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The Mechanisms and Impacts of Capitalism

Defining capitalism

Before analyzing capitalism we first have to define what capitalism is, which may sound simple enough, but it is actually quite complicated. This is because the very definition of capitalism is itself skewed by ideological perspective. Definitions of capitalism are used to frame perceptions of capitalism and to focus on specific qualities while taking attention away from other qualities. Proponents of capitalism provide definitions of capitalism that focus on "free-markets" and private property ownership. These are the most commonly used types of definitions in the United States. Examples of such definitions include:

An economic system characterized by private or corporate ownership of capital goods, by investments that are determined by private decision, and by prices, production, and the distribution of goods that are determined mainly by competition in a free-market.
http://www.merriam-webster.com/dictionary/capitalism

An economic system based on a free-market, open competition, profit motive and private ownership of the means of production. Capitalism encourages private investment and business, compared to a government-controlled economy. Investors in these private companies (i.e. shareholders) also own the firms and are known as capitalists.
http://www.investopedia.com/terms/c/capitalism.asp#axzz1VxMk733J

Economic system based (to a varying degree) on private ownership of the factors of production (capital, land, and labor) employed in generation of profits. It is the oldest and most common of all economic systems and, in general, is synonymous with free-market system.
http://www.businessdictionary.com/definition/capitalism.html

On a side note, capitalism is not the oldest of all economic systems, it is widely accepted to have emerged in the late 18th  to early 19th century.

What is missing from these definitions, however, is any sense of the inherent divisions implied by private capital ownership and the necessary distinction between capital owners and the wage-laborers whom they employ. The result of such definitions glosses over this relationship and leave the impression that in a capitalist system everyone is a "capitalist" or that there are no conflicts of interests between members of the private economy. If anything, such definitions tend to portray a conflict of interest between capital owners and government, which is not at all inherent, but leave no impression of inherent conflicts of interest between capital owners and workers or between capital owners and other capital owners.

The definition of capitalism provided by Wikipedia is a little better, it states:

Capitalism is an economic system in which the means of production are privately owned and operated for profit, usually in competitive markets. Income in a capitalist system takes at least two forms, profit on the one hand and wages on the other. There is also a tradition that treats rent, income from the control of natural resources, as a third phenomenon distinct from either of those. In any case, profit is what is received, by virtue of control of the tools of production, by those who provide the capital. Often profits are used to expand an enterprise, thus creating more jobs and wealth. Wages are received by those who provide a service to the enterprise, also known as workers, but do not have an ownership stake in it, and are therefore compensated irrespective of whether the enterprise makes a profit or a loss. In the case of profitable enterprise, profits are therefore not translated to workers except at the discretion of the owners, who may or may not receive increased compensation, whereas losses are not translated to workers except at similar discretion manifested by decreased compensation.

There is no consensus on the precise definition of capitalism, nor on how the term should be used as a historical category. There is, however, little controversy that private ownership of the means of production, creation of goods or services for profit in a market, and prices and wages are elements of capitalism.
http://en.wikipedia.org/wiki/Capitalism

Here are the important points. Capitalism isn't simply an economic system in which there is private property ownership. For example, if you have a society in which everyone privately owns their property but it is a subsistence economy where for the most part everyone creates all their own goods, i.e. everyone is a farmer who lives on their own property, farms for themselves, and consumes the products of their own labor and property, this clearly is not a capitalist system. It's a system with private property ownership, but it isn't a capitalist economy, indeed it is barely an economy at all, since there is little or no exchange of goods and services.

So a capitalist system is one in which commodities are produced for exchange.

As for "private property", this term is often misconstrued to mean all property, but this is not the case; the definition of capitalism rests not on private property rights in general, but private ownership of the "means of production", i.e. capital, hence the term "capital-ism". Even non-capitalist systems may retain private property rights regarding commodities and non-productive property, like houses, cars, etc., but any economy that didn't include private ownership of capital, i.e. property used to create value and derive income, would not be a capitalist economy.

So a capitalist system is one in which privately owned capital is used to produce commodities for exchange.

However, if everyone owned their own capital and worked for themselves to create commodities then no one would be a capitalist. A capitalist is someone who derives their income through the ownership of capital upon which other people are employed to work. In essence, if everyone owns the capital that they use then no one is a capitalist, since if everyone owned their own capital everyone's income would purely be a product of their own labor, no one would derive income from capital ownership. (We'll get into this more later.)

So a capitalist system is one in which non-capital owners are paid wages by private capital owners to create commodities for exchange.

So these are the core components of the definition of capitalism, an economic system in which some people own capital and some people don't, and the people who own capital pay wages, which are determined by markets, to non-capital owners to use the capital that they own to create commodities for exchange in markets.

While these are the core defining characteristics of a capitalist system, there is always some leeway in the application of these definitions. For example in the United States we have had a federal minimum wage for over 50 years which means that labor prices are not always determined purely by markets. Likewise there are many price controls, taxation policies, and subsidies which distort market prices of other commodities as well. Similarly, as has been noted above, roughly half of Americans own some kind of share of capital, i.e. stocks or direct business equity, etc., but owning a tiny insignificant share of capital doesn't make one a capitalist and doesn't qualify for the condition of everyone being a capitalist so that no one is. Over 99% of Americans who own stock don't own enough to have any meaningful influence over the use of capital, i.e. they have no control over capital through their stock ownership. Likewise, the vast majority of American stock owners own such small shares of stock that the income which is generated from it is insignificant. Most American stock holders work for wages and receive virtually no income from stock ownership until they retire and even then depend on supplemental income such as Social Security or a pension in addition to income from their stock holdings. So while the distinction between wage-laborers and capital owners is somewhat blurry in the American system, if we look at primary forms of income and control, the distinctions are still quite clear.

In essence, what we are really talking about when we talk about all modern economies are systems of collective production. Every modern economy is a "collectivist" system of some form or another, including capitalism. The difference in various modern economic systems is merely in how the products of collective labor are distributed. There are no modern economic systems dominated by individuals working in isolation or through self-employment. The driving force behind all modern economics system is collective production, and the defining characteristic of all modern economies is the massive scale of collective production, not only in terms of the size of collective entities, such as corporations that directly employ millions of workers, but in terms of the collective integration of separate entities. The difference between historically defined systems like communism, socialism, fascism, and capitalism isn't in determining whether people will work collectively or not, it is in determining how the products of collectively produced value are distributed. Who owns the work product that is produced by millions of people working together? That's the real distinction between various modern economic systems.

Also notice that in my definitions of capitalism I did not use the term "free" market. There is a reason for this, not the least of which is that defining what "free-market" means is itself even more difficult and controversial than defining capitalism. If we look at the definition of capitalism provided by Investopedia above we see that it includes the phrases "free-market" and "open competition". These are not actually defining characteristics of capitalism. Capitalist systems can exist that operate under "free-market" conditions (of various definitions, which we will address later) and open competition, but they don't necessarily require "free-markets" with open competition. Indeed the American economy is not a "free-market" (by any definition of the term) nor is there 100% open competition. The key defining characteristic of capitalism is private ownership of capital and the employment of non-capital owning wage-laborers by capital owners. A capitalist system is one in which capitalists profit through their ownership of capital. Even if prices are heavily manipulated or if there is heavy dominance by monopolies, if the capital owners still profit through their ownership of capital then it is a capitalist system. There may need to descriptors attached to the term capitalism in such cases, such as state-capitalism or corporate-capitalism or monopolistic-capitalism, but these are still a types of capitalism, types of systems in which profits are reaped by private capital owners through the ownership of capital and the employment of wage-laborers who produce commodities for exchange.

