‘Capitalism’ and ‘capitalist’ are analytically dreadful terms

That encourage sloppy thinking and the degradation of what works in the name of what doesn’t work. Profit is income from successful discovery, coordination and risk management, not capital.

A discussion of Kautilya’s (375-283BC) classic text the Arthashastra by a contemporary Indian economist, includes the following sentence:

Wages, profit, interest and rent were recognized as distinct factor payments (p.25).

One of these things is not like the others. By factor payments, the author means returns on factors of production — land, labour and capital.

There are three factors of production, yet four different types of income. Labour is paid wages, land accrues rent and capital interest.

So, what about profit? Is that another form of income from capital? Well no. It is:

Profit (commercial): income from successfully coordinating factors of production so as to produce more value than was used to create that value. Includes successfully covering risks of production and exchange.

Commerce is the facilitation of exchange. It is not exchange itself. It is not even trade. Non-commercial entities are perfectly capable of engaging in trade. (Rulers perennially promoted, or engaged in, trade for its revenue benefits.¹) Commerce can be undertaken by separate entities or can be engaged in by a body that also produces goods and services.

Commerce also includes finance, which we do not normally think of as trade. Financing being the provision of resources—normally, some means of payment—now in exchange for (hopefully more) resources in the future.

Commerce can operate in well-worn patterns or there can be various levels of discovery involved. The process of active discovery is entrepreneurship. This need not be commercial. It makes perfect sense to talk of political entrepreneurs.

So, if existing politicians and political Parties leave a “gap” in the political market—such as concerns amongst voters that are not being articulated—political entrepreneurs are likely to engage in market entry to target such gaps. Nigel Farage and Donald Trump—and national populism generally—are all examples of political entrepreneurship.² Such political entrepreneurship can extend to making differences between groups more salient than they previously were.³

Commercial entrepreneurship is a process of discovery and coordination in facilitating exchange, including managing the various risks involved. If you do this successfully, you gain a profit. If not, you make a loss.⁴ It may, or may not, include production of goods and services (beyond facilitating exchange itself).

The possibility of loss operates as a winnowing mechanism, winnowing-out actions, strategies and arrangements that do not work.

Aman Upadhyay, Unsplash.

The profit/loss spectrum indicates how different such income is from wages, rent or interest. You may or not be paid what you are owed, but in the latter three cases, the payment is pre-specified. Profit or loss is the (highly variable) sharp-end of a discovery process, it is not a pre-set payment.

Profit or loss is also called residual income, as it is what is left over after everything else has been paid for. It accrues as a benefit or liability to the person who covers the risks and who also either engages in the process of discovery and coordination or appoints those who do. Why? Because such combinations of actions and returns—so that the person covering the firm’s risks also has authority over its actions—is what is selected for as the way to organise commerce, and commercialised production, in society after society, as it represents the most effective—and so successful—alignment of incentives. It is a successful organisational strategy.

(What do we call someone forced to cover risks they do not control? A taxpayer.)

Producing or financing?

There is, however, an analytical problem in using the term capital both to refer to financing and to the produced means of production (machinery, tools, skills, connections). I will refer to the latter as capital(p).

Financing is payment capacity (what economists refer to as liquidity). Having payment capacity is central to commerce—to cover risks, to hire labour, to rent land, to buy or lease capital(p). Hence financing itself is a form of commerce.

Economist Meir Kohn suggests a definition of capital that covers all uses of the term in commerce:

resources invested in the process of production (broadly conceived) to generate or increase future revenue. It includes not only fixed capital, but also working capital and intangible capital.

This makes the breadth of things covered by the term capital less jarring, but, if anything, brings out even more clearly the centrality of risk management to commerce and commercial production. Still, covering cash, credit, skills, connections, reputation, buildings and machinery under the one term means it is easy to engage in bad reasoning by thinking too narrowly about capital.

