WHAT IS CAPITALISM?

WHAT IS CAPITALISM?

When students ask the question that is the title of this essay, which they frequently do, they are surprised to learn that scholars have been divided on the nature of capitalism and that, as of yet, no definitive answer is available. Let us sketch the main contours of the debate: if we view capitalism as an economic system, then we must focus on its functions and seek to identify its distinguishing features (if any such exist) with reference to such functions. According to the standard account, an economic system is supposed to answer the fundamental questions of WHAT is to be produced, HOW and FOR WHOM. Some scholars would argue that what distinguishes capitalism from its predecessors is the extensive reliance on a system of decentralized markets combined with private ownership of productive factors and the profit motive for the purpose of resource allocation. Many economists would contend, however, that rationality (defined, at the individual level, as some sort of optimizing behavior over a set of consistent preferences) cuts across time and space, so that the fundamental complexion of economic institutions throughout history reflects the universal imperatives of economic efficiency. In the former view, capitalism is an economic system sui generis; in the latter, it is seen as the outcome of man’s inexorable, though time-consuming and uneven, march toward ever-increasing mastery over his environment.

And yet there can be no doubt about the historically unique performance of capitalism (where by capitalism we understand here the economic system which emerged in the aftermath of the Industrial Revolution, first in England and then in the other countries of northwestern Europe including their colonial offshoots in North America and Oceania). It is a fact that, over a very long stretch of time extending from the beginning of the first millennium BC to the Industrial Revolution, real per capita output displayed no long-run tendency to rise.2 This stands in striking contrast to the performance of capitalist economies in which per capita income has been steadily rising at a (roughly) constant proportionate rate.3 In the present context, a few facts must suffice: per capital GDP in Western Europe circa 1400 was an estimated $400 at 1985 prices), somewhat less than the corresponding figure for Italy in the era of the Antonines more than 1200 years earlier. Similarly, China (perhaps the richest country in the world in the early fifteenth century) was caught in a stagnant state: per capita income there remained constant at $500 over the next four centuries. By contrast, real per capita income in capitalist US over the 1820-1989 period rose from $1048 to $18317, a stunning 17-fold increase.

Naturally, capitalism’s overwhelming productive superiority calls for explanation and there has been no shortage of attempts at it. Observers of capitalist economic performance have frequently emphasized the phenomenal accumulation of physical and human capital in the indicated economies, while some have explored the origins of such accumulation which, depending on their vantage point, they have traced to widely different spheres of social structure. Thus Max Weber argued that incipient capitalist accumulation derived from the nexus of Protestant religious imperatives, while Eric Williams claimed that it was the prodigious profits from the Atlantic slave trade that made the financing of the Industrial Revolution possible. Regardless of their merits in explaining the origins of capitalist accumulation, however, neither argument can provide an adequate account of sustained exponential growth in western per capita income. The reason is, of course, the operation of the celebrated law of diminishing marginal returns. Indeed, with a given technological horizon, incessant capital accumulation must eventually depress the net productivity of capital to near zero. The reader can convince himself of this by considering the number of airports or highways that can be built in a given region or, for that matter, the number of computers operated by a given population, before their further contribution to production drops to nil. But if capital accumulation by itself cannot account for the unprecedented rise of living standards under capitalism what can? The obvious candidate is, of course, technical progress where by that term we refer to improvements in society’s generic ability to combine resources in order to produce output. Technical progress implies purposeful activity of a certain type which, following Joseph Schumpeter, economists have dubbed innovative entrepreneurship. Schumpeterian entrepreneurship can then be understood as the capacity, inherent in individuals, to employ resources in order to (a) satisfy existing human wants more thoroughly than currently available alternatives (b) satisfy new human wants which arise from the outcome of the innovative activity itself. Nevertheless, if we are to understand why such activity is so much more prevalent under capitalism, we must make use of a different and somewhat comprehensive conception of entrepreneurship. For our purposes, we shall define entrepreneurship as (individual) capacity to effect arbitrage, i.e., to undertake enterprise for which the cost of required inputs falls short of the value of the corresponding output. It goes without saying that the indicated surplus (whether it be called profit, tribute, plunder or whatnot) supplies the driving force that sustains entrepreneurial action. Thus, in our scheme of things, Napoleon or, for that matter, Alexander, Genghis Khan and Ali Pasha were just as entrepreneurial as the renowned innovators of the Industrial Revolution or the present-day pioneers in the commercialization of robotics and information technology. Similarly, Europe’s conquest, whether undertaken by Charlemagne, Hitler or Stalin, was most certainly an entrepreneurial venture in our sense of the term which, at least by the prospective conqueror’s cost-benefit calculus, was worth the effort. (A word of caution is perhaps in order at this point: there is no presumption that the entrepreneur’s motive is strictly that of material gain or even, in many cases, primarily that. Nevertheless the perception of the indicated surplus is sine qua non for the execution of entrepreneurial ventures, Schumpeterian or otherwise.)