Value creation, compensation, and modes of production

I consider this subject to be the single biggest point of confusion when it comes to economics in general, but especially in regard to capitalism.

Probably the most significant subject of economics, at least from a moral and philosophical perspective, is the issue of contribution vs. reward. Everyone has a fundamental sense of fairness which directs us to believe that, at base, individuals should be rewarded based on their contributions. This is the essence of John Locke's statement that an individual has a right to the value that they create with their own labor. Basically, if I go to unclaimed land and dig up some clay out of the ground and fashion it into a bowl then that bowl is mine, I have a right to it, and virtually everyone agrees with that premise.

The problem with discussions of contribution vs. reward in a capitalist economy, however, is that while virtually all discussions are based on that premise, that premise is completely invalid in a capitalist economy. To be more specific, discussions of value creation and reward within a capitalist framework are almost always framed as if everyone in a capitalist economy is an individual producer and receives nothing more in reward than the value created by their own labor, when in fact no one in a capitalist system is an individual producer who receives the true value of their own labor.

Let's examine various modes of production outside of the context of any given economic system, without regard to property rights or labor markets, or any defined framework for allocating the products of production.



The most basic mode of production is simply individual production. With the individual mode of production it is relatively easy to determine who creates what, and what each person's reward should be. Assuming that there are no existing property rights and a right to the products of one's own labor as described by John Locke, each individual's reward is simply in keeping the products of their own labor. Again, this assumes no existing property rights, which is a fundamental requirement for the basic functioning of John Locke's natural right to property, because if an individual were to labor on someone else's property or using someone else's property, then the whole picture gets far more complicated, as we will later see. So under the individual mode of production, assuming no existing property rights, and a natural right to the product of one's own labor, it is quite easy to determine who creates what and what value each individual is entitled to.

Using the diagram above let us refer to the light blue diamonds as "widgets" and for sake of argument imagine a theoretical economy where widgets are the only commodities that exist. What we can see is that individual A creates 1 widget, B creates 2 and C creates 4. Regardless of why there is a difference between what A, B, and C produce (maybe A is a child, maybe A is disabled, maybe A is elderly, maybe A is simply lazy, or maybe A just isn't very good at producing widgets) clearly there is a difference in what each of the individuals produce.

In terms of basic fairness, assuming that all else is equal, we would say that taking a widget from C to give to A because A has fewer widgets is unfair. This is a position that basically every economist from John Locke to Adam Smith to Karl Marx to Ayn Rand to Milton Friedman is in agreement on. There is, essentially, nothing controversial about our understanding of the individual mode of production. It might be nice for C to give a widget to A, but to forcibly take a widget from C to give it to A would indeed be a form of theft and would be unfair to C.

But now we move on to collective production. By collective production we mean simply any mode of production in which multiple individuals work together to produce goods or services. As we can see, the total number of widgets produced by individual production is 7 and under collective production we have 12 widgets being produced. This represents the fact that individuals work collectively because individuals are able to create more net value by working together than they are able to create when working individually.

Note that for the sake of this discussion, A, B, C do not represent the same individuals under each mode of production. The diagram for each mode of production is separate from the rest, meaning that we aren't to imply that individual A is less productive in the collective production diagram because individual A is less productive in the individual production diagram.

So the interesting thing about collective production is that while it leads to increased net productivity, determining who created what is much more difficult, even without the complicating factor of property rights. Assuming no property rights, how are the widgets to be divided up amongst the individuals who created them? According to John Locke's statement on an individual's right to possession of the value that they create with their labor, each individual should get what they produced. But with collective production it is essentially impossible to determine what each individual produced, since, by virtue of the fact that collective production is more productive than individual production, this implies that "the whole is greater than the sum of its parts", which is to say that a certain portion of what is produced is a product of collectivism itself, i.e. it is not a product of the labor of any individual, it is truly a product of the interactions between the individuals.

If you were to take a small group of people and have them work collectively and then have them divide up the products of their collective labor, in a neutral setting what would most likely happen is that individuals would pay attention to who contributes what and who was working the hardest, etc. and form opinions in their mind about what portion of overall production each individual was responsible for. They could even go so far as to track the exact output or the exact working time of each individual. Accordingly people would then divide up the proceeds of production in proportion to the relative estimated contributions of each individual. That's not how our economic system works and its not how hardly any economic system has ever worked. In reality, under collective forms of production, such as existed in tribal groups, etc. everything was highly influenced by social status, which was itself a highly complex system based, variably, on any number of things, from family history to individual accomplishments to intimidation to political or religious power to bribery, etc. So all kinds of means have existed throughout history that have distorted the ways in which individuals received rewards from collective production, over-compensating some individuals while under-compensating others. Yet, collective production persisted for a variety of reasons, including that fact that even individuals who were under-rewarded based on their relative contribution may still have been better off than they would be under an individual mode of production. Another reason, of course, has been coercive force, be it slavery or simple social pressure, to get under-compensated individuals to contribute to collective production while being under-rewarded. Throughout history the "fairness" of collective production has varied widely from one society to the next, and indeed a major aspect of social structure in every society has been precisely how to deal with dividing up the fruits of collective production.

Now let's move on to hierarchical collective production. Hierarchical collective production is essentially just a form of collective production that involves greater division of labor and specialization, within a hierarchal structure. Fundamentally hierarchical collective production isn't much different than basic collective production, but there are some important distinctions. Within the hierarchical mode of collective production the ability to determine how much value each individual creates is complicated by two primary conditions, the first being division of labor and specialization, the second being the nature of hierarchy itself. When each individual is roughly equal and each individual is doing roughly the same type of work, then evaluating how much each individual contributes is relatively simple. However, division of labor and specialization implies that individuals are performing significantly different tasks. The most fundamental of these divisions may be planning vs. execution, or managers vs. performers, which brings us to the hierarchical aspect.

Under a hierarchical system of collective production some individuals are directly involved in the production of goods and services, while others are only indirectly involved. Generally speaking, "managers" do not directly create value via hierarchical collective production, they (theoretically) add value by enhancing the productivity of the performers that they manage. Looking at the diagram for hierarchical collective production above, we see that all of the widgets are actually produced by individuals B and C, A doesn't create any widgets. This means that in order for A to be compensated some portion of the widgets produced by B and C have to be allocated to A.  Typically, of course, an individual would not manage only two other individuals, as depicted here. This is an important note since managers/planners/administrators, etc. don't produce commodities, all of the compensation for such positions has to be generated by the production of commodities by performers. This is a major reason why hierarchical systems have pyramid type structures, because it takes many performers to support a manager.