Financing is typically done via money or credit, and is where the role of money as the hinge between goods-and-services exchange and assets is most obvious. When it is held, money is an asset. But it is an asset because it can be spent in exchange (i.e., is an exchange good). Any such exchange good will be able to be used in exchange or held as an asset.⁵ Transferring purchasing capacity across time is one of the great advantages of money.⁶ (The other great advantage of money is minimising search costs.)

Credit is all about action across time. You acquire purchasing capacity now that you promise to pay back later (with interest). Such a loan is a liability for the borrower and an asset for the lender. Expanding the level of credit in society expands the capacity to act across time—which can, of course, lead to debt-traps, such as debt-bondage.

The classic ways for a firm to acquire such purchasing capacity from others are to borrow (so promise to pay back with interest) or to sell equity in the firm—that is, a claim on profits that is also purchases authority over the firm’s decision-making, so as to make covering the commercial risks manageable.

If you have the financing capacity to cover accrued losses, you remain solvent. If not, you are insolvent and, unless someone covers your losses, you go bankrupt. Hence commerce selects out what does not work in a way that nationalised industries do not—for then the state (i.e., the taxpayer) covers the losses while neither the decision makers within the nationalised firm, nor those who appoint them, have any official claim on the residual income. (They may, however, potentially appropriate income from the enterprise for their own purposes.)

Commerce selects for efficiency, as untapped resources represent an income opportunity. Bureaucracy selects for inefficiency, as the more resources consumed by the bureaucracy, the better for the bureaucrats.⁷

Loss and bankruptcy provides private firms with pressures against bureaucracy selecting-for-inefficiency that state bureaucracies do not have. Non-profits tend to be somewhere in the middle in that they lack the coercive guarantees of the state but also lack the efficiency and efficacy pressures of commerce. Especially as “value” for non-profits is “appealing to donors”—the connection between that and positively contributing to human flourishing can be weak, or even perverse: “not for profit” can be a form of moral cover.

Misleading labels

So, is a capitalist a capitalist because they own capital(p) or because they own financing capacity? The former does not inherently generate the role in a firm that accrues residual income—such capital can be leased—while the latter would make a banker the ultimate capitalist, but only in banking.

Given the enormous range in use of capital(p) across businesses, including ownership of such capital(p), plus the complete failure, in Marx’s original conception of capitalist, to grapple with the coordination and risk-management roles that are central to commerce, or the discovery that is central to being an entrepreneur, capitalist is a highly misleading label.

Nor is capitalism much better. Yes, mercantile societies create and use a lot of capital(p). Especially when commerce and commercialised production is in a position to develop and use technology—so to tie discovery of technological possibilities with the discovery of commercial possibilities. But that comes out of discovery, coordination, risk management, and the incentives to engage in the same. Capital is a a tool in that process, it is not the process itself. What is referred to as capitalism is better thought of as a commercial or mercantile economy: with capitalism not being a good label for such.

The basis of the Great Enrichment—aka the Industrial Revolution—was jobbing artisans finding ways to expand the use of energy to solve commercial problems in an institutional framework that enabled gaining income from doing so—even though the original entrepreneurs only captured a tiny fraction of the overall social benefit their discoveries generated. Hence, blocking such possibilities imposes huge social costs in foregone prosperity—compare China 1949-1979 to China post-1979, or Chinese per capita GDP with that of Singapore, Taiwan or Hong Kong.

State capitalism elides the key distinctions between commerce and state production precisely because capitalism is such a poor label for a technologically-dynamic mercantile society and capitalist is such a poor label for a person engaged in commerce or commercialised production.

Such misleading labels are very bad for clear thinking. Using capitalist and capitalism has encouraged the “assemble the factors of production and crank the handle” approach to economic growth that has been such a failure for foreign aid. An approach that has also been a failure—after initial surges in production based on adding inputs (particularly moving peasants into factories) to processes copied from mercantile societies—in command economies.

