure movement had reached such a peak that
large portions of the peasantry, that had traditionally lived in the countryside, were being forced
off the land because they were unable to pay the rent now demanded by landlords. This had the
effect of creating a huge pool of propertyless workers moving into towns and cities in search of
employment. Homelessness and vagabondage became a growing problem in the cities and
villages of the time. And it was from this growing pool of disposed people that a working class
was forged. That is, the enclosure movement led to the development of a class of people who do
not own productive property (in this case land) and, as a result, have no option but to offer their
labor in the hope of garnering a livable wage. That is, the emergence of a working class, as
distinct from a peasant or serf class – which does have access to means of production, however
modest, is intimately tied to the dislocations brought on by the enclosure
movement.
At the same time that the enclosure movement was working its way through England, and
more broadly Europe, merchants and medieval guilds were gradually being transformed into
what we would now-a-days call factories. This is a fascinating history and one that,
unfortunately, we do not have time to explore. It’s enough to note that the beginnings of the
factory system occurred in textiles and cloth production. Indeed, the leading industry which
propelled England, and more broadly Great Britain, to imperial status, was the cloth trade. Prior
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to the enclosure movement, or during its infancy, cloth production was carried out by peasants
living in the countryside. Their access to sheep, and thus wool, along with the modest equipment
they owned to transform wool into cloth, made it easy for them to produce and sell this good, in
addition to whatever other – mostly farming – activities they carried out in the countryside. This
was, overwhelmingly, domestic production, that is cloth production was carried out within the
peasant’s humble home.
The cloth merchants would travel through the countryside purchasing the finished cloth
from the peasants and then take it to other sectors of England and/or other countries, to sell it at a
price that, hopefully, covered their cost plus a tidy profit. The profit that could be made from this
trade would obviously depend on the difference between the price at which the cloth was sold
and the price at which it was purchased. So long as the sell price exceeded the buy price by a
reasonable margin, then a profit could be made. But competition among merchants had the effect
of narrowing the gap between these two prices, and in an effort to bypass this problem the idea
gradually emerged of controlling the price of the input, the cloth, by controlling the cost, and
specifically, the labor, involved in its
production.
At first, the merchants introduced what came to be called the putting-out system. The
idea here was that the merchant would first purchase the wool, instead of the finished cloth, and
then take the cloth to a peasant to have him/her transform it from wool into the finished cloth.
This would give the merchant a bit more power over the cost of the primary input, wool, while
also making it easier for him/her to haggle with the peasant over the cost of transforming the
wool into cloth. But the problem with this technique is that the merchant could never be sure that
the amount of time (labor) which the peasant claimed was necessary to create the cloth, was
indeed correct. The peasant had every incentive to claim that it took much longer to produce the
cloth, while the merchant had every incentive to claim it took much less. In short, the merchant
could never be sure that the effort (labor) which the peasant claimed was necessary to the
produce the good was indeed the amount needed. And the only way to know for sure would be to
oversee the laboring activity of the peasant.
So, little by little, merchants began to bypass the putting-out system by building
warehouse-type structures that housed the wool they had purchased as an input plus various
machines, spindles and whatever other contraptions peasants used to produce cloth. The
merchant could then announce that he/she would hire people to work at the factory. The
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merchant would only pay for the laboring activity of the hired people and could now directly
observe whether or not the workers were operating at a tempo that could generate the product,
and thus profits, expected by the merchant (who had now been gradually transformed into a
capitalist).
Notice, however, that this new system can only work if the laborers do not have
reasonable alternative to employment in the factory. If the factory had existed prior to the
enclosure movement, the typical worker could easily leave the factory and its employment, if
working conditions were seen as too onerous and/or the wages were thought of as inappropriate.
The laborer could simply walk out and go back to his/her plot of land and continue eking out an
existence as a peasant. The fact that peasants could sustain themselves from their own labor
would have made it difficult to sustain this kind of business. Such factories would not be
profitable, since labor could not be controlled, and would cease to exist.
But the enclosure movement had the effect of creating a huge pool of people who no
longer owned land, or the simple implements of production, and were now far less willing to
quite working for an onerous or stingy employer. And this in turn made it far easier for the
employer, the merchant/capitalist, to control the labor of his/her employees and demand a high
level of productivity. The power which the merchant/capitalist had over the employee came from
the fact that he/she could always threaten the worker with unemployment, being fired – leaving
the worker to figure out how to survive in the absence of a job. In short, the enclosure movement
created the conditions for the emergence of a working class that would now be obliged to work
in these new factories, even if working conditions and wages were onerous, simply because they
had no other option.
Beyond the above transformations, it’s also the case that the transition from feudalism to
capitalism involved improvements in technology that led to the creation of greater surpluses. We
know that, during the course of the medieval era, gradual improvements in transportation and
agricultural production, led to the development of agricultural surpluses which could then be
exchanged for the manufactured (artisanal) goods being generated by the guilds within the cities
and towns. This led to a gradual increase in the size of the cities and a growing volume of
manufactured (artisanal) goods.
At the same time, we also know that trading activity increased, not only trade between
the countryside and the cities, but increasingly long-distance trade. Indeed, many have argued
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that it’s not a coincidence that the era of imperial conquest (starting from the conquest of the
Americas in the early 15th century and continuing on into the 20th century) coincides with the
development and eventual maturation of capitalism.
The above outline has been far too terse, but it should provide you with enough material
to place the following theories in their proper context.
Adam Smith’s Theory of History
While Adam Smith wasn’t the first to develop a theory of society that highlighted
economic activity, he quickly became the founding father of a way of thinking about society that
focused on the manner in which humans go about producing and reproducing their material
conditions of life. Smith argued that laboring activity is the original source of all wealth, and that
nations that wish to become wealthy should encourage the division of labor by setting up a
system of natural liberty, what contemporary American audiences would call economic freedom.
He imagined that societies organized along the lines of natural liberty would eventually
become the norm and believed that commercial society (what we would now call capitalism) was
the highest stage of human civilization, the pinnacle of human progress. In arriving at this
conclusion, he developed a theory of history which laid out the various stages through which
human society had evolved. It was a linear theory of history in the sense that he imagined that all
societies would move, in varying degrees, through a series of successive stages or eras that
started from the most primitive and would culminate in the most advanced, commercial, stage.
Each stage was defined by a set of conditions that distinguished it from the previous, while – at
the same time, setting the preconditions for the next, higher, stage of social development.
All of human history, he argued, could be broken down into the following successive
eras: hunting, pasturage, agricultural, and commercial. The hunting era of human society was the
most primitive, followed by the pasturage era, then the agricultural era, and finally the
commercial era.
The first, and most primitive, era of human society was the hunting phase. Technology
was very primitive, consisting of little more than bows and arrows and the various flint
instruments used to capture and butcher animals, and use their hides and bones to fashion
clothing, tools, and shelter. Private property did not exist and there was very little surplus
production. Laboring activity, in the form of hunting – and the production and distribution of the
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goods made possible by the hunt, was used almost exclusively to provide for the sustenance of
the group. As a result, the material conditions of life were poor and precarious. Social
organization was communal and egalitarian, and there were no institutionalized hierarchies or
government. Smith saw the Native Americans of the 18th century as a prime example of this level
of social evolution.
The next stage in the development of human society was the pasturage era. By now,
technology had advanced to the point where humans had domesticated animals and were herding
cattle or sheep (we can include all other forms of domesticated animals, such as chickens, pigs,
and ducks, as well) as a way of providing the community with all the byproducts (food, clothing,
shelter, implements, etc.) that come from that activity. The herds or flocks were the first form of
property and were the foundation upon which the first hierarchies of wealth and power were
established. Men with larger herds were wealthier and more powerful than those with smaller, or
no, herds. It was also during this era that the notion of inheritance begins to take shape, with the
owner of a herd invariably bequeathing his “property” to his son or sons in varying proportions.
And yes, the focus was on patriarchal control or possession of property (i.e. herds or flocks). The
existence of property and the obvious imbalance between the haves and have-nots leads to the
development of government. Smith sees the origins of government as emerging at this stage and
explicitly defines government as an institution that emerges for the purpose of defending the rich
(those who own property) against the poor (those who do not own property). The examples he
uses to describe this stage of human civilization are the Tartars and Arabs of his time period.
The next era in the development of human society is the agricultural stage. Technology
has now advanced to the point where, in addition to the domestication of animals, plants have
also been domesticated to the point where agricultural production is now a feature of the system.
This has the effect of creating settled communities and the emergence of landed estates (manors).
As a result, he sees Medieval Europe as the prototypical example of this era of human
civilization. Property is now held in the form of land and landed estates are passed on through
inheritance. There are institutionalized hierarchies of wealth and power but little commercial
activity among the various estates (manors). As a result, the surpluses that are generated in this
era are used overwhelmingly, if not exclusively, for the maintenance of a large group of retainers
and dependents, ostentatious displays of wealth, and waring capabilities.
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The last stage in the evolution of human society was the commercial era. Smith saw this
era as emerging from the medieval towns and, in particular, the actions of the burghers that
dominated those towns. Trade and, more broadly market activity, was the vehicle through which
the medieval towns expanded and became a central part of the growing division of labor between
the city and countryside; with the cities specializing in the production of artisanal, manufactured,
goods, and the countryside specializing in the production of agricultural goods. The growth of
the cities also coincided with the growth in rights to property and freedom of economic
movement.
By the time of Smith, this commercial stage had evolved into what we would now call a
capitalist society – though it wasn’t called that by Smith (the term capitalist, or capitalism, didn’t
come to be used until the 19th century). In this stage of development, property relations are
broken up into the following categories: landlords (owners of land), capitalists (owners of
capital), and workers (who do not own property, just their ability to labor). By the time of Smith,
and even though the system could still be defined as Mercantilist, commercial society could be
characterized by the fact that labor was set into motion by the investment activity of capitalists
(features that are central to capitalism). The capitalist invests in the machinery, raw materials,
buildings, etc. necessary for the production of a good, rents land from the landlord, and hires the
worker to labor with the tools and raw materials owned by the capitalist. The resulting product is
then sold on the open market to generate an income that in turn is partitioned into the wages of
labor, the rents of the landlord, and the profits of the capitalist.
Adam Smith believed that the gradual transformation of human society from the hunting
stage up to the present commercial stage, was the result of the human propensity to truck, barter,
and exchange. This tendency sets into motion the specialization of labor and thus, the division of
labor into ever more specialized activities. As the level of wealth increases, the opportunity for
exchange also increases and so too does specialization and the division of labor. As a result, one
can interpret Smith’s theory of history as a prolonged (millennia long) process of having the
social division of labor become increasingly more intricate as a result of the increasingly greater
opportunities for exchange that are presented as the level of wealth increases over time. The
removal of artificial barriers to exchange, which was ubiquitous in the Mercantilist period of his
time, would set into motion greater opportunities to truck and barter. And this, in turn, would
encourage a greater division of labor and thus wealth.
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Karl Marx’s Theory of History
Karl Marx had a much more elaborate theory of history than did Adam Smith. But, they
held in common the idea that history, or the social evolution of the human species, should be
seen as the on-going outcome of the laboring activity of humans; that the way in which humans
go about producing and reproducing the stuff of life (the food, clothing, housing, entertainment,
etc., they need to get buy or flourish) is the fundamental reality of life which, in turn, molds the
way in which humans go about organizing their ideas about politics, government, religion, and
so on. Marx referred to his theory, or method of analyzing history, as Historical Materialism
and saw it as an antidote to the ideological interpretations of history that were prevalent in his
time, and still are. (An ideological interpretation of history would be one that privileges ideas,
and specifically ideals, as the motive or engine of history, that human societies evolve as a result
of an on-going elaboration and redefinition of what it means to live the good life or what it
means to be good or pure.)
The basic idea undergirding the theory of historical materialism, was that human society
can be thought of as composed of two very broad components: on the one hand the economic
base of society, consisting of the forces and relations of production; and on the other hand, the
superstructure of ideas making up the dominant beliefs (the ideology, religion, political and
scientific ideas) that are widely accepted as “truths” by the people of a society. Marx referred to
this constellation of relationships (the economic base and the superstructure) as a mode of
production.
The forces of production represented the foundation of any one mode of production
(society) and consisted of the technology that exists to transform nature into the array of goods
needed or desired by a society. This technology is, by its very nature, inherent in the memory of
the people (passed on from generation to generation through oral tradition and/or more formally
in the form of written records and formal instruction) and, as such, must be seen as a feature of
the people themselves, rather than a thing that exists outside of human nature. The social
relations of production, the other component of the economic base of a mode of production,
consist of the ways in which humans typically organize themselves to produce and distribute
goods. It represents the pattern of work and control, the class structure of society helping to
explain who works, who doesn’t, who organizes work, and who benefits from the work of others.
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This aspect of the economic base is often, particularly since the beginning of class divided
societies – several thousand years ago, formalized in rules or laws regarding the nature of
property and work and the legally or morally accepted ways of organizing labor and distributing
the proceeds of that work.
The forces of production are always advancing, sometimes slowly, sometimes quickly,
but advancing nevertheless. They advance because humans are creative creatures always trying
to figure out a different or better way of producing or doing something. But as the forces of
production advance, inevitably a new set of social relationships, a new social class, emerges
seeking to organize society along different lines. This new social class will have ideas that come
into conflict with the ideas of the existing ruling class steeped in the traditions and beliefs of the
previous social order. For a period of time society will be in a state of revolution during which
the new social class, and its accompanying ideas, will be in conflict with the ideas of the old
ruling class and its ways of organizing society. Eventually, the new social class emerges
triumphant and a whole new era of human history emerges, one with a different economic base
and a whole new set of beliefs, the superstructure that represents the politics, religion, sexuality,
etc., of the new era.
This is the framework that Marx used to argue that history had evolved from primitive
communism, to slavery, to feudalism and now capitalism. While each of the preceding eras
lasted for thousands of years, capitalism, he believed, was destined to be short lived. This was
due to the fact that under capitalism, the social relations of production are structured in such a
fashion that capitalists, the ruling class under capitalism, are in perpetual competition with one
another for market shares. This economic competition forces capitalists to be attentive to new
technologies and methods of production that can provide them with a market advantage. Each
capitalist is forever seeking ways to increase his/her market share at the expense of other
capitalists. But the search for new technologies and methods of production means that a portion
of the profits appropriated by capitalists (the surplus produced by workers) is always being
invested in new technologies. In other words, under capitalism, the social relations of production
are structured in such a fashion that the forces of production (technology) grow by leaps and
bounds due to the investment activity of capitalists. This explains why the volume and variety of
output is so much greater under capitalism than under any previous mode of production.
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In previous eras, the social structure of production was such that the upper classes tended
to consume most of the surplus on warfare, interesting costumes, temples, etc., instead of
investing it in new productive capacity. Of course, the upper classes under capitalism also
engage in consumption such as warfare, temple building and lavish parties, but the proportion of
the surplus allocated to the creation of new productive capacity is far greater than anything that
went before. As a result, technology grows at exponential rates under capitalism speeding up the
day when the human species will be able to conquer nature and the economy without being
subjected to the imperative of private profitability.