It is virtually impossible, however, to determine the real contribution of "managers". Let's use a rowing team as an example. Rowing teams use someone called a coxswain who sits in the boat with the rowers and sets the pace, helps guide the boat, and provides encouragement, etc. Now, let's say that a rowing team with a coxswain performs 25% better than one without a coxswain. Does that mean that the coxswain is fully responsible for 25% of the performance of the team? Let's say that the team has eight rowers and they enter a race (in which all of the other teams also have eight rowers and a coxswain). Let's say that first prize for the competition is $10,000. How should the team divide the prize money? Should the coxswain get 25% of the prize money because a coxswain generally improves performance by 25%? This would result in the following compensation assuming all rowers get the same amount: $2,500 for the coxswain and $938 for each rower. But what does a coxswain do compared to the rowers? The coxswain is certainly an easier job; they don't have to workout or train as intensively, they don't have to exert themselves as much during the race. Let's say, for sake of argument, that simply putting a metronome in the boat would increase performance by 10%, which is less than the coxswain, but more than doing nothing. No one would argue that the metronome or the metronome owner should get 10% of the prize money would they?

So, when it comes to hierarchical collective production determining what each individual actually produces is even more difficult because "non-performers", i.e. managers, executives, administrators, etc., don't directly produce commodities of determined value. To complicate matters even more, hierarchical systems are heavily influenced by social pressures. There is strong incentive to compensate managers more than the performers that they manage, even if they contribute less to overall production than any individual performer, because of the way that people perceive authority. Authorities within hierarchical systems tend to have more control and asymmetric information regarding performance, as well as the ability to affect conditions for those under them. The very nature of the pyramid structure of hierarchical systems means that individuals are generally increasingly powerful the higher up in the hierarchy they are. In relative terms, generally every individual is as powerful as the collective total of the individuals below them in the hierarchy. In other words, in an organization with 100 performers, which are managed in teams of 10 resulting in 10 middle managers, who are managed in teams of 5 by 2 executives, who report to a president, each of the middle managers is essentially as powerful as the 10 performers that they manage, and the 2 executives are as powerful as the 10 middle managers that they manage, and the president is as powerful as the two executives that he manages, which means that the president is 100 times more powerful than any individual performer, and middle managers are 10 times more powerful than any individual performer. Thus, in terms of determining compensation, those higher up in the hierarchy have a disproportionate ability to influence compensation, to distort compensation in ways that don't reflect actual contribution, which invariably leads to distorting compensation in ways that benefit those higher in the hierarchy. This is the basis for the formation of unions to band individuals at the lower levels of hierarchical organizations together so that they can act as a single individual, thus putting the workers, acting as a single entity, on par with others higher in the hierarchy in terms of power, which is something that I'll address in greater detail in a later section.

And now we finally arrive at industrial collective production. Industrial production is also inherently hierarchical, but the difference between industrial production and simple hierarchical production is that under an industrial system of production the tools of production are far more significant. In theoretical terms we ignore the impact of tools when considering simple hierarchical production, but when we consider industrial production we acknowledge that the tools themselves are a major contributor to productivity. Indeed the term "tools" puts things very mildly, what we are really talking about are machines, which is to say automated tools or tools powered by something other than people or animals.

The important difference between simple hierarchical production and industrial production is that changes to the tools of production under an industrial system can have significant impacts on workers in the system. The major advantage of industrial production over other forms of production is labor efficiency, which means that industrial production reduces the amount of labor required to generate a unit of output. Note, however, that this doesn't necessarily mean that industrial production is more efficient in terms of its use of resources, indeed in many cases industrial processes waste more recourses per unit of output than non-industrial methods. The tradeoff with industrial production is in terms of labor efficiency, which means that if it take less human effort to produce a widget using an industrial system, but in the process excess material is wasted, the overall system is more efficient in terms of labor but less efficient in terms of resources. This can still lead to an overall increase in output and overall reduction in commodity prices when the acquisition of raw materials itself becomes industrialized, thus reducing the amount of human labor required per unit of output.

But let's stick to the relationship between tools and workers under the system of industrial production. Tools increase the amount of output each worker is capable of generating, which is a good thing. This means that in total we can produce more goods. It also means that improvements to the tools of production can increase productivity even more, which means that improvements to the tools of production can result in workers going from being able to produce 10 widgets a day to being able to produce 15 widgets a day. But here is the big question: If improvements to the tools of production lead to increased output, who gets the increased output? Furthermore, how can one differentiate between increases in output due to improvements to the tools vs. increases in output due to improvements in worker performance? Note that in this section we are simply dealing with modes of production, not economic models, so things like who owns the tools or how compensation is determined are not defined. So let's move on to the next section where we can examine how this all works within a capitalist system of property rights and labor markets.

Property rights and labor markets

In the previous section we raised a lot of questions about how to determine who actually creates what value under various modes of collective production. It is very easy to determine who creates what value under individual modes of production, but capitalism is inherently dominated by collective modes of production, most specifically the industrial mode of collective production. A "capitalist economy" may include individuals who work for themselves, by themselves, but such individuals are not capitalists and aren't a part of the capitalist system, they are independent individuals who co-exist within a capitalist economy, just as co-ops and state run enterprises may exist within a capitalist economy even though they are not capitalist entities.

When we are dealing with capitalism what we are really dealing with is a particular system of laws that govern forms of collective production. And the particular set of laws that define capitalism, as we have previously noted, are laws defining private ownership of the means of production (i.e. tools and raw materials) and the use of labor markets to determine how value that is created by multiple people working together is distributed. To put it another way, capitalism is a form of collectivism that allocates the fruits of labor to property owners.

We noted above that the discussion of the modes of production was going to ignore property rights for the moment, particularly property rights in relation to capital. This is because property rights in relation to capital greatly complicate the issue of how value that is created by individuals' labor is allocated. Let's go back to the most basic mode of production, individual production. We've said that, in agreement with John Locke's statement that an individual has a right to the products of his or her own labor, every individual should receive the full value of what they create with their own labor. But, what if someone exercises their labor upon property that someone else owns? I used the example previously of someone digging up clay and making a bowl from it, noting that of course this person should have a right to keep the bowl that they made. But what if the person dug up the clay on land owned by someone else? Then who has a right to the bowl? Technically, the material the bowl is made of belongs to someone else, and the value added to the raw clay belongs to the person who made it, but these two "things" co-exist within the same object. Certainly the issue of "having a right to the product of one's own labor" is complicated by private ownership of capital. Objectively we may conclude that the value of the raw clay belongs to the owner of the property and the value added to the raw clay belongs to the individual who exercised their labor upon the earth to dig it up and fashion it into a bowl, but that isn't how it works within a capitalist system.

Here is what is important to understand about the capitalist framework. Within the capitalist framework fundamentally everything goes back to property rights, which means that under a capitalist system the bowl belongs completely to the owner of the land from which the clay was drawn, even if the value of the raw clay was five cents and the value of the bowl is fifty dollars. So 100% of the value belongs to the original property owner, the laborer has no right to any value, and thus is in fact deprived of the value created by their labor. That is, at least, the starting point of capitalism. We have, over time, established laws that grant some rights to laborers, such as minimum wages, guarantees of payment, etc., but fundamentally the right to ownership of newly created value belongs completely to the owner of the property used to create said value. Typically in a capitalist system, however, individuals come to an employment agreement when an individual is going to exercise their labor upon someone else's capital, in which the laborer and the capital owner agree to a set price to be paid to the laborer, with the capital owner keeping full ownership of the resulting work product.

So let's move on to collective production and labor markets to see how this plays out in the big scheme of things. Advocates of capitalism claim that "labor markets" can properly distribute the fruits of collective production among all of those involved in the production process, including workers and capital owners. Labor markets effectively only play a role in hierarchical and industrial modes of production, where workers negotiate their compensation with some hierarchical authority. According to neo-classical labor market theory, the value that an individual worker creates is determined by the price they are able to negotiate for their labor. This view is treated as common place in neo-classical economics, as described in this passage from a paper on the effect of minimum wages by a "libertarian" think tank.