One form of bad reasoning encouraged by capital referring to such broad array of phenomena is precisely to think too narrowly—and so too simplistically—about economic processes by focusing just on, for instance, physical capital. That culture and institutions turn out to matter (a lot) for long-term economic growth is much more mysterious if one is not across the breadth of things required for economic dynamism, thereby not understanding what commercial success actually involves.

Capitalism also conflates what states do with how commerce and commercialised production operates. Actions by state institutions can be implicitly or explicitly blamed on corporations and “capitalists”. This can be a great distorter of history: for example, blaming imperialism on “capitalism” when imperialism is what states do—as soon as there are states, there starts being imperialism. Or to confuse the pathologies of bureaucracy with other forms of social action and sources of dysfunction. The term capitalism allows the conflating of different social actors in a way that can be rhetorically very effective but is very bad for clear thinking or historical understanding.

Various forms of crony capitalism do involve a merging of state and private interests. In effect, the notionally private firm harnesses the coercive power of the state to increase, or even guarantee, their income flows. There may well be some political, rather than commercial, entrepreneurship involved.

Such crony capitalism provides another potential form of profit, by using the power of the state to exclude competitors and, to the extent it does so, is an exploitive mode of economic activity. Systematic exploitation more or less inevitably involves the application of coercive power to block people choosing otherwise. This is most explicit in the various forms of labour bondage—slavery and serfdom.

A major issue with states is precisely that they can exploit their subjects by using their coercive power while providing cover for such exploitation behind various grand moral and social purposes and their democratic (or other) legitimacy. It is not accidental that the states with the most grandiose moral purposes—Marxist Party-States committed to profound social transformation of the human condition—have been the most brutally exploitive forms of the state. Stalin’s regime was far more brutally successful in extracting resources for the purpose of the ruler than Tsarist Russia had ever been.

The paradox of polities

Trade-offs all the way down

An understanding of commerce and of mercantile societies in terms of what folk actually do—of the discovery, coordination and risk-management roles—entails accepting that social action is a matter of trade-offs all the way down. This is true for everything biological, and it is true of everything social, as everything social is emergent from the biological.

A biological organism is something that uses information⁸ and resources to maintain itself. This gives biological organisms directedness. They confront diminishing returns as a result of being structured, and operating in a complex and shifting environment, as there will always be a constraint that increasingly binds, restricting the benefit of doing the same thing more and more.

What is also clear is that Marx’s theory of surplus value is nonsense. Discovery, coordination and risk management are not remotely incidental to the processes of commerce and commercialised production. They can, however, generate income that seems mysterious to outsiders. This explains much of the antipathy that market-dominant minorities have generated in society after society.⁹

Marx’s theory of surplus value is a pseudo-sophisticated declaration that there is no mystery to their income, it is just parasitic behaviour. Hence his theory of surplus value has been used as justification in every Marxist mass murder — these people are just exploitive parasites — and is an incitement to mass murder, starting with Lenin’s infamous hanging order. If you convince a bunch of Homo sapiens that those people over there are parasites, and that you and your society would be better off without them, mass murder is primed to follow. Of course, killing off, dispossessing or driving away the most entrepreneurial in your population is not good for long-term success.

Marxist regimes, based on disastrously false (but highly motivating and coordinating) Theory, have been far more brutally exploitive—and far worse for human flourishing—than mercantile societies, with their selected-for mechanisms for aligning incentives.

Capitalism and capitalist are like cis- in pathologising and de-normalising what is ordinarily human and historical.

Perfectionism as cope

The biological, and the social, is a matter of trade-offs all the way down. So, perfectionist thinking is a profound mistake as a basis for analysis for biological and social phenomena.

As physicist Sabine Hossenfelder has pointed out, we have not developed good analytical or mathematical tools for analysing complexity. We have developed mechanisms for coping with complexity, some of which are counter-productive. Reducing the flow of events to comforting narratives as a response to the ever greater floods of information is an example of counter-productive coping.