Marxists tend to see the emergence of capitalism as emanating out of the agricultural
surpluses that were made possible by the new technologies that had been gradually introduced
during the feudal era. They see it as emerging from within the feudal order and not the result of
some outside factor – such as international trade, which is often mentioned by mainstream
authors as a reason for the emergence of capitalism. But, once agricultural surpluses could be
generated, the thirst for more wealth led to the enclosure movement and the development of a
working class. The emerging capitalist class could now extract greater levels of productivity
from this working class, setting into motion the political and economic dynamics characteristic
of capitalism.
Thorstein Veblen’s Theory of Social Evolution
Veblen argued that institutions, i.e. habits of thought, structure the way we interpret
reality and organize our lives. That is, we are thoroughly social creatures, not just in the sense
that we live in groups and experience empathy toward others, but – more importantly, in the
sense that our behavior and ideas are heavily influenced and informed by the broader social
context of which we are a part. The actions we carry out, and the justifications used to explain
them, are heavily influenced by our culture, education, socialization, and need to belong. This
does not mean we are automatons reproducing whatever beliefs and actions are common to the
social milieu of which we’re a part; individual actions and beliefs can differ from the group. Yet,
it’s the actions and beliefs of the group and society, the institutions of society, that structure
social life and the patterns of thought and behavior common to the individuals of a society. The
norms we have internalized about the way society views a wide variety of individual behavior is
experienced by us, as individuals, through the sense of shame or guilt we often feel for behaving
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in ways we know are frowned upon by society at large, likewise with the sense of pride and
satisfaction we experience when behaving in ways we know are socially approved. In both cases,
our behavior is guided by the belief systems of society which we, in turn, have internalized and
made a part of our world view.
Veblen believed that two broad types of institutions govern social behavior: those that
deal with the problem-solving aspect of life, the technologies developed by humans to
domesticate plants and animals, build tools, furniture, dwellings, invent things, etc.; and those
that seek to explain or justify the way power is organized to distribute work and the output of
that work. The first set of institutions were progressive in the sense that they sought to improve
on the current way of doing things, facilitating and improving the process of social provisioning.
The second set of institutions were conservative in the sense that their primary aim was to
reinforce belief systems and ways of doing things.
Both sets of institutions were seen as evolving out of fundamental, biologically given,
characteristics of humans. He tended to refer to these fundamental characteristics as instincts, but
a more appropriate term would be proclivities or propensities; that is, behavioral characteristic
that are common to humans regardless of their cultural or social context. Thus, the sex drive is
innate to humans, but the form it takes and the way it’s expressed varies across cultures and
social settings.
Veblen identified several propensities or instincts. There was the instinct of
workmanship, the parental bent, and idle curiosity, as well as the predatory instinct and a related
set of ceremonial and ritualistic behaviors. The instinct of workmanship dealt with the human
need to work and create things, while the parental bent referred to the inclination to care and
provide for one’s children (future generations) and provide them with the requisite set of social
skills (socialize them into the various institutions needed to thrive in society). The propensity to
engage in idle curiosity referred to the tendency humans have to imagine how things work, to
seek answers to the question why, or to explore how sounds, colors or ideas interact. The
predatory inclination referred to not simply the human capacity to inflict harm on other humans,
animals, and the environment, but the capacity to belittle, denigrate, ostracize, shame, and
condemn, others. One of the characteristic features of the predatory propensity is that it is
associated with feelings of envy and tendency to covet the behavior and beliefs of those we think
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of as our betters. It is also expressed in the tendency to glorify and lionize those whom we see as
our betters.
It’s important to note that the above extremely short outline of Veblen’s view of human
behavior underscores the extent to which he did not accept the utilitarian view of humans. He did
not believe that humans were passive hedonists motivated only by the pursuit of pleasure and the
avoidance of pain, doing nothing unless the marginal benefit of an action outweighs the marginal
cost of exertion. Like Marx, but also to some extent Smith, Veblen saw humans as purposeful
creatures forever molding their physical and social environment. What’s more, they derive
pleasure and meaning from work. The instinct of workmanship involved more than simply doing
things, it also carried with it the sense of pride and accomplishment that comes from a job well
done, a well-executed dance routine, song, painting, sculpture, or an interesting and impressive
feat of engineering, scientific discovery, etc. We are, in short, doers and derive pleasure from a
job well done.
These two sets of institutions, those associated with technology and those associated with
ceremonialism, are forever interacting with each other to bring about the kind of social system
that’s characteristic of any given society. The institutions associated with technology are
progressive in the sense that they propel society forward, developing better ways of producing
and distributing goods, or more humane and more efficient means of sustaining life, or creating a
more peaceful life sustaining environment. In the meantime, institutions associated with
predation and ceremonial behavior are conservative and reactionary in the sense that their
primary objective is to insist on the sanctity of things as they currently are and, as a result,
making it difficult, if not impossible, to employ new ideas or technologies to extricate humans
from whatever current dilemma may be confronting a society.
Societies generally evolve as a result of the on-going reliance of technology (and the set
of institutions associated with it) to resolve existing social problems, but they can also stagnate
and slip back into obscurity, the dark ages, as a result of a stubborn insistence on implementing
idiotic ceremonial beliefs. This framework is very similar to that of Marx’s theory of historical
materialism. Veblen’s progressive institutions (those associated with technology, workmanship,
and idle curiosity) can easily be interpreted as Marx’s forces of production. In both cases, the
behavioral patterns associated with this aspect of social life are the ones that are moving society
forward, making the future better than the past. Likewise, Veblen’s ceremonial institutions (those
15
associate with predation and ritual) can be easily interpreted as Marx’s social relations of
production. In both cases, the behavioral patterns associated with this aspect of social life, are the
ones holding back progress and insisting on doing things the way existing ideas and sacred
beliefs demand they be done. But where they differ is how they view progress and evolution.
With Marx we get a much greater sense of progress and the belief that, despite the conservative
nature of social relations, the old ways will inevitably be broken asunder and a new social era
will eventually emerge. But with Veblen, there is no such optimism. While he clearly preferred a
future that’s very similar to that envisioned by Marx, he doesn’t believe that progressive
institutions will inevitably win out. Humans are quite capable, he argued, of dooming themselves
by stubbornly believing in stupid ideas they see as sacred and beyond debate.
Veblen used this framework to explain the political economic behavior of advanced
capitalist societies, specifically the USA in the late 19th and early 20th century. In his Theory of
the Leisure Class he explains the emergence of the upper class, what he calls the leisure class, in
evolutionary terms. Prior to the emergence of human civilizations, sometime around 13 to 15
thousand years ago, humans lived in extremely precarious situations as a result of their crude
understanding of things, technology had yet to advance toward a stage where surpluses could be
generated from work. This is the era referred to as primitive communism by Karl Marx or the
hunting stage by Adam Smith. During that era, Veblen imagined that the distribution of peaceful
proclivities (i.e. parental bent, workmanship, idle curiosity, etc.) predominated over predatory
proclivities. As a result, in that era, there was a greater emphasis on cooperation and sharing,
social solidarity, than on exploitation, subjugation, and oppression. But once humans developed
technology to the point where surpluses could be generated (through the domestication of plants
and animals and the creation of tools and dwellings) then the predatory inclination began to
dominate society. With the emergence of surpluses there now was something worth fighting for
and, in consequence, the emergence of class divided societies begins, replete with temple
building cultures, elaborate religious and political rituals, as well as slavery and warfare.
The emergence of surpluses provided an opportunity for predatory proclivities to gain
dominance in the organization and culture of human societies. A warrior class emerges seeking
to gain control of the surpluses by regulating the working activity of those who labor in its
production. The warrior class appropriates the surplus through brute force, warfare. But, over
time, they develop justifications for their privileged status by claiming to be descendants of gods,
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or to be gods themselves. Religious temples are created to praise and eulogize the order and
civilization brought about by the warrior class; and a priestly class emerges to sanctify the
actions of the warriors with rituals and ceremonies. Distinctions begin to emerge between those
who labor in the production of the surplus and those who live off the surplus: the warriors and
their growing entourage of sycophants, priests, priestesses, and all of those who attend to the
whims of the powerful. The upper class distinguishes itself from the masses by the fact that they
do not work; they instead engage in war, sports, religious ceremonies and temple building (more
accurately enlisting the energies of architects and workers to build the temples). In contrast, the
toiling masses work and gradually come to see the upper class as worthy recipients of the
surpluses. Working activity comes to be seen as less glorious and edifying than the exploitative
activities of the warrior classes; and evidence of work in the form of calloused hands and work-
soiled clothes come to be seen as unflattering. In the meantime, exploit and warfare, athletic
prowess and ceremonial (religious) leadership, come to be seen as praiseworthy; while un-
calloused hands, manicured fingernails and toenails, and clothing unsuitable for work, come to
be seen as signs of merit and refined social standing. The entire culture takes on a predatory tone
and competition and envy, instead of cooperation and solidarity, come to dominate society.
Veblen views the class divisions in the USA in the late 19th and early 20th centuries as the
evolutionary outcome of the patterns that emerged early on in human history. The leisure class
distinguishes itself from the common person by engaging in predatory behavior and conspicuous
consumption. They achieve their fortunes through sabotage, chicanery, exploit and theft, but
justify their actions by appealing to stories of merit, industry, religious piety, or free enterprise.
One way they display their power is through conspicuous consumption, that is, purposefully
making a show of what they can afford by consuming goods and services that will never be
within the reach of the common person. Indeed, the more expensive and less useful the item, the
better. It underscores the power of the wealthy, their capacity to use resources on meaningless
trinkets that serve no useful social purpose, other than to underscore their capacity to be
indifferent or wasteful in the use of resources that could serve a better purpose in provisioning
society at large. It also underscores their capacity to move resources away from the production
and distribution of goods that enhance the quality of social life and employ them instead in the
production of luxury goods that only serve to highlight the power of a tiny minority.
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In the meantime, the common person comes to see the conspicuous consumption of the
leisure class as evidence of their superiority and good social standing. They then go about doing
their best to emulate their behavior by going out of their way to purchase items that mimic the
conspicuous consumption of the wealthy. Just as the wealthy are intent on displaying their social
status through conspicuous consumption, the common person displays his/her social repute by
imitating the consumption patterns of the wealthy. But the problem is that, unlike the leisure
class, which abstains from work – indeed non-work is a sign of their superiority, the common
person must work for a living and can seldom afford to purchase the luxurious trinkets so
beloved by the wealthy. So, they purchase cheaper versions of the same and/or go into debt so as
to obtain the symbols of status they so desperately need for social esteem. The net result is that
the working class ends up on a treadmill, forever working harder and harder, to purchase items
that serve little utilitarian purpose but provide them with a fleeting sense of social repute.
The working class, Veblen’s common man, is thus burdened with not only the disrepute
associated with having to work for a living (as opposed to the exalted status experienced by non-
working elites) but induced by envy to buy, buy, and buy, items that serve little utilitarian
purpose other than to signal to society that he/she has, in some small measure, arrived and is
socially meritorious.
Veblen views all of this as contributing to the dissatisfaction endemic to the working
classes and to the waste that’s central to predatory societies and, in particular, capitalism.
Industry, in such a system, will end up producing all the items of conspicuous and emulative
consumption demanded by the capitalist and working classes. But, even if industry delivers those
items at rates that meet the needs of the consumers, and even if the items are sold at prices that
match their minimum average cost, the system would still be wasteful because resources would
be allocated to the production of things that serve little, if any, utilitarian purpose and seldom
enhance the quality of social life. So, resources are spent on the production of conspicuous and
emulative consumer goods instead of on the production of things that enhance the provisioning
of the community.
Note that Veblen doesn’t directly address the question of how capitalism evolved.
Instead, he sees capitalism as being nothing more than the most recent example of a broader
genus of societies that he would call predatory. That is, the predation, invidious distinctions,
conspicuous and emulative consumption, he sees in capitalism, is not unique to capitalism, it’s
18
instead a feature of all predatory societies. The major difference is that, unlike previous
predatory societies, such as medieval Europe, technological advances under capitalism has
allowed the system to produce a much larger volume of waste – generating ungodly amounts of
things that do not necessarily enhance social provisioning but rather destroy the ecological
environment in an endless pursuit of status through the accumulation of trinkets, temples and
costumes that do little to improve the life of the common man, indeed leaves him in a perpetual
state of anxiety.
Karl Polanyi theory of Capitalist Development
Karl Polanyi’s theory of capitalism, specifically his theory regarding the origins and
nature of capitalism, was laid out in his famous book “The Great Transformation,” published in
1944. In this work, Polanyi explores how capitalism came to be thought of as a system of self-
regulating markets and, in the process, lays out three interesting hypothesis: the first one is that
capitalism (a system of self-regulating markets) represents the first time in human history where
the economy, instead of being embedded within social relations, stands above society –
structuring the nature of social relations; the second hypothesis is that capitalism did not evolve
spontaneously out of the evolution of market activity, but rather was constructed by the early
mercantilist governments, the early nation states, seeking to expand their power; and the third
hypothesis is that capitalist societies have two contradictory impulses, what he calls the double
movement, which are at odds with each other and generate eras of social disruption and
increased inequality when the laissez fair impulse is dominant, and eras of improved social
relations and less inequality when the market regulation impulse is dominant.
Polanyi argues that, prior to the emergence of capitalism, the economic relations of a
people, of a society, were submerged within the social fabric of life. The act of producing and
distributing goods was carried out in the context of an intricate network of social relations and
meaning that focused more on human interaction, such as reciprocity, than on the pursuit of
material gain. Economic activity, and specifically gain-seeking market exchange, was submerged
within a network of social, cultural, and political relationships. Clearly, economic activity was
taking place, but it was not perceived as standing apart from, or prior to, the network of social
relationships that made up the fabric of life. Social relationships, and cultural and political
activity, was the context through which economic behavior was carried out. Work, production,
19
and distribution was performed within a cultural, social, and political context that gave that work
meaning. But, with the emergence of capitalism, this order is inverted, and it is now society and
social relations that fall by the wayside as economic activity, and specifically the pursuit of
material gain, comes to dominate social relations. The social fabric of life is now submerged
under the growing dominance of gain-seeking market exchange. Paraphrasing Marx, the market-
nexus expands to such an extent under capitalism that all social relationship eventually come to
be perceived in terms of cost and benefits, exchange, and “what’s in it for me.”
But it’s not just that, under capitalism, the economy now stands above society (instead of
being subsumed under society, as in previous eras) it’s that the economy, and more specifically
market exchange, now comes to take on a life of its own. In all previous systems, the market was
a subset of the formal and informal rules and traditions that had emerged over time. But with the
advent of capitalism, the idea emerged of the self-regulating market; that somehow, and in the
absence of conscious coordination, the market coordinates production and distribution without
conscious oversight. So, it’s not just that the economy stands above society, but more
importunately, that the economy somehow regulates itself and, as a result, stands above the
social, cultural, and political fabric of life. The market system, in short, is self-regulating
(whether this self-regulation is consistent with the common good is another matter).