But though, from our perspective, entrepreneurship can be hardly confined to the Schumpeterian variant, the latter’s impact on society’s productive powers can be radically different from that of warrior-conquerors or Hebrew prophets or Athenian demagogues. William Baumol, among others, has stressed the preponderant role of (what he calls) destructive entrepreneurship in pre-capitalist societies.4 To see what is involved we must transcend contemporary social accounting, which identifies any and all increases in material production with higher social welfare, and focus instead on the subjectively experienced index of individual welfare which economists call utility. No doubt, increases in material production must raise utility somewhere in the economy but they raise social welfare unambiguously only if they do not destroy utilities elsewhere. If I coerce my neighbor into endless drudgery, it is entirely possible to register an increase in output (GDP growth as we would call it today); and yet such a statistic, ignoring as it does the slave’s material, mental and ethical degradation, can hardly be deemed a satisfactory measure of social welfare. A moment’s reflection suffices to show the devastating economic implications of predatory entrepreneurship. The key element, as already indicated, is that predatory enterprise often combines fabulous private rates of return with social rates that are appallingly negative. It is precisely this conjunction of lucrative private prospects with nasty social outcomes which accounts for the endless recurrence of predatory enterprise in the midst of Malthusian poverty.5 But how did western societies manage to escape form this near-Hobbesian state and resolve humankind’s primeval prisoner’s dilemma? It is impossible to provide here an account, or even a sketch, of the slow and precarious development in the modern Occident -and nowhere else- of social groups whose very existence was predicated on the imposition of binding institutional constraints on the exercise of predatory power. But the significance of the ascendancy of these groups cannot be overemphasized. For if voluntary exchange in intensely competitive markets is to be the prime form of man’s economic activity, the suppression of predatory expropriation of market-based wealth is sine que non. Was this not a vital part of the great political and intellectual struggles that shook the western world to its fundaments in the 17th and 18th centuries? Wasn’t the security of market-based wealth a fundamental objective of the eminent revolutionaries of that time and wasn’t it enshrined in the great documents of that era? No doubt, incipient capitalism got it right at the institutional level for by safeguarding property against predatory expropriation, it eliminated at one stroke a vast field of privately attractive yet socially destructive entrepreneurial action. At the same time, by defining success to be primarily economic success, it redirected a relatively large part of society’s entrepreneurial talent from predatory to Schumpeterian endeavors whose social rates of return, though not always coincident with private rates, have proved vastly superior to anything that alternative institutional arrangements could offer.

What then is the upshot of the above discussion? If the preceding argument is nearly correct, capitalism can be effectively distinguished from its predecessors (and rivals) by a unique set of institutions (“rules of the game”, some would say) which have constrained predatory enterprise on a far more comprehensive scale than alternative forms of economic organization ever have. This, however, is not to suggest that extant capitalist institutions invariably maximize economic efficiency. In fact, destructive entrepreneurship can definitely be active in democratic politics as the massive increases in inequality of wealth distribution which have occurred in advanced capitalist economies post-1980 reveal.6 If those who suffer (what they perceive to be) unmerited deprivation are driven to behavior which undermines productivity growth, then the ever-increasing use, over recent decades, of political means by privileged groups to effect massive redistribution hardly warrants complacency on the part of those who value continued material progress. Nor is destructive redistribution in today’s capitalist societies confined to the present generation. For even where and when it is politically difficult to redistribute wealth among society’s present members, it is always possible to effect intergenerational income transfers as the dismal record of global environmental degradation indicates. Since those who are most adversely affected by intergenerational redistribution cannot resist it (for they have not been born yet!), who would correct such devastating external effects? After all, as Joan Robinson has famously remarked, “whatever has posterity ever done for me?”

None of the above is to imply that economic efficiency ought to be the primary, let alone the exclusive, preoccupation of the good society. In fact, our initial premise notwithstanding, capitalism has never been just an economic system: its arrival in the modern Occident has brought about a monumental transformation, not merely of economic but also of political, intellectual and cultural traits there. Put differently, capitalism appears to be what people have in mind when they speak of a distinct civilization. If this is true, however, the separation of one social sphere (say, the political) from another (say, the economic) may not be possible. (In this connection, the reader may wish to recall the experience of the inter-war years of the previous century when the Great Depression was accompanied by the rise of totalitarianism in Europe and elsewhere.) Presently, those who cherish the ideals of a liberal international order cannot afford to be complacent. A number of disturbing signs are already visible on the horizon.

Notes:

This controversy is known as the primitivist or Finley debate to which a good, though somewhat dated, introduction is provided in Karl Polanyi, et al. Trade and Market in the Early Empires.
For more information on longest-sweep patterns of growth the reader is referred to Gregory Clark’s A Farewell to Alms and Angus Maddison’s Contours of the World Economy.
For the mathematically trained reader we may write y(t)=y(0)eλt where y(t)=per capita output at time t, λ=proportionate growth rate of y. Whereas in the pre-1800 period λwas approximately nil, in the capitalist epoch λ has been close to 2 percent.
See his The Free-Market Innovative Machine.
The entire pre-1800 era is sometimes called Malthusian after Thomas Malthus (1766-1834) whose dire forecasts of humankind’s material prospects derived from his insistence upon an uneven race between population and productivity.
These trends have been amply documented in Thomas Piketty’s Capital and, for the US, Joseph Stiglitz’s The Price of Inequality.

By Dr. Iakovos Arapoglou
Instructor of Economics
New York College