Perfectionism can also be a way of dealing with complexity, for it simplifies by rejecting the complex-but-imperfect. If we are dealing with quantifiable phenomena, perfectionism can be a way of making matters mathematically tractable. Samuelsonian Physics-envy mathematisation of economics is an example of such perfectionism. Setting perfectly rational beings with complete (i.e. perfect) knowledge operating in fully (i.e. perfectly) delineated markets as the base model of analysis is an example of such perfectionism.

In other words, let’s assume away awkward trade-offs that, among other things, limit our ability to access and process information, because doing so makes the maths so much easier.

Such default perfectionism also naturally leads to a “assemble them and crank the handle” view of factors of production. Not of commerce, or commercialised production, as trade-offs all the way down, as processes of discovery, coordination, risk management where incomplete information is utterly pervasive. Instead, we get the views that knowingly assembling the blocks of production will do: the lego-land theory of growth.

Except of course, the experience of command economies is that, once the process of adding previously under-utilised inputs—classically shifting peasants into factories—is exhausted, what actually follows is increasing economic stagnation, as the inefficiencies of the system mount.

Equilibrium and uncertainty

If equilibrium is where no agent has a reason to shift behaviour, equilibrium is going to be a fairly unusual state. For shifting information shifts incentives and risks.

If an asset has no physical relationship to time except as a repository of information—true of all financial assets—then markets in such an asset will not have an equilibrium, in any useful sense, unless there is no new information. Indeed, any market where expectations about future value dominate price will lack such an equilibrium, unless there is no new information.

Conversely, goods with a predictable physical relationships with time, and a strong relationship to human needs, can have persistent equilibrating tendencies in their patterns of exchange—sometimes over very long periods of time—as we can see from what is often a striking historical persistence in trade patterns.

If we take the Knightian distinction between risk (which is calculable) and uncertainty (which is not), and face that we are dealing with social agents, then, in situations of uncertainty, folk are going to be unable to make independent calculations, so they will make social calculations instead.¹⁰ That is, they will place themselves to react to shifts in other people’s behaviour—presumably due to those others having information they do not yet have—so as to not be a (negative) outlier. Hence, you will get herd or flocking behaviour. Hence, uncertainty leads to wild swings in market behaviour, through compounding crowd effects.

It is not true that uncertainty is always negative for economic activity. On the contrary, booms generated from new technology can lead to uncertainty driving asset prices up, driven by positive—but not yet calculable—expectations of profit. It is subsequent uncertainty-reducing information about what actually works—and what does not—that can reverse such asset booms.

Economist Arnold Kling puts the difference between the firm in theory and the actual practise of business nicely:

If you are motivated by intellectual curiosity, I would recommend going into business. First of all, you will learn a lot about human behavior, which is important for understanding the economy. You will see the inside of a firm as something much different from the unitary, flawless profit-maximizing entity that is portrayed by economic textbooks and anti-capitalist demagogues alike. Real businesses operate in a fog of uncertainty, groping for ways to capture revenue and contain costs, surviving many mistakes and dysfunctional processes. Especially in large firms, one of the biggest challenges is getting the different parts of the organization to work with one another.

Risk management is central to how commerce, and commercialised production, organises precisely because information is always limited and shifting. Certainty requires complete information, and that is not what biological beings ever have, as it is trade-offs all the way down. This includes in perception mechanisms and cognitive capacity, limiting ability to acquire and process information. Perfectionist models may well be mathematically tractable, but they are also hugely misleading, encouraging reified notions of markets rather than examination of the realities of commerce.

Perfectionism can also be a way of making things morally and rhetorically tractable. All forms of politics which base themselves on the imagined, transformational future do this. They typically engage in some level of mystification of language to hide the banal simplifications they are actually pushing—such as treating all social interactions as a matter of power, or some form of the oppressor-oppression duality as pervasive. Making the imagined future their moral and cognitive benchmark creates a standard that can be as perfect as one wants, while all those defending actual human achievement—that involves various trade-offs and failings, moral and otherwise—will be stuck with defending dealing with the complexities of reality against the simplifications of imagined perfectionism.