Minimum wage laws, if meaningful, require employers to pay some workers more than they would have earned in an unhampered market economy. For example, whereas the federal minimum wage at this writing is $5.15 per hour, in the absence of this minimum some employers might pay their workers $4.50 per hour. Economic theory suggests that in competitive markets, workers will be paid their marginal revenue product—the amount of revenue that the worker contributes to the firm. That is a wage consistent with the profit-maximizing behavior of employers and the utility-maximizing behavior of employees.

Thus, if a firm in an unregulated market economy is paying its workers $4.50 an hour, it is probable that the marginal contribution of the worker to the firm is about $4.50 in revenue per hour. If, in fact, it were higher, say $5.00, it would be profitable for another firm to offer the worker in question a higher wage than the existing $4.50.
- Does the Minimum Wage Reduce Poverty?- Employment Policies Institute

If this were true then employees would be paid the exact full amount of all of the value that they create. This is the way in which all discussions of income, or value creation and reward, are popularly framed in America today, yet it is obviously incorrect and completely contradicts classical economics, as noted by Adam Smith's statements on wages and profits in The Wealth of Nations and as noted by the classical economist David Ricadro.

The value which the workmen add to the materials, therefore, resolves itself in this case into two parts, of which the one pays their wages, the other the profits of their employer upon the whole stock of materials and wages which he advanced. He could have no interest to employ them, unless he expected from the sale of their work something more than what was sufficient to replace his stock to him;
- Adam Smith; The Wealth of Nations - Book 1 Chapter 6

Thus the labour of a manufacturer adds, generally, to the value of the materials which he works upon, that of his own maintenance, and of his master's profit. ... Though the manufacturer has his wages advanced to him by his master, he, in reality, costs him no expence, the value of those wages being generally restored, together with a profit, in the improved value of the subject upon which his labour is bestowed.
- Adam Smith; The Wealth of Nations - Book 2 Chapter 3

If the corn is to be divided between the farmer and the labourer, the larger the proportion that is given to the latter, the less will remain for the former. So if cloth or cotton goods be divided between the workman and his employer, the larger the proportion given to the former, the less remains for the latter.
- David Ricardo; The Principles of Political Economy and Taxation, 1817

The important phrase of note in the statement from the Employment Policies Institute is "competitive markets". Given the context, this term can only be interpreted as meaning a "perfect market", which is a subject that we will address in detail in a later section on markets; but it is sufficient to say here that the statement that in a perfect market "workers will be paid their marginal revenue product" is technically true in the theoretical sense, yet it is never true in an actual capitalist system because perfect market conditions never exists. Under the conditions of a "perfect market" all profits are driven to zero, under which conditions capitalism cannot operate, which is why, as we will explore more fully, capitalism is dependent upon imperfect, or distorted, markets.

For now let's set theory aside and look at reality. The reality is that, as Adam Smith describes, in order for an employer to have any reason to hire an employee, that worker has to create surplus value above and beyond what is paid to the employee. As Adam Smith describes it, the value created by the worker is divided between the portion that is paid to the worker in the form of wages and the portion that is retained by the employer in the form of profits, which is to say that profits are the value created by workers which isn't paid to workers as compensation, but is rather retained by capital owners.

But the reality of labor compensation is even more complex than what Adam Smith describes, and really demonstrates why the notion that workers could ever be paid the full amount of the value that they create within a capitalist system, or any system, is nonsense. The reality is that in order for a worker to contribute toward profits for a capital owner they have to not only create enough value to cover the cost of their wages plus the profits of the capital owner, they also have to generate enough value to cover the costs of employing them, which is to say that in reality if a worker is paid $4.50 an hour, then in America we also have to consider the additional Social Security contributions of the employer, the employer's workers' compensation insurance to cover the employee, the unemployment insurance paid on behalf of the employee, the cost of the capital used by the employee, the costs of training the employee, the cost to supervise the employee, the cost of administration to process the employee's records and pay, etc., etc.

Thus, a worker being paid $4.50 would actually costs an employer more like $8.00 an hour to employ. So, we know that the value of the employee's labor must actually be at least around $8 in order for an employer just to break even, but if the value of the contribution of the employee is only $8, then it still wouldn't be worth employing them at all either, because at a cost of $8, there would be no benefit to the employer from employing the employee. So, in reality we know that the value created by the employee has to be more than $8.

Therefore, generally speaking, in order for a worker to be "worth hiring" to an employer within a capitalist system they have to be able to create enough value to cover their wages, the capital owner's cost of employing them, and the profits of the capital owner or owners. The diagram below depicts a worker who creates 10 widgets, out of which 5 widgets are paid to the worker to compensate them for their labor (light blue), one widget goes to taxes paid on behalf of the worker (red), one widget goes toward insurance and other costs associated with the employment of the worker (dark blue), one widget goes toward the costs of administration and supervision of the worker (i.e. goes into a pool of widgets used to pay managers and human resources staff, etc.) (yellow), and 2 widgets go to the capital owner and are considered "profits" (green).



In this example a worker under the industrial mode of collective production is keeping half of the value that they create, with the other half going to the costs of employment, managing said worker, and to the profits of the capital owner or owners. How that value is actually split is determined by "labor markets" within a "free-market" system.

Under the individual mode of production an individual's "reward", or compensation, is determined purely by the market value of what they produce, i.e. the end product. If an individual goes out into the woods, chops down some trees, uses them to build a boat, and then sells the boat, they receive the full value of that boat. So an individual's income in that case is a direct representation of what they produce, i.e. their rewards are always reflective of their contributions.

Under hierarchical and industrial modes of production however, where individuals are paid wages, the system is split into two separate markets, the labor market and the commodity market, that sever the relationship between what an individual produces and what an individual receives in compensation. What "capitalists", i.e. owners of capital, i.e. employers, essentially do when they hire someone is they are engaging in speculation, and what any employer is doing is they are hiring a worker at a set price on the bet that what the worker produces will be more valuable than the price paid to the worker. There isn't necessarily anything wrong with this, the employer is taking on risk after all, but the real value of the worker's contribution isn't what was paid to the worker, it is the value of the product of the worker's labor, and given the nature of the relationship between capital owners and workers under hierarchical and industrial modes of production, capital owners are at inherent advantages in the deal. The capital owner benefits from asymmetric information and lack of market transparency, as well as hierarchical power. Indeed there are a vast number of reasons why labor markets result in under-compensation of workers, which we'll address in more detail after a further examination of market theory itself.