Polanyi provides numerous examples of how economic activity, in pre-capitalist
societies, was subsumed within the social fabric of life. While we will not be going over these
examples with the detail that he does, it’s enough – for our purposes – to note that the social
patterns of reciprocity, redistribution, and householding, were the context through which
production and distribution took place in pre-capitalist societies. These principles, he argues are
sufficiently broad that they can be found in all societies, though his focus is on pre-capitalist
societies. But the form these principles can take, that is, the institutional forms that emerges out
of these principles, will vary from one society to another. Thus, with reference to the social
principle of reciprocity, individuals or groups develop symmetrical patterns of exchange; while
with the social principle of redistribution, societies develop centralizing institutions (he calls this
centricity); and lastly, with reference to the social principle of householding, individuals, groups,
and society develop autarchic institutions. He uses the behavior of the Trobriand Islanders of
Western Melanesia as examples of economic activity which is carried out under the social
principles of reciprocity and redistribution. And he points to the Kingdom of Hammurabi in
20
Babylonia, as well as the New Kingdom of Egypt, as examples of social arrangements that
reflect redistribution and centricity. The Greco-Roman era, as well as European feudalism of the
deep middle ages serve as examples of householding and autarchy.
So, for thousands of years, humanity carried out economic activity within a network of
social relationships that set the context within which economic behavior was carried out. This
pattern was inverted with the arrival of capitalism and the emergence of the self-regulating
market system. But the self-regulating market-system didn’t come onto its own until the early
19th century. What’s more, it required a prolonged period of transition, which occurred in Europe
from the end of the feudal era until the late 18th and early 19th century; a transitional period
referred to as Mercantilism by economic historians. Moreover, the eventual emergence of the
self-regulating market system did not come about as a result of the unfolding of some presumed
innate human tendency to truck, barter, and exchange, as Smith believed. Instead, the self-
regulating market emerged as a result of a prolonged period of regulation which was consciously
instituted by the state. What happened, specifically, was that the nation state was consolidating
its power into a set of laws and regulations that applied to the entire nation, eliminating local
differences and establishing a wide arena for competitive markets. This stood in contrast to the
provincialism and scattered centers of power (such as the manors and towns) that characterized
the medieval period. This, in turn, had the effect of creating a market system throughout the
nation which introduced competition among numerous venders selling similar goods. While
there clearly had been trade and exchange which took place during the medieval period, it was
largely a form of carrying trade which involved little competition among the producers who, in
any event, were inevitable scattered over large geographic distances and not directly in
competition with one another. This was true with respect to long-distance trade as well as local
trade (as in the medieval towns). Within the towns of the middle ages, trade was highly regulated
so as to ensure a flow of income that allowed the guilds and burgers to sustain their station in
life.
Mercantilism had the effect of extending the regulatory impulse that existed in the towns
and manors of the medieval era to the entire nation. And while this did not bring about the kind
of competitive, self-regulating, market which is celebrated in contemporary capitalist culture, it
did provide the infrastructure, the groundwork, needed for its emergence. That is, the self-
regulated market system did not emerge out of some innate tendency on the part of humans to
21
trade, barter, and exchange, it instead emerged as a result of a conscious effort on the part of the
state (the monarchs of the mercantilist era) to impose all manner of regulations on the economic
behavior of the subjects of the crown.
The manner in which these regulations were introduced, and the concern displayed by the
emerging states over the impact economic activity could have on humans (labor) and the natural
environment (land), highlights an interesting feature that has been part and parcel of capitalist
societies since their emergence at the end of the mercantilist era; namely what he calls the double
movement. That is, capitalist societies are forever torn between two contending impulses: on the
one hand, the inclination to free the system of regulations so as to provide as wide an arena of
action to business owners, what can be called the free market impulse; and, on the other hand,
the inclination to regulate the system so as to protect the social fabric, not just those who are
most directly impacted (such as propertyless workers or the environment), but social mores that
begin to fray as a result of the extension of the market-nexus into social relationships.
While Polanyi saw these two impulses as always present in the era of, he does draw
attention to the fact that during some eras the free-market impulse holds sway, while under other
eras the regulatory impulse holds the upper hand. This is very similar to a proposition that was
introduced by Kevin Philips in his 1990 book “The Politics of Rich and Poor.” In that book,
Philips argues that political economic history of the United States can be characterized as going
through successive waves of free-market and regulation. When Republicans gain political
control, they inevitably introduce efforts to free the market system of regulations and generally
usher in a period of unbridled expansion accompanied by growing inequality. But as speculative
fever, inequality, and poverty, begin to take their toll on the population, the citizenry reacts by
bringing into power Democrats who now introduce legislation intended to protect society against
the vicissitudes of the free market. This then ushers in another era of economic expansion, but
now accompanied by stable patterns of distribution and far less speculation and poverty. This
eventually comes to be seen as stifling to economic growth by the business class and, over time,
a new era of Republican rule is introduced, bringing about, once again, speculative manias,
inequality and poverty. Philips argued, in the early 1990s, that the era of Republican rule (which
had just started about a decade before the publication of his book) would inevitably give way to
Democratic rule as the population would react against the speculation and poverty brought about
by free market economics.
22
Note that Polanyi sees capitalism as emerging out of a conscious effort on the part of the
newly emerging nation states, at the end of the feudal era, to consolidate their power by creating
a nationwide system of common laws and regulations. In short, it was government that created
the pre-conditions for what eventually came to be called capitalism.
Ellen Wood on the Coercive Market
One of the most perceptive arguments advanced to explain the evolution of capitalism
has been provided by Ellen Wood in her 1999 book The Origin of Capitalism. Her work is
important, in no small measure, because of the corrective she offers to the common mainstream
belief that capitalism emerged over an extremely long process wherein traditions, regulations,
and ineffectual laws, were gradually removed allowing the underlying, natural, elements of
capitalism to blossom and mature. The idea underlying this perspective is the notion that
capitalism rests on the principle of self-interested exchange; that – at its core – capitalism is
compatible with human nature, specifically the self-interested pursuit of material gain. In this
sense, the basic elements of capitalism have always been around and found in the various market
and commercial societies that have populated history since the beginning of human civilization.
Unfortunately, this perspective continues, previous societies sought to regulate and channel the
self-interested aspect of human behavior and, in the process, restrained economic growth. It was
only when these burdensome traditions, regulations, and laws, were removed, when the principle
of laissez faire was introduced, that the market was able to flourish and bring about the bounty
which capitalism promises.
This idea appears in various guises. Among contemporary pundits this often shows up in
the shallow claim that China, a socialist society, is moving toward capitalism because it has been
introducing market reforms since the late 1970s. It also shows up in the work of some historians
who argue that the commercial success of medieval Venice represented an early version of
capitalism which, unfortunately, was sidetracked by inappropriate rules and laws. Adam Smith’s
theory of history represents one of the earliest versions of this thesis. He saw the development of
capitalism, which he calls a commercial society, as emanating from the medieval cities and,
more specifically, the widening of the division of labor between the countryside and the urban
centers, as a result of the trading activity of merchants and artisans.
23
Central to all the versions of this perspective is the notion that the basic elements of
capitalism have always been around, just waiting to be unleashed. And that its emergence came
about as a result of the, sometimes conscious and at other times unwitting, removal of
unnecessary rules, regulations, and laws. Capitalism, in other words, is always waiting to be
unleashed, and its only when the fetters restraining self-interested exchange, however well-
intentioned those fetters might be, that capitalism blossoms.
Wood disagrees with this perspective and argues instead that capitalism is a specific
historical formation and not some underlying principle of self-interested exchange just waiting to
be unleashed. Market using, commercial, societies, have been a feature of humanity since the
beginning of civilization. But the widespread use of markets, as in ancient Mesopotamia, Persia,
Greece, or Rome, does not mean that those societies were capitalist, any more than the existence
of a robust commercial society, as in medieval Venice, means that it was capitalist.
The widespread reliance on markets and commerce, does not, in and of itself, make such
a society capitalist. It’s true that such societies rely on the pursuit of material gain, to make a
profit (surplus) from exchanging goods. The merchant is central to such societies and she/he
makes her/his fortune by trading in goods that have already been produced. The object of the
game is to buy cheap and sell dear. But the goods themselves need not be produced along
capitalist principles. Indeed, throughout the course of much of human history, production was
carried out by slave labor. The slave produces a volume of goods which exceeds the subsistence
requirements of the slave, allowing the owner of the slave to appropriate the difference in the
form of a profit (surplus) upon selling the finished good to a merchant. The merchant than sells
that good in another region of the economy and charges a price that exceeds the original price by
an amount that covers the cost of transportation, storage, other sundry expenses, and a mark-up
for profit.
A similar set of relationships can be found in the feudal societies of medieval Europe,
where the bulk of the gross product was generated by serfs who were obligated to provide their
overlords with the surplus generated from their labor. The merchants would then purchase the
output generated by the serfs and, as in the case of slave-based societies, sell the resulting output
elsewhere at a profit.
In both slave and feudal societies, the surplus that’s generated by the primary producer,
i.e., those laboring to produce the good, is appropriated by their owner or lord through extra-
24
economic means, such as through violence, tradition, and/or law. This is most readily apparent in
the case of slavery where it takes little imagination to understand that the owner forces the slave,
on pain of physical punishment, to generate a surplus beyond his/her own subsistence. But what
makes capitalism different from previous market-based, commercial, societies, is that the
appropriation of the surplus from the direct producers, i.e., free laborers, occurs through
economic means (instead of extra-economic means that occurs under slavery or serfdom). In
other words, under capitalism the worker is not owned by the capitalist nor does he/she have
feudal obligations to an overlord, he/she is free. Yet, economic necessity, compels him/her to sell
his/her ability to work to the capitalist and, in the process, generate a surplus (profit) which
exceeds the wages he/she retains for himself/herself. This is what Wood, and Marxists, mean by
economic coercion.
But it must be noted that this issue of economic coercion is not confined to the behavior
of the worker, who must always offer labor so as to purchase the necessities of life, it’s also a
feature of capitalist behavior. The capitalist is also operating under the compulsion of the market
to generate the profits he/she is forever pursuing. He/she is in constant competition with other
capitalists, limiting the profits that might be captured from selling the finished good. So, while
surpluses are indeed generated by the direct producers (workers) under capitalism, this is carried
out not through extra-economic means (such as corporal punishment, violence, as in the case of
slavery) but through economic means where exchanges are voluntarily entered into. Yet, despite
this freedom, both workers and capitalists feel driven by the imperatives of the market.
This characterization of capitalism, as a system of economic compulsion, is a common
feature in Marxian interpretations. Indeed, it’s the way in which Marxists generally explain
capitalism. It’s viewed as a system in which both the worker and the capitalist are free to buy and
sell whatever they wish, but the capitalist owns the means of production while the worker does
not. This imbalance allows the capitalist to hire workers to generate a value that exceeds the
competitively determined wage rate. The difference between the value of the produced good and
the wages of the worker is retained by the capitalist in the form of profits. But all of this occurs
in a context of free-wheeling market exchange. The worker is not forced to work for the
capitalist and the capitalist is not forced to hire any one worker. Yet, the ever present need to
sustain one’s self compels the worker to generate a surplus to the capitalist, even though both the
worker and the capitalist view this exchange as voluntary and non-coercive; after all, the worker
25
can always quit, if he/she finds the terms of employment onerous; and the capitalist doesn’t have
to hire a specific worker and can easily terminate the relationship, if his/her productivity is too
low.
This characterization is generally presented in the context of an industrial economy, with
firms operating in an urban setting, producing and selling commodities through mechanized
techniques of production. As a result, Marxian interpretations of capitalism frequently focus on
the industrial context of that relationship. There’s a pool of propertyless workers forever seeking
employment, and competition among these workers has the effect of keeping the wages of labor
close to subsistence (the cost of reproducing labor). The capitalist then hires workers at the going
wage and has them interact with the machines and raw materials owned by the firm to generate a
product which is then sold at a price that exceeds the cost of labor and materials. That excess is
retained by the capitalist in the form of profits. Economic compulsion ensures that capitalists will
generally be able to extract a surplus from the workers, but not because the workers are slaves or
serfs, but because the need to subsist will ensure that workers generate a value that exceeds their
wages.
While Wood has no quarrel with the above characterization, what makes her argument
interesting is that she places the origins of capitalism not with the industrial revolution, which
began toward the end of the 18th century, but with the enclosure movements and the
centralization of land that occurred in England beginning in the late 15th and early 16th century.
In other words, capitalism had its origins in agriculture, the countryside, and not in industry and
urban centers. Indeed, in her telling of the story, the industrial revolution occurred in large
measure because capitalism had already emerged in the countryside.
The centralization of land, that is the growing concentration of land ownership in the
hands of a relatively small proportion of the population – the nobility and aristocrats of that era,
along with the enclosing of formally common lands, had the effect of wiping out a significant
proportion of the peasant farmers that had formally made a living through subsistence farming.
This, in turn, had the effect of creating a much larger class of tenant farmers. People, oftentimes
former peasants, who would now rent land from the landowner in an effort to generate a
marketable agricultural good which could, hopefully, be sold at a price that covered the cost of
the material inputs, their own subsistence needs, and the rent due to the landlord. A market for
leases began to emerge where potential tenant farmers would compete against each other to rent
26
land from the landowners in the hope of producing an agricultural good that would pay for the
rent, material inputs, and their consumption needs. The tenants were motivated to be as
productive as possible, to ensure they could keep for themselves any revenue that exceeded the
cost of materials and rent. At the same time, the landlords now had an incentive to rent out the
land to those tenant farmers they viewed as most productive. In other words, economic coercion
was motivating the tenant farmers to be as productive as possible, allowing the surplus, in the
form of rent, to be appropriated by the landowners, but not through non-economic means of
coercion, as in the case of slavery and serfdom, but through the economic coercion exerted by
market relations.
Note that this economic coercion is being felt by the tenant farmers, not because they are
propertyless workers but because if they do not manage to rent land, they’ll be incapable of
generating an agricultural product which will allow them to survive and hopefully prosper. In
other words, economic coercion was already becoming a feature of the system, but it was being
felt by the tenant farmers and not by a class or propertyless workers. And both the tenant farmer
and the landlord were now feeling the pressure of having to depend on the market to obtain their
income. If the tenant farmer’s productivity was inadequate, he/she could easily lose the right to
rent the land, and thus the flow of income that could be generated from that activity. The
pressure. was on to be as productive as possible. Economic coercion, in other words, was already
in play. And it’s this aspect of capitalism, namely economic coercion, which Wood sees as one
of the defining features of capitalism.
This new set of property relations had the effect of increasing output from the
countryside. Agricultural productivity set the context for the industrial revolution which would
occur a little over two centuries later. The surpluses being generated from agriculture facilitated
the development of industry which would occur later on. In the meantime, of course, the
enclosure movement also had the effect of creating a class of propertyless workers who would
also feel the economic coercion being experienced by tenant farmers. But by the time of the
industrial revolution, an economic system organized on the basis of market driven economic
coercion was already in place. In other words, capitalism had already emerged, at least two
centuries. earlier, by the time of the industrial revolution.