Perfectionism as a way of making things morally and rhetorically tractable is what we see in all the streams of thought that descend from Hegel and use some version of the Hegel mode of analytical framing. The Hegel mode being the combination of scientific illiteracy, prophetic pretensions, power worship and obscurity creating a patina of profundity. Making no biological sense; believing one knows the rightful direction of history (often marked by some phrase such as “thus the dialectic advances”); insisting everything is about power and/or demanding the power to change everything; engaging in mystifying language to appear profound, to signal commitment and to generate social leverage by using your language but not your dictionary; are all patterns we see again and again in all the streams of thought that feed into Post-Enlightenment Progressivism (”wokery”).

None of which is at all conducive to understanding commerce, or why we see different societies evolve similar ways of doing commerce again and again. Conversely, the crude, misleading simplicity of capitalism and capitalist work just fine for Hegel-mode analytical framing and moral and rhetorical perfectionism.

All of which leads to the Communism [Marxism] does not know how problem that Michael Nayna¹¹ and James Lindsay so well identify. The failure to understand how things work leads to no serious idea of how to make things better.

Even worse, the motivating vision of the final society makes no biological or informational/computational sense. Hence the war against anything that undermines the (false) blank slate theory of humans and human minds. The entire thrust of Western Marxism—of Lukacs (1885-1971), Gramsci (1891-1937), Horkheimer (1895-1973), Adorno (1903-1969), Marcuse (1898-1979)—is to undermine the success of Western mercantile societies that frustrates achievement of the imagined-to-be-wonderful, unspecified, biologically and computationally impossible, final society. Ideas that harken back to the communal sharings of forager bands and families that do not scale up.

This is left-progressivism in a nutshell—degrading what works in the name of what can’t work. (But, with the right sort of ignorance, sounds really good.)

Social science that accepts the constraints of consilience that are basic to science—specifically, that everything social is emergent from the biological—is going to build its understanding from the interactions of humans upward. Not from congenially tractable perfectionism downwards. Working from the interactions of humans upwards enables us to understand how commerce, and commercialised production, works and what misleading terms capitalist and capitalism are.

This post has been greatly improved by email discussions with Meir Kohn.

References:

Klaus Adam & Albert Marcet, ‘Booms and Busts in Asset Prices,’ CEP Discussion Papers,  dp1059, Centre for Economic Performance, LSE, 2011. https://www.researchgate.net/publication/242696531_Booms_and_Busts_in_Asset_Prices

Christopher I. Beckwith, Empires of the Silk Road: A History of Central Eurasia from the Bronze Age to the Present, Princeton University Press, 2009.

Satyajit Chatterjee, ‘A theory of asset price booms and busts and the uncertain return to innovation’, Business Review, Federal Reserve Bank of Philadelphia, 2011, issue Q4, pages 1-8. https://www.philadelphiafed.org/-/media/frbp/assets/economy/articles/business-review/2011/q4/brq411_theory-of-asset-price-booms-and-busts.pdf

Roger Eatwell and Matthew Goodwin, National Populism: The Revolt Against Liberal Democracy, Pelican, 2018.

Eugene F. Fama and Michael C. Jensen, ‘Separation of Ownership and Control,’ Journal of Law and Economics, Vol.26, No.2, Corporations and Private Property: A Conference Sponsored by the Hoover Institution (Jun., 1983), 301-325. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=94034

Eugene F. Fama and Michael C. Jensen, ‘Agency Problems and Residual Claims,’ Journal of Law and Economics, Vol. 26, No. 2, Corporations and Private Property: A Conference Sponsored by the Hoover Institution (Jun., 1983), 327-349. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=94032

Yegor Gaidar, ‘The Soviet Collapse: Grain and Oil,’ AEI, April 2007, 2007-09 #21440, compiled from a lecture delivered by Yegor Gaidar at AEI on November 13, 2006. https://www.scribd.com/document/428148552/Grain-and-Oil

F. A. Hayek, ‘The Use of Knowledge in Society,’ American Economic Review, Sep. 1945, XXXV, No. 4, 519-30. https://statisticaleconomics.org/wp-content/uploads/2013/03/the_use_of_knowledge_in_society_-_hayek.pdf

Garett Jones, The Culture Transplant: How Migrants Make the Economies They Move To a Lot Like the Ones They Left, Stanford University Press, 2023.