Defining "free-markets"

Now to address the issue of "free-markets". The concept of  a "free-market" comes from Adam Smith, was embraced by other classical economics such as David Ricardo, and has of course become a concept central to neo-classical economics. But what exactly defines a "free-market"? First let's look at one of the important descriptions given by Adam Smith:

Secondly, it supposes that there is a certain price at which corn is likely to be forestalled, that is, bought up in order to be sold again soon after in the same market, so as to hurt the people. But if a merchant ever buys up corn, either going to a particular market or in a particular market, in order to sell it again soon after in the same market, it must be because he judges that the market cannot be so liberally supplied through the whole season as upon that particular occasion, and that the price, therefore, must soon rise. If he judges wrong in this, and if the price does not rise, he not only loses the whole profit of the stock which he employs in this manner, but a part of the stock itself, by the expense and loss which necessarily attend the storing and keeping of corn. He hurts himself, therefore, much more essentially than he can hurt even the particular people whom he may hinder from supplying themselves upon that particular market day, because they may afterwards supply themselves just as cheap upon any other market day. If he judges right, instead of hurting the great body of the people, he renders them a most important service. By making them feel the inconveniencies of a dearth somewhat earlier than they otherwise might do, he prevents their feeling them afterwards so severely as they certainly would do, if the cheapness of price encouraged them to consume faster than suited the real scarcity of the season. When the scarcity is real, the best thing that can be done for the people is to divide the inconveniencies of it as equally as possible through all the different months, and weeks, and days of the year. The interest of the corn merchant makes him study to do this as exactly as he can: and as no other person can have either the same interest, or the same knowledge, or the same abilities to do it so exactly as he, this most important operation of commerce ought to be trusted entirely to him; or, in other words, the corn trade, so far at least as concerns the supply of the home market, ought to be left perfectly free.
- Adam Smith - Wealth of Nations Book 4 Chapter 5

Here Smith is discussing the matter of buying and reselling commodities over a short period of time, which was considered to be three months or less, to gain a profit. As Smith had discussed prior to this, laws against such activity had been on the books "since ancient times", as such activity was widely viewed as callous and injurious to the public. Specifically Smith was arguing against a law in England which set the upper limits at which staples like corn could be bought and sold again on the same market within a short period of time. Here Smith is arguing that such activity does the public a service, and that therefore there should be no such restrictions on commodity markets.

There are several key concepts to highlight here. The first of course is to note that in the paragraphs prior to this quote Smith states that laws against this type of speculative activity date back to "ancient times", so Smith was arguing for market liberalization against long standing practices. Secondly, Smith is arguing not for the "wisdom of crowds" (which is what markets are often touted as), but for the wisdom of specialists with in-depth knowledge to drive prices. Third, of course, is the fact that Smith presents the activity of the specialist trader in driving prices up in the short-term ultimately as a public service that will presumably result in lower prices in the future. Thus Smith argues that these corn merchants should be allowed to engage in short-term trading for profit, which can drive up prices in the short-term, because he argues that by doing so they perform a public service by limiting supply in times of plenty thereby conversely preserving supply for times of scarcity, thereby more evenly distributing the commodity supply across conditions of bounty and dearth.

Without going into any further analysis of Smith's thought experiment quite yet, let's simply note that Smith's ideas are foundational to the modern concept of "free-markets", so now let's look at some current definitions of "free-market":

Business governed by the laws of supply and demand, not restrained by government interference, regulation or subsidy.
http://www.investorwords.com/2086/free_market.html

A market economy based on supply and demand with little or no government control. A completely free-market is an idealized form of a market economy where buyers and sellers are allowed to transact freely (i.e. buy/sell/trade) based on a mutual agreement on price without state intervention in the form of taxes, subsidies or regulation.
http://www.investopedia.com/terms/f/freemarket.asp

A free-market economy is one within which all markets are unregulated by any parties other than market participants. In its purest form, the government plays a neutral role in its administration and legislation of economic activity, neither limiting it (by regulating industries or protecting them from internal/external market pressures) nor actively promoting it (by owning economic interests or offering subsidies to businesses or R&D).
http://en.wikipedia.org/wiki/Free_market

So here we can see some of the immediate problems with the concept of a so-called "free-market". The term "free-market" is largely defined simply as a market without government regulation, however implicit in the very same definitions is the idea that without government regulation markets would operate according to "the laws of supply and demand", that there would be no "subsidy", that "buyers and sellers" would be "allowed to transact freely", and that economic activity would be otherwise unhindered.

These assumptions are not just without merit, but real world experience demonstrates to us that such conditions don't exist in markets of any meaningful size. Without government interference there is nothing to prevent interference, restriction, and subsidy by the mafia, an activity for which we have real world examples. Without government interference there is nothing to prevent the erection of barriers to free transaction, used either to extract rents, to marginalize competition, or to punish groups of people based on any number of criteria such as race, religion, gender, etc. Furthermore, there are any number of ways in which non-governmental entities can implement rules and regulations which distort the laws of supply and demand, a classic example being the National Football League's imposition of salary caps and profit sharing across organizations.

So let's look at some specific cases where private actors take action to subvert the laws of supply and demand or prevent people from transacting freely in the absence of government regulation. We can forgo obvious examples like mafia interference and cite practices that are currently legal or don't involve the use of force or threats.

Manufacturers paying retailers to eliminate competition

The classic case here is the case of Coca-Cola and Pepsi paying and providing other incentives to retailers for them not to carry competing products. At certain levels this practice is deemed illegal in the United States, but it still takes place in more modest forms as well. Soft-drink manufacturers still provide incentives to restaurants for exclusive contracts to carry only their beverages. Though it is deemed illegal for soft-drink companies to pay retailers not to carry competing products at all (they have done this many, many times), they can pay retailers to heavily promote their products and not to promote competing products. In such cases soft-drink companies pay retailers for exclusive preferential product placement, advertising promotion, sales, etc. In these cases the retailer is only rewarded if they promote their product exclusively, so they are paying not just for their own promotion, but also they are paying them not to promote the competition. Keep in mind that this is the currently legal version of the practice, in the past soft-drink manufactures would legally pay retailers not to carry competing products at all, and even after that was outlawed the practice continued leading to numerous legal cases.

So in the absence of regulation we have an example here of a practice that clearly violates business being governed by the laws of supply and demand, in which there is private interference and subsidy, and in which buyers are prevented from transacting freely with retailers by the suppliers. The practice of paying retailers not to carry competing products is, arguably, on-par with mafia practices. Certainly such practices don't meet Adam Smith's criteria of promoting the public interest.

So here we see a contradiction within the popular definition of a "free-market" as one in which there is both no government regulation and the market operates according to market principles. This is a case where regulation is required to prevent the undermining of market principles, which creates a direct contradiction in the term "free-market".

References:

COCA COLA COMPANY v. HARMAR BOTTLING COMPANY

LOUISA COCA-COLA BOTTLING v. PEPSI-COLA METROPOL

Monopolistic practices

There are of course many examples of outright monopolies throughout American history, but a well known company that currently engages in monopolistic practices and gets away with it is Ticketmaster. Ticketmaster's basic approach has been to pay venues for exclusive contracts to sell tickets for performances at those venues, then they tack on high service fees to the price of tickets for the performances. Given that there is no competition, and that under the terms of the agreements even the venues themselves can't sell tickets directly in many cases, there are no alternatives for consumers. In some cases the venues themselves do retain rights to sell tickets directly at the door, but since Ticketmaster is their only competition their fees typically match or are only slightly lower than Ticketmaster's fees.

Unlike Coca-Cola and Pepsi, however, which paid for exclusivity at given locations but were never able to completely dominate the national market, Ticketmaster's practices have led to a virtual monopoly on the national market. This is in part due to the nature of the industry that it is in. Whereas there are many outlets for the sale of soft-drinks, such as grocery stores, gas stations, vending machines, restaurants, movie theaters, etc., for which there are hundreds or thousands of such outlets in any given city, there are typically only a few major venues for live performances in any given state. Whole states typically have anywhere from one to ten venues where major live performances can be held and 10 to 50 moderate size locations, so its much easier for Ticketmaster to monopolize the market by obtaining exclusive contracts with a few hundred locations nation wide.