Firms, Markets, and Income
Firms, Markets, and Income
Firms
Corporations
Partnerships
Single Proprietorships
Firms as units of capital
Capitalists see firms as an investment that is expected to generate a stream of profits over time.
Firms are generally beyond the reach of most workers (i.e., too expensive to purchase).
Firms, Markets, and Income
Capitalists
Industrial capitalists
Commercial capitalists
Financial capitalists
Capitalists v entrepreneurs
Capitalists v rentiers
Firms, Markets, and Income
Firm profits distributed in following ways
Dividends
Retained earnings
For gross investment (depreciation and/or net investment)
Rent seeking (lobbying government, influencing legislation, etc.)
Firms, Markets, and Income
Inputs to firms and flows of income
Labor
Labor of employees – wages and salaries
Labor of owners – compensation for their labor also called wages. Estimate.
Wages represent the return to labor, both employees and owner’s labor.
Capital
Fixed and Circulating reproducible goods
Financial capital
Profit a return to the firm (physical capital). Interest a return to loans (financial capital).
Land
Non-reproducible.
Firms consider it as a form of capital
Rent a return to land
Finance
Interest a return to money
Firms, Markets, and Income
The firm as a unit of capital (K)
Assets = Capital (Fixed & Circulating), Land, Financial Assets
Liabilities = various loans and balance on lines of credit
The Value of the Firm = Net Worth
Net Worth (K) = Assets – Liabilities
Return on Investment in Firm (Value of Firm) = Profits ()
Rate of return (rate of profit) = r = /K
Firms, Markets, and Income
Markets
Creative destruction
Firms are forever searching for monopoly profits
Entry and exit of firms into markets keeps pressure on prices and thus profits
Firms seek to avoid competition by investing in new technologies
Competition also avoided through rent-seeking (gaining legislation and rules that favor them)
Capitalist market economies cannot operate without
Brokers
Money – finance – banking
Firms, Markets, and Income
Classical Circular Flow Model
The model ignores the role of government and foreign trade
Workers offer labor and are paid wages
Workers consume all their wages – no savings (for the class as a whole)
Capitalists manage their firms by hiring labor to produce and sell output
Profits (surplus) equals the difference between value of output and wages.
Capitalists consume and invest their profits
Firms, Markets, and Income
Classical Circular Flow
Firms, Markets, and Income
Classic Circular Flow
Y = W + Π
E = Cw + Ck + Ig
Y = E ==> W + Π = Cw + Ck + Ig
Sw = W – Cw
Sk = Π – Ck
S = Sw + Sk = Ig
System reproducing itself perfectly, in equilibrium, when
Y = E
S = Ig
Firms, Markets, and Income
If Y > E
Then S > Ig,
Inventories growing unintentionally,
production and employment start to slow down
If Y < E
Then S < Ig,
Inventories depleting unintentionally,
Production and employment start to pick up
Firms, Markets, and Income
Investment, capital accumulation, drives the system
,
Sw = W – Cw = sw・W, where sw = Sw/W
Sk = – Ck = sk・, where sk = Sk/
Y = E -->
substituting (Y – for W
solving for
or
, when = 0
Chapter3
Firms, Markets, and Income
I. Firms and Income
The owners of firms are called capitalists or business owners. The defining criterion is
that in addition to owning a firm or shares of a firm – as in the case of a corporation, capitalists
are also engaged in managing the enterprise and making decisions regarding the generation and
use of the firm’s profits. In the case of a single proprietorship the capitalist is the individual who
owns and manages the enterprise. In the case of a partnership, the capitalists would be the active
partners of the enterprise engaged in various aspects of management and allocation of profits.
And in the case of a corporation, the “capitalist” is actually a collection of individuals, the top
managerial staff – the CEOs, CFOs, Presidents, and such – that own shares of the business and
make decisions regarding production, sales, and the use of corporate profits. We can also refer to
capitalists as entrepreneurs to underscore the fact that they are the ones guiding the business and
making decisions regarding investment, production, employment, sales, and profits. But, while
all entrepreneurs are capitalists, not all capitalists are entrepreneurs. Some capitalists engage in
very little to no managerial oversight or productive economic activity, they simply live off the
dividends generated by the firms they own. We call such capitalists, rentiers.
Rentiers refer to a class of people who own property and live off the income generated
from such property but are not actively engaged in productive economic activity. In the case of
rentiers who live off corporate stock, they’re content to collect dividends and/or enjoy capital
gains without taking any significant role in the management of the business. Rentiers can also be
found owning other kinds of assets in addition to corporate stock, such as real estate and various
kinds of debt instruments such as notes, bills, and bonds. The common thread connecting this
class of people, the rentiers, is that they receive a flow of income despite not being engaged in
productive economic activity or managing such activity. The income they receive, either in the
form of dividends, interest, or rent, is due solely to the fact that they own assets such as shares of
a business, financial securities, or real estate, but are not active participants in organizing
whatever work might be necessary to make such assets productive.
The classic example of a rentier would be the aristocratic English landowner of the 18th
century who received a flow of rents from lending his land to capitalist farmers but was not
2
involved in managing or producing the goods generated by the capitalist tenant. Other examples
would be contemporary trust fund babies who inherit their parent’s wealth and are entitled to a
handsome flow of property income without overseeing the properties embodied in that wealth
and often knowing little about the property and firms they own. Another example would be
wealthy bond holders who live off the interest income and capital gains provided by the
securities they own, without engaging in productive economic activity.
Of course, any one individual may very well be an entrepreneur with regard to her/his
own business but a rentier with regard to the real estate or financial assets she/he owns. Yet,
despite the existence of such overlapping patterns, it’s important to distinguish between these
two categories of owners, and treat them as separate classes of people, not only because of the
distinct motivations underlying each group, but because of the different roles they play in their
use of private property, productive activity, and flows of property income (profits, interest, and
rents).
The profits of firms are generally distributed in four broad forms: first, as income that
flows to the owners of the firms either in the form of dividends to the owners of corporate stock
or as the portion of profits that owners set aside for themselves and their families; second, as
retained earnings held in the form of cash or financial securities that generate interest income and
can be exchanged for liquidity on fairly short notice; and third, invested in maintaining the firm’s
existing capital stock in good repair, adding to or enhancing the firm’s capital stock, or investing
in a new firm. Beyond these three uses of a firm’s profits, it’s common for capitalists to use a
portion of their profits for political activity, lobbying or legal representation, for the purpose of
defending or enhancing their flow of property income; that is, using a portion of profits to
influence government into setting up a legal or regulatory environment that guarantees a flow of
rents to the firm.
The inputs that are used by firms to produce profit-generating goods consist of two broad
categories: labor and capital. Labor refers to all forms of laboring activity and should not be
thought of as being confined to the direct production and delivery of the good, the kind of work
normally carried out by the non-supervisory personnel of a firm. It includes, in addition to such
work, a wide variety of overhead work involved in the maintenance and advancement of the
firm, such as management, research and development, accounting and finance, marketing,
secretarial services, information technology, janitorial work, and security, among others. In
3
short, labor refers to all of the work carried out by the employees as well as the work of the
owners or managers.
The compensation of labor we call wages, even though it’s common to make a distinction
between something called wages and something called salaries or more broadly lab
or
compensation. As is common in economics we will lump together all these forms of labor
compensation and call them wages. The key idea here is that wages refer to the income that
accrues to the laboring activity necessary to keep the firm going, regardless of whether it
involves the direct production and delivery of the good or various forms of overhead activity.
On the whole, those who offer their laboring services to the firms, the working class,
consists of people who own very little wealth or capital and, as a result, must offer their ability to
work in return for wage income. Obviously, if they owned enough financial and/or physical
capital (specifically a firm) to live off the property income generated from that wealth they
would not need to work for others. But they don’t. As a result, the need to find a job that will
provide, at a minimum, a flow of wages sufficient to purchase the socially necessary bundle of
goods is urgent. The exception to this generalization occurs in the case of the top managerial
strata of large firms, say corporations, where the wages of managers generally exceed what
might be thought of as appropriate compensation for labor and includes a portion of the firm’s
profits (though it isn’t measured as such in the ledgers). Thus the “salary” of top corporate CEOs
is often represented as compensation for labor, even though it would be more appropriate to
break up that “salary” into a portion that involves compensation for labor (i.e., wages) and a
portion that involves a return on the firm’s capital (i.e., profits).
This feature of capitalist societies has the effect of keeping the balance of economic
power between capitalists and workers on the side of business owners, keeping wages and
working conditions more favorable to capitalists than to workers. In their search for profits, firms
have a strong incentive to keep wages relatively low while demanding as much effort as possible
from their labor force. But the extent to which this incentive shows up in the wages and work
conditions offered by firms depends on the legal and regulatory framework created by
government, as well as the nature of competition in the labor market. LME capitalist societies
tend to provide little infrastructural support to workers and as a result, wages tend to be lower
and work conditions more onerous than in social CME societies. And in both cases, wages and
4
work conditions tend to improve during periods where firms are actively competing against each
other for laborers, while deteriorating when the demand for labor diminishes or stagnates.
The firm’s capital refers to all of the assets that are owned by the firm and used by labor
to generate the goods and services for sale. It’s a huge category and is traditionally broken down
into two components: fixed and circulating. A firm’s fixed capital refers to all of the physical
structures, machines, and tools, used to carry on the production and delivery of the commodity.
It’s generally referred to as the firm’s plant and equipment. Circulating capital refers to all of the
raw materials that go into the production and delivery of the commodity, the inventory of raw
materials waiting to be used, the inventory of the commodity at various stages of production, and
the inventory of the finished commodity waiting to be sold. All of this is the physical stuff that
must be used by labor to produce a finished good and deliver it to the market.
Land, both the surface upon which buildings sit as well as the land that might be used for
primary sector activities (farming, ranching, mining, logging, etc.), occupies an important though
complicated position within the process of production. From the perspective of the firm, land is
an owned or rented asset and, as such, viewed as a part of the firm’s capital structure and/or a
necessary expense of doing business. The firm thinks of it as a form of capital since it’s owned
with the intention of using it, along with other inputs, to make a profit from producing and
selling a good. But, unlike capital goods, land is not a produced good; it is a gift of nature, and,
as such, non-reproducible. The non-reproducibility of land is the source of rents to landowners
and rising unit cost brought on by diminishing returns to land. In addition, the non-
reproducibility of land poses ecological problems of sustainability when injudiciously exploited.
Beyond the physical capital needed for production, firms also own a wide array of
financial assets. Examples of this would be the firm’s cash and demand deposits, its accounts
receivable, and the various financial securities, such as stocks and bonds, it might own and can
sell in exchange for liquidity. This too is part of the firm’s capital but unlike its physical capital,
these financial assets are used to make a wide variety of payments for the purchase of raw
materials, capital goods, the services of labor, and/or more financial assets. Additionally, the firm
has a variety of liabilities, various types of loans it has incurred in the past, which it is committed
to paying on a regular basis. The financial obligations associated with these liabilities, such as
the monthly payment on a loan, must also be paid out of the firm’s financial assets, either with
cash on hand or selling other financial assets to pay existing liabilities. The firm is always
5
replenishing its financial assets with money it receives from selling its produced goods and/or
purchasing financial assets that promise a stream of interest income and/or capital gains. At the
same time, it’s drawing on this fund to pay the various financial obligations it has incurred in the
past.
We can think of the firm as a unit of capital, a productive asset, that is expected to yield a
profit to its owners. The value of the firm, or stated differently – the value of the capital invested
in the firm, is equal to the value of the firm’s physical capital (both fixed and circulating) plus
the value of its financial assets minus the value of its liabilities. The resulting amount would be
the net worth, or value, of the firm. There are several different ways of estimating this value, but
for our purposes it’s enough to know that the firm is seen as an investment of capital which the
owners have made on the expectation that it will yield a stream of profits over time.
The minimal amount of capital that’s needed to invest in a business, and manage it
successfully, is generally beyond the reach of the average worker. To be sure, there are cases
where such things occur, but they are the exception to the rule. Most families do not own a
business firm; they instead work for those who do own a firm. This is not to say that small
artisanal businesses do not exist in capitalist societies, they do. The economic landscape is
populated with independent craftsmen who combine their skilled labor with the modest capital
they own to produce a good or service for income. Independent contractors, small family
farmers, and CPAs operating out of their home, are examples of this form of economic
organization. They lie in between the capitalist and the worker, having elements of both. They
own capital but they also work their own capital to generate a flow of income. Most of the
income that flows to this class of people is a wage (i.e., compensation for their labor), even
though they mistakenly refer to it as a profit. The return to capital, namely profit, is usually a
smaller proportion of their total income, explaining in large measure why small business owners
generally put in a lot of hours working. These “firms” have more in common with small peasant
producers or medieval craftsmen than with the profit driven firms of capitalism which is the
focus of our study. In short, a capitalist economy is not an artisanal economy, a commodity
producing society wherein most families own a modest amount of capital and provide for
themselves by using their own labor to produce and sell goods. Instead, a capitalist economy is
one wherein most families do not own a small business and are thus obligated to work for those
who do own firms.
6
II. Economic freedom and creative destruction
Economic life in capitalist societies is anything but stable. These systems are continually
changing what they produce and how they produce it. The composition of the gross product,
along with its method of production and labor processes, is in a constant state of flux. The
introduction of new goods is accompanied by the introduction of the new labor processes and
techniques required for their production. Entire industries, replete with enormous factories, vast
networks of suppliers and distributors, and work forces numbering in the tens of thousands, are
created in a few short years. At the same time, unprofitable industries are abandoned, factories
and machines sold as scrap, and workers dismissed and forced to move on. The incessant
transformation in the methods of production and items of consumption bring along with them
changes in centers of political and economic power, location of cities, forms of entertainment,
nature of warfare, and styles of life. To paraphrase Joseph Schumpeter, capitalism is in a
perpetual state of creative destruction, continually breaking down unprofitable goods,
institutions, and social relations, in favor of their more profitable counterparts.
The commodity producing character of capitalist societies, that is the fact that they rely
on markets and the profit motive, is one of the major factors contributing to the kind of
dynamism implied by the phrase creative destruction. In these systems income seekers are
always moving into those activities that offer a greater flow of income, while leaving those that
offer a smaller flow. Capitalists invest greater amounts of capital into sectors that experience
greater than normal profits while emigrating out of those that experience little to no profits.
Likewise, workers migrate to those sectors which offer greater than normal wages while leaving
those which offer declining wages.
Yet, while both workers and capitalists move out of low paying areas and into high
paying areas, it is the capitalist who sets the stage for the process of creative destruction.
Whether an industry will be growing or contracting is ultimately dependent on the rate of profit
that can be earned in that industry relative to other possibilities. Since capital will only be
invested in productive capacity that promises to pay a return that is no less than what could be
earned in the next best alternative, the extent to which the productive capacity of an industry is
funded depends on the extent to which it can earn a return that is no less than the return being
earned elsewhere. If the return earned in any one industry falls short of the return earned in some
7
other industry, capital will be moved out of its current commitment and into the more profitable
alternative.