Israel M. Kirzner, ‘The Alert and Creative Entrepreneur: A Clarification,’ IFN Working Paper No. 760, 2008. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1224842

Frank H. Knight, Risk, Uncertainty and Profit, Cosimo, [1921], 2005.

Meir Kohn, ‘An Alternative Theoretical Framework for Economics,’ Cato Journal, Vol. 41, No. 3 (Fall 2021). https://www.cato.org/cato-journal/fall-2021/alternative-theoretical-framework-economics

Benoit Mandelbrot with Richard L. Hudson, The (Mis)behaviour of Markets: A Fractal View of Risk, Ruin and Reward, Profile, [2004] 2008.

Alfred Mitchell-Innes, ‘What is Money?,’ The Banking Law Journal, May 1913, 377–408. https://www.community-exchange.org/docs/what is money.htm

Alfred Mitchell-Innes, ‘The Credit Theory of Money,’ The Banking Law Journal, Vol. 31 (1914), Dec./Jan., 51-168. https://cooperative-individualism.org/innes-a-mitchell_credit-theory-of-money-1914-dec-jan.pdf

Mancur Olson, Power and Prosperity: Outgrowing Communist and Capitalist Dictatorships, Basic Books, 2000.

A. Hingston Quiggin, A Survey of Primitive Money: The Beginnings of Currency, Routledge [1949], 2019.

Balbir Singh Sihag and Alok Saini, Kautilya: The True Founder Of Economics, Vitasta Publishing, 2014.

1. One of the reasons that Chinese imperial sources talked about relations with foreign powers—particularly the horse-trading nomads to their North—as “tribute” and “gifts” was to obscure the fact that the Son of Heaven was the world’s greatest merchant, trading silk for horses on a grand scale, while also buying peace on the northern border.

2. The institutional barriers to entry to new political Parties in the US are sufficiently high, that Trump sought the Republican nomination. Conversely, Nigel Farage and other national populists have regularly created new political Parties.

3. The difference between a “Kirznerian” entrepreneur who spots a vacancy in the political market and a “Schumpeterian” entrepreneur who offers a newly-created political product.

4. Economists think of profit as any return after payment to the various factors of production. So, (economic) profit is the reward for entrepreneurship.

5. The quantity theory of money can only make sense if the use of money as an exchange good is separated from the holding of money as an asset.

6. This is why Say’s Law does not work as Jean-Baptiste Say (1767-1832) originally envisaged, as Brad DeLong nicely explains here (archived here).

7. Such inefficiency includes consuming the attention of decision-makers. A key element of prices is that they aggregate into tractable (and motivating) form distributed information.

8. Information is what is conveyed or represented by a particular arrangement or sequence of things.

9. Not necessarily all of such antipathy. Market minorities can often be highly clannish, as it is precisely their strong trust and reputation effects that helps them be commercially successful. This separateness can extend to failure to participate in wider pro-social activities, or even shared forms of civility.

10. The shift to/use of social calculation is a key element in what John Maynard Keynes described as animal spirits, especially for asset markets.

11. Michael Nayna describes it as the “scene missing” problem, where believers shift from critique of what exists to the imagined, transformative future with no explanation of how the destruction of the former will lead to the latter. This is social alchemy theory: the notion — expressed in Critical Theory but also implicit in Marxism — that if the structures of oppression are burnt away, the transformational future will emerge, just as alchemists thought if the base metal is burnt away, the gold will be revealed.