Exclusivity contracts can't possibly promote the interests of either consumers or performers. The entity which pays the most for an exclusivity contract, all else being equal, is the one that will get the contract with the venue, which means that they then have to charge the most in terms of additional fees to recoup the cost of the contract. Even if the additional fees lead to diminished ticket sales the venue and the ticket seller can still come out ahead, at the expense of the consumers and performers (or the performer's manager as the case may be), whose revenue comes from the base price of the tickets.

Live performances are forms of natural monopolies. There is a fixed supply of available "goods", i.e. "seats", at a single location. The price of admission for those seats will have zero impact on the supply of the goods. Adam Smith's argument for a "free-market" in which prices are allowed to rise was that the rising of the prices would lead to an equilibrium of supply and demand over time, such that fewer goods would be consumed during times of bounty if prices were elevated during times of bounty, and those excess goods would be saved for times of scarcity, leading to lower prices and more supply when harvests were low. Nothing of the sort can happen in terms of live performances. The supply of available "seats" at a given venue is always fixed, it can't go up or down. Inflating the price of tickets serves no market function, the only thing it does is increase profits, but with no resulting "public good" as Smith envisioned. And any possible "public good" that could even be argued for, such as perhaps allowing the extension of a tour by getting more venues to accept booking, would be entirely redistributive, unlike Smith's example. In Smith's example the same population of people "benefit" from the evening out of prices and supply over time. Generally the same people who would have paid more for the corn during a time of bounty would be paying less than they otherwise would during times of scarcity. However, even if charging more for tickets in Los Angeles led to additional venues signing onto a tour in Chicago, the effects would be totally redistributive, where the excess fees paid by consumers in Los Angeles would be benefiting consumers in Chicago, not themselves. Likewise, there is no ill effect from lower prices, as in Adam Smith's example either. In Smith's example the lower prices during times of bounty led to waste of resources that could have been saved for times of scarcity. In the case of live performances there is nothing to "waste". There is a maximum number of people who can purchase the good no matter what. All that lower prices do is shuffle who that group of people might be. If a venue of 5,000 seats will sell out at $10 a ticket and also at $50 a ticket, in either case 5,000 people are going to see the performance. At $50 a ticket it may be a somewhat different group of 5,000 people, but nothing of substance changes.

In the case of Ticketmaster the additional cost of tickets above what would be possible in the presence of ticket selling competition serves no market function in terms of supply and demand, and it has no benefit for the performers and their managers. The primary benefit goes to Ticketmaster, with a secondary benefit going to the venue, and the cost of those benefits are born by the consumers and performers, with no benefits. Ticketmaster is clearly a rent seeking agent of extortion.

It's impossible to argue that a company which pays to eliminate a market is interacting in a "free-market". Several lawsuits have been filed against Ticketmaster on anti-trust grounds, but they have all been dismissed or settled out of court. The most prominent lawsuit, brought by Pearl Jam in 1995, was inexplicably dropped by the Justice Department without any explanation before ever going to trial.

It is difficult to argue that if the government were to more strongly regulate the ticket sales industry to outlaw the practice of ticket sellers obtaining exclusive contracts with venues that this would make the market for live performance tickets "less free", yet at the same time this clearly indicates a contradiction in the definition of "free-market".

References:

U.S. Ends Ticketmaster Investigation

Wikipedia: Ticketmaster

The National Football League

The National Football League organization is technically a non-profit association which oversees franchises of individual owners. There are no corporations allowed in the National Football League according to the rules of the association. Taken as a whole, the franchises of the National Football League are the most successful and profitable of any sports league in the world. The National Football League association is a private governing body which enforces a strict structure of economic regulation upon the franchises and players, which is widely considered to be the foundation of the league's financial success. So does the economic model of the National Football League constitute a "free-market" simply because the regulations are being enforced by a private association instead of "the government"? Let's take a closer look.

The NFL classifies revenue into two basic categories, shared and non-shared revenue. The primary sources of shared revenue come from broadcasting contracts and merchandise licensing. All shared revenue is divided equally among all of the NFL franchises. Since this shared revenue is also the largest form of revenue in the league, this creates a relatively even playing field among the teams, allowing each team to be relatively competitive. Non-shared revenue comes primarily from stadium ticket sales. Not only is a majority of the revenue shared equality across all franchises in the league, but in addition salary caps and floors are set based on shared revenue, such that even if an individual franchise is able to generate higher non-shared revenue the salary caps and floors for that franchise are still the same as all other franchises in the league. Not only that, but stadiums themselves, the major source of non-shared revenue, are also highly regulated by the league with maximum seating caps.

In addition all NFL football players are members of the National Football League Player's Association, which is a union, under which all salaries and benefits for football players are negotiated. So there is virtually no aspect of the economy of the National Football League that operates according to market principles, the entire league is essentially a planned economy (in which corporations are forbidden), and yet it is largely due to this planned economy that the The National Football League has become the dominant sports league in the world.

So we get back to the central question, how does the definition of "free-market" as a market that is free from government regulation, where prices, exchanges, and compensation are determined by market forces, apply to the National Football League? Clearly the NFL is an example of a private organization in which prices, exchanges, and compensation are not determined by market forces at all, nor are they regulated by "the government".

References:

http://stateoftheshield.com/

http://www.shmoop.com/nfl-history/economy.html

http://mpra.ub.uni-muenchen.de/17920/1/MPRA_paper_17920.pdf

Discrimination

Another "free-market" paradox is the issue of discrimination. Because markets can essentially act as a "tyranny of the majority", market forces can lead to instances of exclusion of certain groups of individuals based on things like race, gender, religion, or any type of characteristic. In such a situation market forces would actually be the primary barriers to allowing certain individuals to "transact freely" and would prevent the determination of prices by supply and demand.

Contrary to the recent claims of the libertarian Congressman Rand Paul, racial segregation and discrimination in the treatment of customers in the South would not have been solved by "the free-market", indeed it was a product of market forces. Paul's basic claim was that due to the fact that business owners are driven by profit motive, they would have had an incentive to cater to African American customers in order to gain additional customers and thus increase their revenue, so even without government intervention "the market" would have eliminated segregation and discrimination against blacks in the South by business owners. Paul stated in interviews that businesses in the South which discriminated would have lost revenue due to having fewer customers since they would have been missing out on black customers and would have lost the business of "good" whites who would have boycotted their businesses.

The problem with Paul's claim, however, is that it completely misunderstands what was happening in the segregated South. Businesses weren't spurning black customers because the business owners were racists (though they may or may not have been), rather they were spurning black customers because their white customers were racists. You see, Paul's logic only works if the only reason that business owners discriminated against blacks was because of their own racism, but that's not the case. Business owners in the South discriminated against black customers due to market forces, in response to the demands from their more economically important white customers, thus, "the market" was driving the discrimination. A case in point was the famous Woolworths' policy of not serving blacks at white-only counters, which was a policy that the national chain only held in the South in order to "abide by local custom". After all, when president Eisenhower forcibly integrated Central High School in Little Rock, Arkansas in 1957 the National Guard had to be brought in to protect the black students from angry white mobs and to escort them inside the school.