In the meantime, whether labor will move from one sector of the economy to another is
dependent on the extent to which there has been a prior commitment of capital. It is not until
capital has been invested in some new sector of the economy that labor can move. Since the
production and eventual sale of output requires that workers interact with productive capacity,
the investment of financial capital into some new capacity always carries with it a
complementary demand for labor. Thus, as the tempo of capital accumulation increases in any
one sector of the economy so too does the demand for labor and, depending on the intensity of
the competition for labor, the wages of labor as well.
The opposite set of circumstances takes place in those sectors of the economy where the
profit rate is falling. In these declining sectors capitalists will be liquidating their investments by
selling portions, or all, of their now unprofitable capacity. Factories, office buildings,
warehouses and machinery will be put to some other use or sold as scrap. Capitalists will be
incurring losses and, depending on the severity of the downturn, closing down their firms and
declaring bankruptcy. At the same time, the demand for labor will be falling, unemployment
rates will be rising, and wages will be falling.
Beyond all of this, there is another aspect to this process that is not captured in the above
descriptions, something that goes beyond the relatively simple act of moving capital and labor in
and out of existing industries. The most critical feature of the process of creative destruction is
that it involves the commitment of capital to the creation of goods that are currently non-existent.
The capitalist does not sit back and wait for market signals, such as differential profit
opportunities, to tell him or her when and where to invest. The capitalist is an aggressive creature
who goes out and creates the environment needed to generate the greater profits. He or she is
continually testing the market, seeing if this or that version of the good, or some new-fangled
gizmo, might provide a better return.
This is the entrepreneurial, innovative, aspect of capitalist behavior. The capitalist-
entrepreneur commits capital to the creation of goods that are currently non-existent but that,
hopefully, will be bought in prodigious amount once it hits the market. There is of course a risk
involved in such an undertaking, the newly created good may turn out to be a dud – an Edsel, and
destine the capitalist to future losses; but, if it is something consumers take a fancy to, the
8
capitalist will be in the fortunate position of being the sole provider of the good. He or she will
have achieved a monopoly position and, in consequence, be able to capture monopoly profits.
The problem is that, in the context of a relatively free and open market system, any new
monopoly position which is captured by some entrepreneur will always be subject to attack by
other capitalists also wishing to cash in on the profits. Copycat versions of the good will begin to
appear on the market vying for a share of the income which previously went to the innovating
capitalist. As competition from other invading capitalists heats up and the market share of the
innovator begins to shrink, the entrepreneurial capitalist will begin to search, once again, for
other, “new and improved,” products to create and sell.
Capitalist competition thus involves an on-going search for the monopoly profits that
might be captured from the introduction of some new good. The aggressive, entrepreneurial,
capitalist is continually investing a portion of his or her profits into researching and developing
some new commodity that offers the promise of greater profits. As a result, capitalist societies
are always being bombarded by new commodities, new productive techniques, or new ways of
delivering an existing commodity. While much of this competition leads to the introduction of all
sorts of frivolous and ultimately useless things, it is also responsible for the introduction of
genuinely useful items. A testament to this is the enormous variety of goods, such as the
automobile, the vacuum cleaner, television, the refrigerator, radio, air conditioning, the
microwave oven, and personal computer, that workers in advanced capitalist societies consider
socially necessary items of consumption.
III. Free competitive markets
The creative destruction characteristic of capitalist societies is largely the result of a
political economic system that encourages economic freedom; a system that allows individuals
and firms to pursue their search for income any way they see fit, so long as it doesn’t interfere
with the right of others to do the same. Adam Smith first expressed this idea in the latter half of
the eighteenth century.1 The thesis he proposed is that a nation’s wealth and income, the volume
and variety of goods it produces, will be enhanced if it pursues a policy of economic freedom.
1. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations. Edited with introduction, marginal
summary and enlarged index by Edwin Cannan. New York: The Mod
9
He supported this thesis by noting that the volume of products generated by a society is
related to the degree to which its labor force is subdivided into differing occupations and
industries. The more intricate a society’s division of labor, the greater the volume and variety of
goods it can produce. The specialization of labor that comes from an increased division of labor
has the effect of increasing labor’s productivity, that is, it increases the amount of gross product
generated per worker. Societies with a wide range of industries and occupations, and further
subdivisions within each of these, generate more output per worker and, as a result, have a higher
material standard of living. In contrast, a less intricate division of labor is characteristic of
societies whose material conditions are meager. And while a nation’s income could be improved
through state mandated activities forcing a greater subdivision upon its labor force, Smith
believed that a more intricate division of labor was best achieved when individuals were given
the freedom to search for income any way they deemed fit.
This belief derived from his assumption that humans are always seeking ways to improve
their material condition and that, because of their inquisitive nature, are forever tinkering with
their material environment coming up with better tools and technologies. Thus, in their search for
income, individuals apply their labor and/or capital to those activities that seem to offer the
highest economic reward. Workers will seek out occupations and industries that offer the highest
wage, while capitalists will invest in those industries that offer the greatest profit. At the same
time, entrepreneurs will invest in the development of technologies that offer the possibility of
future monopoly profits, creating in their wake entirely new spheres of work while
simultaneously enhancing the productivity of labor.
But the extent to which the nation’s labor can be subdivided in this fashion depends on
the extent to which there is a ready market for the growing volume of goods. The introduction of
a new product will increase the flow of income only if there is a demand for the good; that is,
only if the workers and capitalists in the other industries are able and willing to part with a
portion of their income. Exchange and market activity is thus tied to the manner in which the
division of labor evolves as individuals seek to improve their income. The production and sale of
new goods is dependent on their demand, which in turn is facilitated through the production and
sale of other goods. Thus, the tempo at which goods can be produced and sold is constrained by
the rate at which market demand grows.
10
A free economic system thus provides the context through which the division of labor can
evolve into ever more complex forms, reflecting, at one and the same time, the application of
productivity enhancing technologies as well as the level and composition of demand that
emerges from the generation and distribution of income.
Adam Smith viewed this thesis as applicable to the long-term, a characterization of a
society’s likely economic outcome over a period of a generation or two, or more. It was not
viewed as a short-term prescription intended to improve the economic position of society within
a couple of years. Nor was the argument intended to suggest that income would grow
uninterruptedly without episodes of stagnation or depression. Additionally, the thesis said
nothing about whether the nation’s income would be distributed equitably or whether it would be
sufficient to insure a survival flow of income. Indeed, Smith assumed that over the long term,
workers would earn wages that were no greater than the subsistence minimum needed to
reproduce another generation of workers; implying that, at any one point in time, some workers
would be earning below subsistence wages, counterbalanced by those earning above subsistence
wages. He also assumed that the distribution of wealth and income would remain unequal,
reflected in his characterization of economic growth as a process wherein the nation’s income
grows despite a stable class structure.
It must also be emphasized that this thesis was not intended to suggest that beneficial
outcomes would automatically emerge from a free for all, a system unhindered by law,
government, and civility. The institutional environment, as well as the specification of what was
meant by economic freedom, was critical to his belief that economic growth would be the likely
outcome of a nation organized along the lines of economic freedom. At a minimum it assumed
that the pursuit of economic gain would not be carried out by infringing on the right of others to
do the same. It also assumed an economic environment that was sufficiently open and
competitive that it prevented any one capitalist, or coalition of capitalists, from gaining control
over the market. Indeed, he was suspicious of the business class, warning against their self-
interested tendency to conspire against the public good. And lastly, as implied in his discussion
of public infrastructure, his championing of the individual’s right to seek income assumed access
to the means by which such a right can be exercised and made credible.
The economic growth that Smith thought would occur from the adoption of a system of
economic freedom was driven primarily by his assumption that humans are forever seeking to
11
improve their material condition. But this is, at best, a contentious proposition. Historical and
anthropological examples exist of entire cultures that are driven by concerns other than material
gain. And even within capitalist societies one can find people who, despite the materialist
inclinations of such cultures, are indifferent to the pursuit of wealth.
It could be argued, therefore, that the economic growth that is characteristic of capitalist
societies is not so much the result of giving free reign to some presumed natural inclination to
pursue wealth and income, but rather the result of a specific culture (namely a capitalist or
bourgeois culture) that socializes its members to adopt the pursuit of material gain as a symbol of
success and social rep ute. While this undoubtedly plays a role in the long-term economic
expansion characteristic of capitalist societies, there is, as well, another factor, one that is more
immediate and impinging on the economic survival of business, that also accounts for the
system’s growth. This other, more immediate factor involves the nature of capitalist competition.
In a free economic system, the profit that any one capitalist can capture from the sale of
goods is always under the ever-present threat, or actuality, of attack from other capitalists
seeking to sell the same, or similar, goods. The loss of market share, and the corresponding loss
of profit which such an attack represents, induces the capitalist to divert a portion of his or her
profit into the development of new and better goods or more efficient technologies. If the
capitalist fails to invest at the proper rate, or neglects the search for new products, better delivery
systems, or more efficient technologies, the business could die as more aggressive capitalists
invade the market with new goods. Market competition, and the need to keep the business viable,
has the effect of inducing capitalists and managers to invest portions of the firm’s profit in new
capacity and better technology.
The improved capacity and technology made available through this investment process,
enhances the productivity of labor and the nation’s material condition of life. But it depends on
the structure of competition. A system of economic freedom that puts no restraint on the
concentration of economic power in the hands of a small number of capitalists, can lead to a
reduction in economic growth as a result of the declining investment induced by the security
made possible by monopoly power. That is, the achievement of a monopoly position,
unthreatened by the possibility of attack from other capitalists, can lead to a reduction in
investment spending. Thus, productivity enhancing growth requires a specific type of economic
12
freedom, one that encourages competitive markets while remaining vigilant of the monopolizing
proclivities of capitalists.
IV. Markets, money, and brokers
In capitalist societies virtually all markets involve the exchange of goods for money. The
value of all goods is expressed in terms of money, and very few markets, clearly none of the
significant ones, involve the direct exchange of one good for another. Before anyone can
purchase a good, they must first obtain money; and money can only be acquired through the
selling of some other good or borrowing it in the financial markets.
The evolution of capitalism is intimately associated with the evolution of money, or more
broadly, finance. Financial markets are the vehicles through which loans are issued and money is
created.2 These markets are quite large and actually consist of a wide variety of sub-
markets.
While we need not examine the financial markets at this point, it’s enough to know that it is
through the financial markets that money is made available for the buying and selling of things.
In particular, a significant fraction of the investment spending that takes place in a capitalist
society is financed through the money that can be borrowed or purchased through the financial
markets.
The reproduction of a capitalist economy thus requires not only well functioning labor
and product markets, but also well-functioning financial markets. It can be argued that the
behavior of the labor and product markets is dependent on how well the financial markets are
operating. After all, the amount of financial capital, and thus physical capital, labor power, and
material inputs to be made available for the production of goods is dependent on the terms at
which money can be borrowed on the financial markets.
There is one last institutional feature of markets that should be discussed; this involves
brokerage activity. Very few markets, with the labor market being the major exception, involve
the direct interaction of ultimate buyers with the firms producing the good. The majority of
markets, and virtually all product markets, rely on intermediaries whose sole function is to
facilitate the transfer of goods for money. Retailing is one such example. The goods purchased
through a retail store, like a supermarket, are seldom produced at the store. Instead, they are
offered for sale as a result of the brokerage activity of the store.
2. This is explained in chapter 13.
13
The broker’s function is to bring together buyers and sellers, to find buyers for suppliers,
and suppliers for buyers. The broker serves as the mechanism through which supply and demand
is adjusted to each other. In the process, brokers capture income by charging a fee for their
service or marking up the price of the goods they trade. Those who engage in this activity do not
always refer to themselves as brokers; they may, instead, carry other names such as retailers,
wholesalers, or dealers. And while this form of market behavior tends to emerge spontaneously,
not all brokerage activity is informal. Some forms of brokerage activity, as in real estate and
finance, are often formalized by requiring licenses, certificates, and/or formal training.
V. The Classical Circular Flow and the Profit Share
In this section we’ll develop a simple model of a capitalist economy that highlights the
relationship between wages and profits on the one hand, and consumption and investment on the
other. To keep things simple, the model ignores the role of government and foreign trade, and
assumes only two classes of people: capitalists and workers. The capitalists own the firms and
hire workers to produce and sell goods with the aid of the machines and materials made available
by the firms. The capitalists then use the revenue generated from that sale to pay for the wages of
the workers, keeping the remainder in the form of gross profits. Of course, for any one firm there
would also be the expenditures incurred for the use of materials and services bought from other
firms. But for the economy as a whole, these expenditures are ultimately reduced to either wages
or profits because the expenditures of any one firm must end up as the income of the workers and
capitalists of other firms.
The workers spend their wages on the purchase of necessities – the commodities needed
to maintain a socially necessary standard of living. If their wages are large enough, they might
also engage in surplus consumption and save a portion of their wages. But, while individual
workers may save, for the class as a whole saving out wages is relatively small and can, for
purposes of theory, be ignored. The reason for this is that workers’ saving is primarily used to
finance their own future consumption; so that, at any moment in time most of the saving being
generated by one group of workers is roughly counterbalanced by the debt financed consumption
(beyond their wages) of another group of workers. Thus, when viewed from the perspective of
the entire economy, it is not unreasonable to claim that the wages of the working class are spent
on the purchase of consumer goods. The only real distinction would involve a determination of
14
the proportion of workers’ consumption going to socially necessary consumption and surplus
consumption.
In the meantime, capitalists are also spending their income on the purchase of consumer
goods. A portion of this consumption is socially necessary since capitalists do undertake
productive overhead work. But in addition, capitalists engage in surplus consumption and saving.
However, unlike workers, and because of their relatively high per capita income¸ the saving
undertaken by the capitalist class is used to finance investment spending. That is, capitalists use
their saving out of gross profits to purchase new capital goods that in turn increase the productive
capacity of their firms or develop new firms and industries. This increased productive capacity
made possible by this investment then serves as the basis from which more output and income is
generated in the future.
The capitalist’s investment spending consists of two types: first, the depreciation
expenditures associated with the replenishment of the capital goods used up in production, and
second, the purchase of new capital goods, net investment spending, intended to increase the
productive capacity of the firms or to create new firms. The sum of depreciation expenditures
and net investment is gross investment.
It’s important to note that capitalists may or may not spend their profits wisely. It’s
conceivable that they may spend all of their gross profits on consumption, in which case they’ll
be neglecting the productive capacity of their firms, causing the capital of their firms to gradually
deteriorate over time. But, short of war or a prolonged depression, where productive capacity is
reduced as a result of bombardment or neglect due to negative profits, firms are generally trying
to maintain their productive capacity in good running order. For that reason, we’ll be assuming
that capitalists are dutifully setting aside a portion of their gross profits to replenish the capital
structure of their firms, leaving the remainder for consumption and net
investment.
The value of the gross product generated by the nation’s firms will be equal to the sum
of the wages of labor and the gross profits of capital. In the meantime, total spending on the
output of the firms will equal the sum of consumption spending on the part of workers plus the
consumption and gross investment spending on the part of capitalists. Since we’re assuming that
workers spend all their wages on purchasing consumer goods, that must mean that whether or not
the firms are able to sell the entirety of the gross product will ultimately depend on the spending
pattern of capitalists. If they spend all of their gross profits on consumption and gross
15
investment, then the value of the gross product (aggregate supply) will equal the value of total
spending (aggregate demand) and the firms will have sold all of the gross output generated
during that time period. Since the demand for their output matches their supply, the firms will
continue producing and selling the same volume of output and hiring the same number of
workers.
However, the net investment spending taking place during the current time period will
begin to show up, in the near future, in the form of increased capacity. This in turn will require
the hiring of more workers to make that extra capital productive. Gross product will grow as a
result of the increased productive capacity – the new capital and the laborers needed to work that
capital. The output generated by the new capacity will generate income (wages and profits) that
will, once again, be spent on consuming and investing the extra output. So long as workers keep
spending all their wages on consumer goods and capitalists continue spending their profits on
consumption and investment goods, the system will keep growing over time with aggregate
supply matching up with aggregate demand.
In reality capitalist economies seldom, if ever, grow in such a smooth fashion, with
aggregate supply matching aggregate demand. The usual scenario is for aggregate supply to fall
short of aggregate demand, as during a business expansion; or for aggregate supply to be in
excess of aggregate demand, as during a business contraction. But since our purpose here is to
focus on the broad structural features of capitalism, we’ll assume that aggregate supply is
growing at the same pace as aggregate demand. This makes it easier to understand the forces
responsible for the growth which capitalist economies are known for.
This model can be summarized algebraically. We start by noting that the value of gross
output (gross income) can be represented as
𝑌 = 𝑊 + Π𝑔, (1)
where Y represents gross income, W represents the wages of the employed labor force, and Πg
represents gross profits. The spending on the part of workers and capitalists can be represented as
𝐸 = 𝐶𝑤 + 𝐶𝑘 + 𝐼𝑔, (2)
where E represents total expenditures, Cw represents consumption spending by workers, Ck
represents consumption spending by capitalists, and Ig represents gross investment spending on
the part of capitalists.
16
Since we’re assuming that gross income is equal to total expenditures (or stated
differently, aggregate supply is equal to aggregate demand), then it must be that
𝑊 + Π𝑔 = 𝐶𝑤 + 𝐶𝑘 + 𝐼𝑔. (3)
And since workers spend all their wages on consumption (i.e., W = CW), it must be the case that
capitalist profits are equal to the sum of their own consumption and gross investment. That is,
Π𝑔 = 𝐶𝑘 + 𝐼𝑔. (4)
In short, the gross profits of the capitalist class depend on their own expenditures. But, as
we will soon see, it is investment spending that is primarily responsible for the growth in
productive capacity as well as the profits of the capitalist class. This idea might be easier to grasp
by rewriting equation 4 in a way that should seem more familiar. Subtracting Ck from both sides
of that equation provides us with
Π𝑔 − 𝐶𝑘 = 𝐼𝑔, (5)
or
𝑆𝑘 = 𝐼𝑔, (6)
since 𝑆𝑘 = 1 − 𝐶𝑘, or 𝑆𝑘 = (1 − 𝑐𝑘) ∙ Π𝑔, where ck represents the propensity to consume out of
profits, ck = Ck/Π𝑔.
Equation 6 can be restated as
𝑠𝑘 ∙ Π𝑔 = 𝐼𝑔, (7)
where sk represents the propensity to save out of profits (i.e., sk = 1-ck,).
Note that equations 6 and 7 state the well-known macroeconomic proposition that
equilibrium, where aggregate supply equals aggregate demand, requires that saving be equal to
investment.
The act of saving money can take on numerous forms, which will be explored later, but at
this point we can simplify the argument by imagining that saving involves the purchase of
interest earning financial assets, such as bonds. Income that is saved, that is not consumed, is
used to purchase a bond that guarantees a flow of interest income over a span of time. This
contrasts with those who borrow money by issuing new bonds promising to pay interest over
time. Thus, the savers are buying bonds, while the borrowers are selling bonds. We can thus
think of equations 6 and 7 as stating that one group of capitalists is saving money by buying
bonds, while another group of capitalists is borrowing money by selling bonds. The capitalists
who are selling bonds are using the borrowed money to purchase capital goods. The increased
17
output made possible by the growth in productive capacity, which was financed by the borrowed
money, generates a greater flow of income from which to pay the interest charges on the
borrowed funds. Thus, if saving equals investment, then the demand for bonds matches the
supply of bonds, the saving by one group of capitalists matches the borrowing by another group
of capitalists, and bond holders (the rentier savers) are receiving a flow of interest income. In the
remainder of this chapter, unless otherwise noted, we’ll be assuming that saving is always
matched by investment, which is another way of saying that the demand for bonds is equal to the
supply of bonds.
Now, if we divide both sides of equation 7 by the propensity to save out of profits, sk, we
end up with
Π𝑔 = (
1
𝑠𝑘
) ∙ 𝐼𝑔 , (8)
which states that gross profits, for the capitalist class as a whole, depends on their investment
spending, given their propensity to save. Assuming a stable propensity to save, which in the short
run is generally true, the profits of the capitalist class depend on the amount of investment
spending they undertake. This is the well-known profit equation of Michal Kalecki, who
summarized its meaning by noting that workers spend what they earn, while capitalists earn what
they spend.
It’s important to understand that this proposition applies to the capitalist class as a whole
and not to the individual capitalist. There is never any guarantee that the investment spending of
any one capitalist will eventuate in the hoped-for profits; yet, for the system as a whole this does
occur. The reason for this is that the investment spending that is taking place at any moment in
time is always generating a stream of income flowing to the industries producing the new capital
goods being demanded by the investing capitalists, and the income which the capital goods
industries receive from that investment spending is in turn spent on the purchase of goods
generated from the consumer goods industry, setting into motion a spiral of spending and
production that ultimately exceeds the initial spurt of investment spending.
In macroeconomics this idea is called the multiplier. In equation 8, the multiplier is the
inverse of the propensity to save out of profits, that is 1/sk. So, if the propensity to save out of
profits is 0.5, then the multiplier must be 2 (2 = 1/0.5), and gross profits will always be 2 times
the level of gross investment spending. That is, and given this simple example, if the capitalist
18
class is investing $100 then this sets into motion a flow of production and income that eventuates
in profits being $200.
More complicated models that allow for workers saving, do not alter the fundamental
conclusion; namely, that profits depend on the amount of investment spending capitalists
undertake. The major difference is that the value of the multiplier will now differ as a result of
workers’ saving.
Chapter2
Property, Power, and Government
I. Property and government
The principles outlined in the previous chapter are broad enough to be used in the
analysis of a wide variety of economic systems. All economic systems, regardless of whether
they’re organized on the basis of slavery, feudalism, mercantilism, corporatism, capitalism, or
socialism, must – at a minimum – coordinate labor with the means of production to generate and
distribute a gross product that is sufficient to reproduce the conditions of life characteristic of
that system. The more successful systems do more than this by providing a greater amount, or
more appropriate combination, of the goods and services needed to enhance life, improving the
material life of its members over time. Our focus will be on capitalism, though we will
occasionally compare it to other modes of organizing society so as to gain a better understanding
of the system. Toward the end of our study, we’ll explore socialist forms of organization and
contrast it to capitalism. But most of our attention will be focused on capitalist modes of
organization.
A characteristic feature of capitalist economies is that the means of production are, on the
whole, privately owned. Some of the land and capital might be publicly owned, controlled and
managed by government, but it represents a small proportion of the total, and for that reason is
often ignored, or considered exogenous, when thinking of the behavior of capitalist economies.
The focus tends to be on the much larger private sector, where production and distribution is
carried out through organizations called business firms, or simply firms. The firms are privately
owned organizations that own means of production and coordinate them with labor to produce
2
and sell a good or service for a profit.1 What will be produced, how much will be produced, and
by what methods, is dictated by the profits that can be captured by the firms. What’s more, the
distribution of the gross product, as well as the allocation of the resources needed to generate the
gross product, is carried out by firms competing against each other to buy and sell goods through
a dense network of markets.
In these societies government’s primary role is to provide the legal and regulatory
structure through which private economic activity is carried out. It does so by defining and
defending private property while providing the commercial and social infrastructure needed to
carry on. Some goods are produced and distributed by government, such as public lighting,
postal service, public highways, public transportation, and public education, but the volume and
composition of public goods, their methods of production and means of distribution, are dictated
by notions of the common good, with profitability playing a minor role. Yet, while capitalist
governments play a secondary role in the production and distribution of the gross product, they
have a huge impact on economic activity through the legal and regulatory structures they create
and maintain as well as the volume and composition of the public goods they provide. Changes
in that structure can impact how production and employment is carried out, the level and type of
investment, the nature of domestic and international trade, and the volume and distribution of
income and wealth.
While government in capitalist societies is traditionally thought of as being contextual to
private economic activity, particularly when thinking of the production and distribution of the
gross product, it is absolutely essential – and thus, not contextual or exogenous, to defining
1. For the moment we can think of profit as being coterminous with surplus. Later we’ll see that profit is only one
portion of the surplus, which in turn is composed mostly of various forms of property income (interest, rent, and
profit).
3
property rights and maintaining the legal and regulatory environment needed to defend private
property. At first blush it would seem that the issue of individual ownership or private property is
relatively straightforward and uncomplicated. Whether or not this or that piece of property (such
as land, machinery, buildings, or a business) is owned by an individual, a group, or an
organization, is determined by criteria established by government (in the form of titles, deeds,
bill of sale, certificates, etc.); and if there’s disagreement over who owns what, it is government
that ultimately determines the rightful owner, after listening to and evaluating the respective
claims. Once title has been established, we tend to assume that owners can do as they wish with
that property.
But this is not as straightforward as is commonly assumed. Consider, for example,
someone that has legal title over ten acres of land. Does that ownership apply to everything that
exists below the surface of that land, such as mineral deposits that might exist one mile below the
surface? Can that owner exclude others from flying over her/his acreage, tunneling under it, or
traveling across its surface? Can the owner build a nuclear power plant or a skyscraper on that
acreage? Is the owner entitled to destroy the ecosystem of those ten acres? In each of these cases
the question that immediately confronts us is, what exactly are the rights associated with the
ownership of that land? And, more to the point, what are the limits to those rights? At what point
does an owner’s property rights impinge on the rights of others? All of these questions demand
that government, as the ultimate authority of society, define the nature of private property and
the limits or boundaries to which those property rights apply.
The judiciary of capitalist governments is forever developing and modifying the various
rights and responsibilities associated with different types of property. Private ownership
generally carries with it the right to use that property; generate income from its use; transfer,
4
abandon, or destroy, that property; exclude others from using it; and enforce rightful claims to its
ownership. But in each case, the question of the rights associated with private property can vary
depending on the impact which the use of that property might have on others or the broader
community. One person’s right to use her/his property can impact the rights of others, and this
can lead to conflicts which, if not resolved by the parties to the conflict, will be resolved by
government. The use of private property inevitably carries with it questions regarding the impact
of its use on others and this, in turn, requires that government establish criteria regarding its
legality.
These issues are central to not only the immediate question of private property but also to
the exchanges and contracts that are continuously taking place in capitalist societies. The
exchange of one form of private property for another is ubiquitous in these societies. One form
of private property, say money, is exchanged for another form of private property, say a
produced good or land; and in each case, the nature of that property, whether it is indeed what it
claims to be, and whether all the rights associated with it are transferred with that exchange, are
assumed to be understood and agreed to by the parties to the exchange. If not, if what is being
exchanged is different from what had been agreed upon, then the aggrieved party can appeal to
government to resolve the dispute.
Contracts are similar in nature; indeed, they are nothing more than a formal version of an
exchange. There are numerous types of contracts, both formal and informal, and in each case, the
validity of that contract and whether or not it has been honored must ultimately be resolved by
government. As in the case of exchange, there is always the possibility that one of the parties to
the contract might fail to honor his/her end of the bargain. And if a breach of contract does occur,
then it’s government that inevitably must be brought into the dispute to resolve the issue.
5
The foregoing underscores the fact that, in capitalist societies, the private ownership of
the means of production carries with it a government that is forever attending to property rights
and the disputes that invariably emerge over their use. Thus, the claim that capitalist societies are
systems in which the means of production are privately owned is another way of saying that
capitalist governments are forever involved in securing property rights and resolving disputes
over property, exchange, and contracts. But there’s no reason to presume that such resolutions
will generally be fair and consistent with the interests of society as a whole. Government is relied
upon to resolve these issues not necessarily because it will be fair, even though that is often the
hope, but because it is the ultimate authority in society; and individuals must comply with its
dictates or run the risk of being fined, jailed, or put to death.
This does not mean that government can do whatever it pleases; good governance always
involves a judicious attention to the concerns and complaints of the governed. So long as, on the
whole, citizens believe their government pursues policies that are broadly consistent with the
interests of the community at large, then the system will be relatively stable, regardless of the
form of government. Unstable governments are those that are broadly perceived as tendentious,
favoring one sector of society over others; and unless rectified, such governments run the risk of
being overthrown. So, stable capitalist governments are those whose decisions and policies are
broadly viewed as legitimate by the citizenry at large, and – more to the point – by the owners of
private property and, specifically, the individual owners of the means of production. And this is
true regardless of whether the government in question is democratic or dictatorial.
6
II. The Liberal Ideal
One of the earliest examples of a society organized on the basis of private property was
offered by John Locke in his Two Treatises on Government published in the last decade of the
17th century. The arguments which Locke advanced have been central to conceptions of private
property and government in capitalist societies, particularly in societies that have been
influenced by Anglophonic traditions, such as the United States of America (USA). Here, we’ll
sketch the conception of society embedded in his theory of government. This theory is important
because it provided the theoretical context used by the founding fathers to establish the USA
form of
government.
Locke imagines the existence of a society composed of individual property owners.
Everyone in this hypothetical society owns property of some sort, though it’s admitted that some
might own more than others and that the nature of that property might differ from one individual
to the other. Some individuals might own land, a farm or a mine, others might own machinery, a
building, or a collection of goods. The individuals in this hypothetical society make a living by
producing and selling goods that have been generated by applying their labor to the various
forms of property they might own. A portion of these goods are consumed directly by the
individual producers, but most of it is offered for sale to other individual property owners who
have also produced goods which they too intend to sell. In short, what we have here is an
idealized commercial society in which every individual is a property owner and sustains
herself/himself by exchanging portions of her/his property, or the output generated by that
property (with the requisite amount of her/his labor), in return for the property or output of others
who are doing the same. What’s more, all of this is assumed to be taking place without the
existence of government.