Blacks and 2 whites being taunted by white mob during Greensboro sit-in at a Woolworths'


Elizabeth Eckford being heckled on the first day of the integration of Central High School

So here we see the contradiction. The definition of a "free-market" includes the idea that all buyers and sellers are allowed to "transact freely", but in this case we have an example where, absent regulations, the dominant market force (white customers) prevented blacks from being able to "transact freely". So, free from government restrictions, the private citizens imposed their own set of market restrictions. In this case the government restrictions (preventing white business owners from discriminating against blacks) actually brought about the condition of allowing all buyers and sellers to transact more freely, which, again, points to a paradox in the definition of "free-market".

What was happening in the South was that, for example, restaurants run by white owners either refused to serve blacks at all, or if they did they served them in separate dining areas, often with separate entrances and separate restrooms, etc. Obviously this put an additional burden on the restaurant owners because these separate facilities cost extra money and/or they lost black business as a result of these practices. However, the reason that they did this was because if they didn't they would lose almost all of their white customers. White patrons didn't want to sit next to blacks and eat dinner in a restaurant, they didn't want to use the same bathroom as blacks, they didn't want to drink from a glass that had been used by blacks, etc. so if any restaurant that relied on white business would have served blacks the same way that they served whites they would have lost most, if not all, of their white business, which would have been a much bigger economic loss than any gains in black business. The same went for almost any line of business: barber shops, clothing stores, grocery stores, movie theaters, etc., etc. Thus, "the market" is what was actually driving the segregation and discrimination by white-run businesses in the South.

Indeed one of the ironies of the situation was the fact that some white business owners actually wanted to serve blacks and, due to the very reasons cited by Paul, wanted black customers and didn't want the burden of having to provide separate facilities, but due to "market forces" they were unable to run their business the way that they wanted to because they were forced by financial necessity to cater to the tyranny of the white majority. So business owners were in fact being prevented from running their business the way that they wanted to by market forces.

Government regulation, in this case, "freed" business owners to run their businesses how they wanted to and allowed them to expand their customer base without fear of white customer retaliation; so not only did the government regulation banning racial segregation and discrimination by businesses allow blacks to transact more freely, but it also allowed business owners greater freedom in how they ran their own businesses. Paul's argument about how market forces would have "eventually" ended racial segregation in the South relies on an entirely fictional South in which the majority of people were already opposed to racial segregation, but that wasn't the reality. The reality was that the majority of people were in favor of racial segregation, and continuing to cater to the interests of racial segregation in the South wasn't only economically advantageous, it was an economic necessity. Businesses in predominately white areas that tried to serve blacks faced the prospect of going out of business due to market forces, because the overwhelming majority of white customers were racists and would not patronize businesses that didn't discriminate. Granted, the social protests that took place in the South during the late 1950s and early 1960s did make some progress in desegregating some individual locations, almost entirely in the "northern South", but when the Civil Rights Act of 1964 was passed segregation and discrimination was still widespread and firmly entrenched in the so-called "Deep South".

References:

THE GREENSBORO CHRONOLOGY

Erection of toll barriers

A final example of "free-market" contradiction is that of toll barriers. In an unregulated market there is nothing to prevent private individuals from erecting barriers to trade and then charging tolls for the transport of goods. This would, of course, be a purely rent seeking activity and in direct contradiction to the concept of "buyers and sellers" being allowed to "transact freely". Indeed this type of activity happens all the time if allowed. In medieval Japan the practice was so widespread in fact that one of the major reforms of Oda Nobunaga in the 16th century was the abolition of private toll barriers, which paved the way for the unification of Japan. This abolition of toll barriers is simultaneously considered a "free-market" reform while also being a regulation.

The toll barrier example is another good illustration of "free-market" paradoxes. If trade is flowing freely through a mountain pass, then a private individual acquires the land and erects a gate blocking the mountain pass and charges everyone a fee to pass through the gate, is this to be considered a "free-market" activity? Clearly this private individual is preventing individuals from "transacting freely" and the erection of the gate serves no economic purpose other than the enrichment of the individual who charges the toll while providing no benefits to anyone else. Everyone else was better off before the erection of the gate. Government regulation could prevent this, either by ensuring that the mountain pass remains public property, or by regulating the types of modifications that can be done to it by private individuals. In either case such government regulations would protect the ability of individuals to transact freely, thus advancing one of the major elements of a "free-market" through government regulation, which, according to the definition, would make it "anti-free-market".

These are just a few examples of inherent contradictions in the concept of a "free-market". This is why there is no such thing as a true "free-market", and can never be. The principles of a free-market are at odds with one another. Allowing "buyers and sellers to transact freely" in many cases requires government regulation. The whole concept of a "free-market" is paradoxical, illogical, meaningless, and in fact harmful in that it often confuses the conversation and is used to intentionally mislead.

That doesn't mean that the point that Adam Smith was trying to make wasn't valid, it just means that the way that the term "free-market" has been subsequently defined and is widely used as an axiom is not valid. If we go back to what Adam Smith was actually saying and look at the context, what we see is that Adam Smith is actually saying that prices should be determined by knowledgeable individuals with a vested interest as opposed to static rules set by lawmakers who don't have in-depth knowledge of the market. But these same guiding principles wouldn't necessarily preclude price-setting by government agencies. The objective laid out by Smith in the example was to stabilize prices over time by allowing market prices in the present to better reflect predicted future conditions. Smith says that the best way to do this is to let those who know the most about future conditions influence prices to the full extent of their knowledge. At the time that Smith was writing governments didn't engage in things like monitoring crop conditions and making crop forecasts or aggregating and analyzing data, etc. In this situation clearly merchants and farmers on the ground had a better assessment of future conditions than individuals in government, and could certainly have done better than static rules which didn't even take changing conditions into account. But that's not necessarily true today.

For example, today in the United States the U.S. Department of Agriculture engages in crop forecasting that is among the most accurate economic forecasting in the world. This is because the USDA aggregates data from farmers all over the country, and has inspectors that go out on-site all over the country to inspect conditions and get input from farmers. They then use all of this data to make forecasts of future yields. Given that these forecasts are arguably the most accurate picture that we have of future crop production, by Adam Smith's logic the USDA should be setting prices for farm commodities. Adam Smith's argument wasn't really an argument for "the wisdom of markets", it was really an argument for the wisdom of technocracy, set in a time when governments were not technocratic. The point here is not to advocate government price setting, the point here is to point out that Adam Smith's argument was very specific and applied to a certain set of conditions, with a defined purpose, it wasn't a broad principle, as the "free-market" concept is often applied today.

As a broad principle the term "free-market" is a contradictory theoretical term that has all kinds of inherent inconsistencies and undesired implications. The purpose of Adam Smith's invocation of "free-markets" was clearly to better align the prices of commodities with current and future supply and demand. So the objective is simply to align prices with supply and demand fundamentals, the objective is not to have "free-markets" for "free-markets' sake".

While the term "free-market" is ill-defined and inherently problematic, what we can talk about are regulated markets, unregulated markets, degrees of regulation, and pro-market vs. anti-market regulations.