7
He calls this hypothetical society a state of nature to underscore the idea that government
does not exist in this society, even though individuals own private property. That is, private
property is assumed to be a fundamental right, a natural right, that exists prior to government
and, as such, does not need its validation. What’s more, the individuals carry on their economic
activities, producing goods and exchanging them for other goods, in a more or less orderly
fashion. Each individual is seeking her/his own material interest, but in a fashion that’s assumed
to be bound by commercial civility. The parties to a possible exchange are capable of arriving at
a rate of exchange, a price, that’s acceptable to both parties since property rights are, on the
whole, honored by everyone in such a society.
There are, however, inconveniences to this type of system, particularly if there are
individuals who do not honor property rights. It’s quite possible that some individuals will rob
the property of others or renege on their contracts and exchanges. These violations of property
could be resolved by having the injured parties obtain appropriate restitution from the violators.
Each individual has the right to seek justice for violations against her/his property. But there’s no
guarantee that the restitution will be appropriate or achievable, or that the individuals seeking
justice will refrain from exceeding the bounds of civility (by, for example, taking more than the
value of the property that had been stolen or reneged, or maiming the violator). What’s more, as
such instances increase in number, the community might devolve into chaos.
In an effort to overcome these inconveniences, the individuals in such a society give up
their right to seek individual justice and grant that right to a government that will now serve as
the arbiter of property rights. Government is thus created to resolve disputes over property rights.
So long as government is resolving property rights in a fashion that’s perceived as reasonable
and consistent with the property owners’ sense of fair play, then economic activity can continue
8
unimpeded without having to worry about violations of property. The violators will now be
judged and appropriately punished by government, and the broader community of property
owners can go about their business without having to worry about defending their property. If
government ceases to defend property rights in a fashion that’s viewed as appropriate by the
community of property owners, then the individuals have the right to dissolve that government
and create a new one that will hopefully do a better job of defending property.
It’s important to note that Locke’s theory was the first to argue that the legitimacy of a
government is dependent on the extent to which it defends private property. It’s not coincidental
that this theory emerges at a time when capitalism is coming into existence. Governments that
defend private property in a fashion that’s consistent with the community of property owner’s
sense of fair play are legitimate. Governments that do not, are not. The theory is used to set
limits to government authority, by emphasizing the priority of private property. Individuals have
a right to property and can do with it as they wish, so long as it does not interfere with the rights
of others to do the same. And government cannot infringe on that right, telling private property
owners what they can or cannot do with that property, unless it’s determined that an individual’s
use of her/his property is coming at the expense of others or the community at large.
In general, Locke assumed that the economic activity of the individuals in such a society
would, on the whole, generate outcomes that would be consistent with the interests of the
community as a whole. For that reason, he took for granted the idea that government wouldn’t
have to swoop in to resolve property disputes all that often. It would serve as a referee or
nightwatchman, observing the economic game from the sidelines and interfering only when one
individual’s use of property negatively impacted the property rights of others. He acknowledged
the possibility that one segment of society might accumulate so much property that it would
9
interfere with the rights of the rest of the community to acquire property; and under such
conditions he accepted the idea that government might need to permanently interfere in the
private sector so as to ensure that everyone has a right to property. This last possibility, however,
was not emphasized, and the overall tenor of his work implied that government would mostly
serve as a nightwatchman, without the need for on-going and permanent interference in the
private economic activity.
III. Capitalism and commodity producing societies
Capitalism is a specific version of a much broader set of societies referred to as
commodity producing societies. The one common feature present in all commodity producing
societies is that income is derived from producing a good and then selling it on the market. In
such societies, the quality, type, and amount of goods produced – that is, the amount and
composition of the gross product – is determined by the profits (surplus) that might be made from
their sale. The buying and selling of goods, market activity, dominates a considerable amount of
economic behavior. Production tends to be dictated by the profits that might be made from the
sale of goods. Goods that promise a reasonable profit will be produced while those that don’t
won’t; regardless of whether the good in question fulfills some basic physical or social need.
Needs which cannot be met through the selling of an appropriate good at a reasonable profit, will
go unmet unless they are provisioned through some other mechanism such as through
government.
In fact, the term commodity, as opposed to the much broader term, good, is used to
underscore the idea that in commodity producing societies the vast majority of goods are
produced for profit. A good is anything that might satisfy a human need or desire, such as a
10
beautiful valley, a work of art, a backhoe, or a car. As such, it need not be produced – as in the
case of natural beauty – and even if it is produced the motivation for its production need not be
profit, as in the case of a meal prepared for friends or a work of art. The term commodity is thus
used to distinguish goods that are produced for the explicit purpose of generating a profit from
goods in general. A commodity is the result of the on-going production of goods by firms intent
on capturing profits. Thus, in commodity producing societies the vast majority of the goods that
are produced and distributed are commodities, that is, goods produced for profit.
While all commodity producing societies have these features in common, they differ on
the manner in which control and ownership over the means of production is distributed, and on
the manner in which power over the ability to generate and use income is dispersed throughout
the population. For example, it is conceivable that the ownership of productive assets might be
sufficiently dispersed that each family owns enough capital and land to produce for itself and sell
the remainder on the open market. Some families would specialize in the production of
agricultural goods, while others would specialize in manufactured goods or the provisioning of
services. Each family, in other words, would own its own firm.
This type of economic system is referred to as a simple commodity producing society and
represents the kind of economy that Thomas Jefferson thought would have to exist for
democracy to function properly. Jefferson believed that democracy required that ownership of
productive property be widely dispersed. In particular, he imagined that each family would own,
however modest, a farm that would permit the family to sustain itself from its own work. What
would be produced and how much would be produced would be determined by the profits that
might be made from the production and sale of commodities. And if, as a result of insufficient
11
sales, a family could not obtain income through the market, it always had the ability to produce
some of the necessities for itself.
In such a system, the farm would provide, however meager, enough resources to permit
the family to sustain itself from its own production. Each family would always have enough
economic power to generate income for itself, either in the form of the products directly
produced and consumed on the farm, or in the form of the money, and thus the products of other
firms, obtained from selling the farm’s output. Moreover, as a result of this same power, the
typical individual would be free to accept or reject potential exchanges as he or she saw fit.
There would be little to no economic coercion forcing the individual to accept the terms of some
potentially extortionary transaction. The individual could reject such abusive exchanges since he
or she could always live off the farm. If the money being offered for his or her products, or labor
services, did not seem appropriate, he or she could always afford to reject the offer. The
ownership of land would provide the average individual with enough power to reject terms that
seemed inappropriate, while accepting only those transactions that seemed beneficial.
A capitalist society is a specific version, or species, of commodity producing societies.
But, unlike Jefferson’s vision of a simple commodity producing society, capitalist societies are
characterized by the fact that the vast majority of families do not own enough productive
property to generate their own income.2 More specifically, the vast majority of families in a
capitalist society do not own a farm, or business of some sort, which would allow them to obtain
the bulk of their income from the selling of commodities. The income of a typical family in a
capitalist society is determined by the wages that might be obtained from the selling of labor
2. Keep in mind that we are focusing on productive property and not property in general; the latter would also
include consumptive property. Thus, the ownership of homes, a form of consumptive property, is fairly widespread
in the United States, but the ownership of factories, farms, or even small shops, is not.
12
services to the firms. Furthermore, unlike the average individual in Jefferson’s farm owning
society, the average individual in a capitalist society is much more dependent on, and thus less
free to reject, the income that might be obtained from the selling of labor power to the firms.
The typical worker in a capitalist society is less inclined to reject a wage offer that seems
inappropriate than is the typical worker in a simple commodity producing society. The typical
worker, in a capitalist society, cannot go back to the farm and live off the land. In capitalist
societies, private economic power is concentrated in the hands of a relatively small fraction of
the population, those who own and control firms – the business or capitalist class. The business
owners have the power to coordinate the labor process within their firms and thus have enough
power in relation to the workers to set the terms of employment. The firm provides the capitalist
with a greater amount of control over his or her search for income, while at the same time
providing a strong bargaining position with reference to workers and thus their wages and
conditions of work. The average capitalist has a greater capacity to control his or her own search
for income than does the average worker.
The property arrangements typical of capitalist societies are the result of two closely
related sets of circumstances. First, there is a general attitude towards property rights that is
much more unrestrained than in other types of political economic systems. That is, in capitalist
societies property owners have a wide range of economic activities they can pursue, through the
use of that property, without having to first seek approval from government or the community at
large. The range of activities that property owners are prohibited from pursuing is relatively
minor. Second, capitalist societies have developed an elaborate set of financial institutions
through which rights to property and claims on such property are traded. In their struggle for
income, property owners try to defend and/or enhance their economic power by buying various
13
ownership rights to firms and property in general. The accumulation of property enhances the
position of any one individual owner by providing him or her with a greater flow of income and
a larger base of economic power. The result of the competitive struggle for income is not the
widespread dispersal of productive property, but rather the concentration of that property in the
hands of a relatively small fraction of the population. This unequal distribution of productive
property occurs naturally in capitalist societies as a result of the freewheeling competitive
struggle which the property rights and financial institutions of these societies makes possible.
IV. Varieties of Capitalism3
One common way of categorizing capitalist societies is to imagine them arranged along a
continuum that gauges the degree of government oversight. At one end of that spectrum would
be capitalist societies that limit the role of government to a fairly small proportion of total
economic activity, confining its presence to issues of private property and commercial
infrastructure while providing minimal social infrastructure. Capitalist nations that lean toward
this end of the continuum have been defined as Liberal Market Economies (LME), with the
United States of America (USA) being a representative example of this form of capitalism. The
means of production are privately owned, government ownership of land and capital is minimal,
and commercial infrastructure is well developed, but social infrastructure is modest when
compared to other advanced capitalist nations.
This is the “small government” version of capitalism eulogized by conservatives. But it
must be emphasized that the term “small’ is misleading since it suggests that the role of
government in these types of societies is minor or inconsequential. A more appropriate way of
3 The following section borrows the title, and some of the ideas, found in Peter A. Hall and David Soskice’s 2001
book Varieties of Capitalism.
14
thinking about this version of capitalism is that government is confined to those activities that are
central to the defense of private property, the adjudication of disputes among property owners,
and providing the commercial infrastructure needed by business. This is the version of capitalism
that existed in the USA during the 19th century, when social infrastructure was largely neglected
and government focused mostly on issues of private property and commercial infrastructure.
These functions represent the absolute minimum which a government must carry out to sustain
viable capitalist societies. Defining and defending private property is absolutely necessary to the
functioning of capitalism and central to the mission of the judiciary, police, and military
institutions of these societies. Likewise, the development and maintenance of commercial
infrastructure (such as public highways, communication systems, harbors, public lighting, water
and sewage systems) is essential to conducting business. These functions may take up a
relatively small proportion of the nation’s gross output, and as a result considered “small,” but
this does not mean they are of minor importance, they are instead core functions of capitalist
states.
At the other end of the spectrum are capitalist societies that encourage a much larger role
for government by providing more oversight of private economic activity and a more expansive
social infrastructure while still defending private property and maintaining a robust commercial
infrastructure. This class of capitalist societies has been referred to as Coordinated Market
Economies (CME), with the Nordic countries being representative of this form of capitalism.
While the means of production are still, on the whole, privately owned, the portion that’s owned
by government is larger than in their LME counterparts. Yet, they’re just as attentive as their
LME counterparts to the importance of private property and the institutions needed to defend it,
such as the judiciary, police, and the military, and are equally fastidious about maintaining the
15
system’s commercial infrastructure. Where they differ is in the area of social infrastructure.
CMEs offer a more generous set of public goods (e.g., public education, public health care,
public housing, public transportation, day care facilities, maternity and paternity leaves, paid
vacations, etc.) than is common in LME systems. These are societies wherein government has
gone beyond the minimal activities needed to sustain a viable capitalist economy (private
property and commercial infrastructure) and have moved into the provisioning of the public
goods needed to sustain a robust social infrastructure. As a result, government in these societies
takes up a larger proportion of gross output, since they offer a wider and more generous set of
public goods than is common to LME systems.
It’s important to note that beyond the question of the degree of government involvement
in the economy, the above way of classifying capitalist societies draws attention to the way in
which economic activity is organized. It’s not just that the state, in CME systems, has a greater
role to play in the provisioning of social infrastructure than is common to LME systems, it’s that
economic activity is coordinated with the state and the broader public, in particular labor, in
ways that are minimized or non-existent, in LME systems. Liberal market economies rely
heavily on the market as a way of coordinating the profit seeking activity of the firms, and they
leave the firms, and the capitalists that own and manage the firms, free to pursue profits any way
they see fit. In contrast, coordinated market economies are far more comfortable than their LME
counterparts with forms of coordination that require firms to account for the other interests in
society, such as labor, the environment, or more broadly the common good. The latter form of
coordination requires a greater role for the state and a broader range of interests represented in
the governance of firms and society at large.
16
It should also be noted that there is variation within each of these categories and that
some nations possess elements of both LME and CME. For example, even though the USA is
often categorized as an example of an LME form of capitalism, it nevertheless spends far more
on the military than any other LME nation. Indeed, the USA spends more on military related
activities than any other nation on earth. What’s more, the partnership that has emerged in the
USA between the federal government and defense contractors, the so-called military-industrial
complex, has led to the development of technologies that may not have emerged in the absence
of Federal Government subsidies. In other words, despite being perceived as an example of an
LME form of capitalism, which presumably generates new technologies through free market
competition, a wide swath of technological innovations in the USA have emerged from public-
private relationships, such as the military-industrial complex or public subsidies of private
industry, and not from the “free market.”
It should also be noted that there is a cultural and political component to these different
forms of capitalism. The LME forms of capitalism are, on the whole, inheritors of the English
form of capitalism that was later dispersed to the colonies of Great Britain, such as the USA,
Canada, New Zealand, and Australia. All of these nations are often thought of as LME forms of
capitalism even though there are obvious differences among them. While they all have inherited
the liberal traditions of English political economy, the extent to which they provide for social
infrastructure and willingness to regulate markets varies among them. Canada, for example, has a
far more robust social infrastructure than does the USA, even though it is often classified as an
LME system. In contrast, CME forms of capitalism tend to be found in societies that emerged
after capitalism developed in England or the USA. Furthermore, they have political cultures that
are less distrustful of government than is common to societies that inherited English political
17
traditions. Yet, even here, one also finds variations. Thus, it’s common to classify Norway,
Finland, and Sweden as being a form of CME, even though Germany and Japan are also thrown
into the mix. While it’s true that all of these cultures are far more comfortable with the state than
is common to LME systems, there are, nevertheless, significant differences among them.
Both of these forms of capitalism, particularly those found in Western Europe and North
America, tend to have democratic governments, either of the parliamentary form, such as
Norway, or the presidential form, such as the USA. As a result, it’s common, particularly in the
USA, to assume that capitalism and democracy are complementary, that capitalism has a
tendency to generate democratic forms of governance. But this is a questionable proposition
that’s contradicted by the numerous examples of capitalist societies governed by dictatorships,
military juntas, oligarchies, or monarchies. Indeed, capitalism evolved out of a monarchical
context in 17th century England, and it wasn’t until the early 20th century that universal suffrage
gained a foothold in that society. What’s more, even among the capitalist nations of Western
Europe, there have been times when they’ve reverted to anti-democratic forms of government, as
in the case of Spain during Franco’s dictatorship from 1936 to 1975, Nazi Germany in the 1930s
and 1940s, and Fascist Italy from the 1920s to the 1940s.
Indeed, it could be argued that capitalism works best when democracy is restrained and
business interests are allowed to rule unimpededly. So long as capitalists are secure in their
property and allowed to carry on their business in ways that enhance their profits, the lack of
democracy, while it may be decried, will be endured and even celebrated. Chile during the fascist
dictatorship of Augusto Pinochet, from 1973 to 1990, is a good example. But so too is Brazil,
during the military dictatorships from 1964 to 1985, Nicaragua under the Somoza family
dictatorship from 1933 to 1979, Indonesia under the Suharto dictatorship from 1967 to 1998,
18
Congo under the dictatorship of Mobutu Sese Seko from 1965 to 1997, and numerous others
whose listing would take up more space than is needed to make the point.
Clearly, the defining feature of a capitalist society isn’t the existence of democracy, but
rather a form of government that gives priority to, or is sufficiently differential to, those who
own the means of production, a class of people known as business owners, capitalists, or the
bourgeoisie. These are the people that own firms and coordinate labor with capital and land to
generate a profit from the production and sale of goods and services. Capitalist governments,
regardless of whether they’re organized along democratic or non-democratic lines, are
distinguished by the attention they show toward private property and commercial infrastructure,
or more broadly, the needs of business.
This does not mean that capitalist governments, democratic or otherwise, are forever
bending to the demands of business owners. Governments, after all, are expected to speak and
act on behalf of the entire nation, pursuing policies thought to be in the interests of the broader
public and not some narrow segment of society – such as the capitalist class. Governments can
and do pursue policies that may not be favored by business interests if the benefits to society are
thought to outweigh the disapproval of business. But so long as business interests are consulted
in the development of public policy, even if their preferences aren’t always granted, that nation
can be thought of as capitalist, regardless of whether it’s democratic. This consultation might
take the form of ongoing informal discussions between business leaders and government, or it
might be formalized in a legislative body that represents business interests. What’s more, this
consultation need not be harmonious and may at times be contentious. But, regardless of the
form such interaction might take, the point is that capitalist governments, democratic or
otherwise, tend to weigh more heavily the concerns of business than those of other segments of
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society and, as a result, are keen to maintain a framework (private property and commercial
infrastructure) which facilitates the pursuit of profit.
In all capitalist societies the extent to which business interests tolerate the government
under which they operate depends on the extent to which it interferes with profit seeking activity.
In general, the greater the number of economic restrictions and laws unfavorable to the free
conduct of business, the more likely business interests will refrain from investing in that society
and will move their capital to other, more friendly, capitalist societies; a phenomenon known as
capital flight. In extreme cases, the business community will search for ways of overthrowing
that government and instituting another government that is more sympathetic to capitalist
interests. This response is common in all capitalist societies, regardless of whether the nation is
democratic. The possibility of capital flight, and the subsequent economic stagnation or
depression it can provoke, is a sufficiently strong incentive to keep capitalist governments
attentive to the needs of business.
The case of socialist societies, of the form that emerged in the 20th century, is a good
counterexample which sheds more light on this issue. The Soviet Union, The Peoples Republic
of China, and Cuba, differed from their capitalist counterparts in that the means of production,
both land and capital, were overwhelming owned and managed by government. The proportion
that was privately owned was very small. Government coordinated labor with the publicly owned
capital and land to generate and distribute a gross product that would be made widely available
to the general public on the basis of need or public policy, not profits. In these societies, the
firms that coordinate labor and the means of production are public institutions, not privately
owned businesses; and they operate more like public bureaucracies than profit-seeing firms.4 In
4 Some socialist societies have experimented with profit-seeking firms, such as Yugoslavia and China. But, in the
case of Yugoslavia, the firms were owned by the workers and expected to abide by socialist principles. In the last 40
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addition they embrace the principle that, at a minimum, everyone is entitled to a subsistence
bundle of goods (in the form of food, housing, health, education, transportation, and such) that
allows them to survive and hopefully thrive. They are attentive to the needs of the working class
and offer a far greater array of public goods than is common in capitalist societies. But they have
all been governed as dictatorships, usually run by a political party – the communist party, which
sought to manage government, and thus the means of production and labor, in a fashion that
would advance the interests of the working classes. What’s more, they are leery of the capitalist
class because of the role they have traditionally played (in coordination with other advanced
capitalist nations) in overthrowing socialist governments.
Note that dictatorial forms of government might be capitalist or socialist. So, the
difference that exists among capitalist societies and between capitalist and socialist societies, has
less to do with the existence (or lack thereof) of democracy, then on the balance of power that
exists in these societies between the interests of business and those of the working classes. The
common thread running through all capitalist societies is the greater weight their governments
attach to the interests of capital over labor. The LME forms of capitalism are characterized not
only by what conservatives call “small government” but more importantly by the indifference, if
not hostility, displayed toward labor. In contrast the CME forms of capitalism are characterized
by laws and regulations that are more attentive to the interests of labor, than is common in LME
forms of capitalism, even though capital still sets the tone in these societies. More to the point,
socialist societies have traditionally been more attentive to the interests of labor (in terms of their
material needs) than is common in capitalist societies.
years China has allowed the existence of profit seeking firms owned by individuals. But they represent a small
proportion of all business (most of which are still state owned) and are heavily regulated by government.
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V. Property and Democracy
While democracy isn’t necessarily a form of government that coexists with capitalism, it
is the case that modern notions of representative government and democracy emerged with the
development of capitalism. England, it’s widely acknowledged, is where capitalism first
emerged. It evolved over a period of several centuries as Europe, and in particular England,
transitioned from feudalism to what eventually came to be called capitalism. Yet, despite this
long period of gestation, it can be stated with a fair degree of confidence that the fundamental
institutions of capitalism, even if they were still in an early stage of development, emerged in
England during the 17th century. It was during that century that England underwent two
revolutions, causing its political structure to move closer to what we would now call democracy.
More to the point, the monarchical form of government which had ruled England for centuries,
was put in check through the development of a republican institution, Parliament, which though
it had existed for centuries, now had legitimate authority over the king. Government was now
expected to respond to the interests of a broader segment of society (specifically merchants) than
that narrow segment of society (the landed nobility) which had traditionally been the political
base of government.
For centuries, the English monarch would consult with the landed nobility, represented in
the House of Lords – the upper chamber of Parliament composed of representatives of feudal
nobility. The House of Commons, the lower chamber of Parliament representing the interests of
the burghers, came into existence in the 13th century but was largely ignored and possessed little
power. It wasn’t until the mid-17th century that the House of Commons rebuked the authority of
King Charles I by beheading him, dissolving the monarchy, and creating a republican form of
government, the Commonwealth of England. This experiment only lasted for a few years, after
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which a monarchical form of government was reinstated, but this time with the insistence that
Parliament now had authority over the king. By the end of that century, the House of Commons
was more powerful, allowing the concerns of merchants to gain a larger voice in the governance
of society.
It would be a stretch to refer to this early form of representative government as
democratic since the right to vote was highly restricted and confined to a tiny proportion of the
population, namely those that owned enough property to exercise the franchise. This restriction
had the effect of reducing the proportion of the population that could vote to about 1% to 3% of
adult males. Similar laws were in effect in the USA after it won its independence from Great
Britain. In the late 18th century, the franchise in the USA was confined to a small proportion of
white propertied males and excluded white males that did not own the required amount of
property, as well as women, slaves, free blacks, and Native Americans. The extension of the
franchise in the USA took place over a long stretch of time. Thus, it wasn’t until the 1850s that
ownership of property was dropped as a requirement to vote for white males, women didn’t
obtain the right to vote until 1920, and Native Americans didn’t gain that right until 1924, and
even though the 15th amendment (passed in 1870) had granted the right to vote to former slaves,
the Jim-Crow laws of formally confederate states excluded blacks from voting until the passage
of the 26th amendment in 1964.
This brief history should underscore the fact that the conception of government that
emerged with capitalism was a democracy of property owners. In keeping with Locke’s theory of
government and Jefferson’s hope for a democratic USA, the argument was that the interests of
property owners should be represented in government and that the latter should be the vehicle
through which private property is defended, and disputes over property resolved. And the best
23
way of ensuring that government pay attention to the meaning, and disputes over, private
property, is to have property owners, or their representatives, deliberating the laws and policies
of the nation.
But here we must take a minor detour to expand on the concept of property and, in
particular, the kind of property that was envisioned during the first century or so of capitalism.
Private property can be classified into two huge categories, consumptive and productive.
Consumptive property refers to the stock of goods that are owned by individuals or groups for
the purpose of sustaining levels of consumption. Examples of this form of property would be
personal clothing, books, cars, refrigerators, TV sets, homes, and such, that provide a stream of
consumptive services to their owners. This type of property is owned for the sake of sustaining
life or enhancing the quality of life. In contrast, productive property refers to the land or capital,
the means of production, that’s owned by individuals or firms for the purpose of generating a
profit. This is the kind of property that one associates with business firms. It differs from
consumptive property in that productive property generates income and wealth. What’s more,
this kind of property is usually tied to a business enterprise (a farm, retail outlet, factory, or
conglomerate) that hires teams of workers to interact with that property to generate an output
(which is also the property of the firm) that is then sold for a profit on the market.
The kind of property that was envisioned by the early capitalist societies (such as Great
Britain and the USA) was invariably of the productive sort, that is they were thinking of the
ownership of land and capital. So, the kind of democracy they were envisioning was one in
which landowners and capitalists, or their representatives, were actively engaged in defining,
defending, and adjudicating disputes over property, while hammering out the various laws and
policies that could sustain a commercial society. It’s for this reason that the working classes
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(those who do not own productive property – who do not own firms) were initially excluded
from having a voice in the governance of society.
While the right to vote has been expanded over time, allowing the working classes to be
represented in government, its extension has been consistently resisted by the owners of
productive property, the capitalist class. The reasons are fairly obvious. If the working class is
appropriately represented in government, then laws and policies can be instituted that impose a
cost on firms and, more broadly, the owners of productive property. Examples of such policies
would be recognition of labor unions, consumer safety laws, workplace safety laws, minimum
wage laws, social security, work hour laws, etc., that impose a cost on the firms or productive
property owners, in the form of increased taxes and/or regulations. Each of these policies were
strongly resisted, and continue to be resisted, by the business classes. And it’s for this reason
that, to this day, business interests and their political representatives can be found figuring out
ways to restrict the right to vote.
The democratic forms of government that emerged with capitalism allowed the opinions
of workers to be heard and, on occasion, implemented, even though the overall tenor of public
policy favors business interest. As a result, there has been an on-going tension in capitalist
societies between the owners of firms, the capitalists who make-up a small proportion of the
population, and the much larger public, overwhelmingly workers, who exercise the right to vote
and participate in public discourse. But the manner in which this plays out depends on the kind
of democratic mechanisms that have structured the politics of any one nation. Capitalist nations
that provide a greater voice to working class interests, such as the CME nations, tend to offer a
much wider range of public goods, a more robust social infrastructure, than is common in LME
nations, particularly the USA, which do not.
Property, Power, and Government
Property, Power, and Government
Capitalism = private ownership of means of production
Public ownership also exists but represents a small proportion
Government’s primarily role is to provide legal and regulatory structure to private economic activity
Define and defend private property
Provide public goods
Commercial infrastructure
Social infrastructure
Property, Power, and Government
Private property
Not a thing, instead a legal relationship
The right to use owned property
The right to generate income from the use of owned property
The right to transfer, abandon, or destroy owned property
The right to exclude others from using owned property
Government defines and defends private property through its judiciary, police, and military institutions
Capitalist governments are forever attending to the defense of private property
Property, Power, and Government
The Liberal Ideal
John Locke’s theory of government
Government’s only justification is its defense of private property
The right to own property is viewed as a natural right
Required to survive
The individual’s right to property should not come at the expense of other’s right to property
Unreasonable accumulations of property violate the law of nature (the rule of reason)
Government adjudicates disputes over property
1st Version: Nightwatchman State, assumes such conflicts are minor
2nd Version: Social Democracy, government needs to regulate property to ensure everyone has an equal right to survive
Property, Power, and Government
Commodity Producing Societies
Private ownership of means of production
Widespread use of markets to exchange property
Simple commodity producing society
Every family owns enough means of production (farm, factory, business, etc.) to produce for itself and sell the remainder on open market
Exchanges are viewed as mutually beneficial
Thomas Jefferson’s vision of democracy in the USA
Capitalism differs from a simple commodity producing society in that many (most) do not own means of production
Property, Power, and Government
Varieties of Capitalism
LME (“small” government version)
Private ownership of means of production
Rely on market coordination
Commercial infrastructure well developed
Social infrastructure may also be well developed, but sometimes minimized (as in the USA)
CME (social democratic version)
Private ownership of means of production
Rely on market but greater coordination of firms with other stakeholders (in particular, labor)
Commercial infrastructure well developed
Social infrastructure more developed than in many LME societies
Property, Power, and Government
Capitalism and democracy
Not necessarily complementary
Capitalism emerged from a monarchical context
Numerous capitalist societies have been run by dictatorships or oligarchies
Yet democracy commonly viewed as coterminous with capitalism
Largely because of liberal political traditions – i.e., John Locke
Democracy of property owners
Productive property relevant, not necessarily consumptive property
Democracy of productive property owners versus widespread democracy
Surplus Producing Economies
Surplus Producing Economies
Some preliminaries
The economic imperative
Social reproduction
Tools, technology, and instrumental institutions
Ceremonial beliefs, ideology, and values
Economic viability
Stable political economic institutions – legitimacy
Does not require democracy
Feasible technology and resource base
At minimum, output grows at same rate as population
Surplus Producing Economies
Gross Product = Necessary Product + Surplus Product
Q = NP + SP or Y = NY + SY
Necessary Product = Socially Necessary Consumption + Depreciation
NP = Cn + Dp or NY = Cn + Dp
Surplus Product = Surplus Consumption + Net Investment
SP = Cs + In or SY = Cs + In
Note: C = Cn + Cs , and Ig = Dp + In
Surplus Producing Economies
Economic growth requires that a portion of the surplus be used for investment in new productive capacity.
What fraction of SP goes to Cs and what proportion goes to In ?
Depends on the institutional structure, the kind of political economy, of society
Capitalism differs from previous systems in that In tends to be higher.
Market competition among capitalists imposes need to invest.
But note that, under capitalism, production is dictated by profits, not need.
Surplus Producing Economies
Means of production
Land – non-reproducible goods (nature)
Diminishing Returns
Capital – reproducible goods
Tools, buildings,
Technology – knowledge
Surplus Producing Economies
Labor
Direct
Indirect or overhead
Productive
Unproductive
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