Capitalists do not like unregulated markets

One of the biggest misconceptions about capitalism is the notion that "capitalists" themselves, i.e. actual capital owners, like "free-markets". This misconception stems from the historical development of capitalism and the opposition of merchants and manufacturers to the economic controls of feudal aristocracies during the 18th and 19th centuries. The economies of Europe had been tightly controlled under the feudal system for centuries, and were still dominated by mercantilist policies at the onset of the industrial revolution. The works of Adam Smith and other classical economists were in clear opposition to the feudal system and mercantilist policy, as was the new capitalist class that rose to power during the industrial revolution, who sought to overthrow the control of the ruling aristocracies. As such, businessmen during this time certainly opposed the set of rules and regulations put in place by the feudal aristocracies, as those rules and regulations were designed to protect the interests of the aristocracies. In other words, the capitalists of the 18th and 19th century sought markets that were "free from" the regulations and barriers that protected the interests of the establishment, because at that time they were not a part of the establishment, in fact they were a threat to it.

But here is the issue: Once so-called "democracy" and "free-market capitalism" had overthrown the feudal aristocracies and put an end mercantilist policy, the capitalists themselves had become a part of the establishment; they were now the ruling class, and as such they now sought the implementation of their own set of rules and regulations to protect their interests. This issue is actually very similar to the issue of "States' Rights". "States' Rights" is held out by many so-called conservatives as a cherished principle in and of itself, but principles such as "States' Rights" and "free-markets" are seldom really appealed to on principled grounds, they are actually appealed to only when it suits the position of those making the appeal under a specific set of conditions.

For example, the proponents of slavery appealed to "States' Rights" when it became clear that the national mood was trending against slavery and the advocates of slavery began losing power in the federal government. Yet, had the pro-slavery position been the dominant position in the federal government there is no doubt that the advocates of slavery would have appealed to federal power to entrench slavery. Today we have conservatives who appeal to the "States' Rights" argument on any number of issues, from abortion, to immigration policy, to education, to Social Security, when existing federal laws maintain a position that they are opposed to, yet when those same people get into power in the federal government they immediately advocate for federal laws to enforce their views on the whole country.

The issue is the same with capitalists and "free-markets". Capital owners advocate for "free-markets" when there are existing rules or restrictions that are against their interests, but they also do everything in their power to enact rules and restrictions that benefit their interests. They don't actually adhere to "free-markets" as a principle, they just appeal to "free-markets" when it suits them, and it really couldn't be any other way. It would be against the self-interest of a capital owner to accept a "free-market" if competition and market forces would result in losses for them. Thus, when faced with unfavorable market conditions all capital owners are compelled to advocate for regulations to protect their interests, and they do so. The most fundamental example of this from the 18th and 19th centuries was in the area of patent and copyright law. Patents and copyrights are of course regulations, which put limits on markets and create monopoly rights thereby inherently restricting supply. The strengthening of patent and copyright law was instrumental to the rise of capitalism and to the fortunes of a great many individuals. This again points to the inherent contradictions within the "free-market" concept. In a true purely "free-market" there would be no patents or copyrights, these are clearly forms of regulations that capitalists, and indeed non-capital owners, want, at least in certain forms. Patent and copyright law, at least initially, was extremely beneficial to non-capital owning individuals who had good ideas. They helped to ensure, in many cases, that "the little guy" was able to get the just rewards for their contributions. Indeed patents and copyrights were among the most common ways that poor and working-class individuals were able to become wealthy during the 18th, 19th, and even early 20th century. Patents helped to ensure (though of course they never guaranteed) that a poor worker with a good idea could benefit from his or her innovations without their boss or some other established businessperson profiting from it without giving any compensation to the inventor. Today, however, the overwhelming majority of patents are filed by corporations, not individuals, and patent and copyright law is more likely to be used by established capital owners against the "little guy" upstarts than the other way around.

Furthermore, the fact that capital owners support many regulations isn't necessarily a bad thing, in fact in many cases its a very good thing. The point, however, is that the notion that unregulated markets are always preferred by capitalists is completely false. Let's look at some scenarios where capitalists seek out market regulation.

When bad actors can undermine whole industries

This is a scenario where the actions of a single or small number of individuals or corporations can undermine an entire industry, causing losses or reducing gains for other "good actors". This scenario is especially common in the food industry, where food-born illnesses can lead to recalls or customer shunning of whole categories of food, even though only one or two manufacturers may have been the cause of the food born illnesses. A recent example of this is the listeria outbreak among cantaloupe, which resulted in over 20 deaths and one hundred reported illnesses, all of which originated from a single farm in Colorado. Even though all of the tainted cantaloupe came from a single farm, it resulted in all cantaloupe from all farms being pulled from shelves and consumers shunning any and all cantaloupe, and its likely that this will have impacts on consumer behavior for at least one or two years; so while one farm was the source of the problem, the economic impact was felt by all cantaloupe farmers.

In these situations "responsible" businesses who have a lot of capital at risk don't want their businesses to be undermined by irresponsible or fly-by-night businesses, so they develop best practices and/or standards and then appeal to government to enforce those practices or standards upon the whole industry. The classic example is H.J. Heinz's support of the Pure Food and Drug Act of 1906. Indeed Heinz's support for this act was so instrumental that the Heinz food company touts the company's role in the passage of the act and its continuing role in government food regulation on its website under the section Pure Food. Pure Good.

The passage of the Pure Food and Drug Act of 1906 resulted in a massive number of food processors going out of business due to inability to comply with the regulations. This clearly had a beneficial impact for Heinz, as it eliminated competition and increased the company's market share, however, it's difficult to argue that forcing companies out of business that were unable to comply with food safety regulations was a bad thing. The reason that the legislation was even brought up was because it had the mutual support of consumers, public health experts, and industry leaders like Heinz. This was because at that time there were no regulations at all dealing with food labeling or industrial food safety, and there were thousands of different food processing companies engaged in things like canning and jarring at this time. There were no standards; companies could put whatever they wanted on their labels, they often made completely unsupported medical claims, describing things like cocaine as a health food, and not all of them used sanitary practices. But due to labeling practices, etc. even knowing which company's food you were buying wasn't always clear. Even if you could tell, at this time things were in such flux that there was little in the way of established brands that you could rely on being in the store on a regular basis, etc. Likewise, it was impossible for responsible food processors to compete on price with irresponsible food processors, which enabled irresponsible food processors to hang on to market share since their products were safe enough that people didn't get sick from them every time.

As a result, what was happening was that unsanitary food processors were ruining the reputation of processed food for everyone. When someone would try canned food and then get sick from it, it would turn them off to all canned food, etc. So Heinz and other industry leaders who did practice quality control appealed to the government to enforce their type of quality control practices on everyone, so that consumers would feel safe buying processed foods so that the industry as a whole would benefit. If, in the process, some food processors couldn't afford to adopted the practices necessary to meet the standards, well, that was just too bad.

The act of regulation was a benefit to specific capitalists and a detriment to others. For those capitalists who benefited, they had succeeded in getting the cost of quality control for their industry to be paid for by taxpayers and in erecting barriers to entry for any would-be upstart competitors. While Heinz benefited from the regulations. The enforcement of the regulations, which the corporation benefited from, cost Heinz nothing other than the lobbying efforts on the bill's behalf. The cost of inspecting individual food processors and enforcing the rules fell onto the government, and was paid for by the entire tax paying population. This is another reason why capitalists like government regulation, because it almost always is a means of externalizing costs for those businesses that benefit.

When short-term incentives run counter to long-term interests

The obvious example here is the recent housing bubble. We've already gone through the details of the housing bubble, but the thing to focus on here is the fact that many individual mortgage brokers and loan originators did not want to give loans to people that were obviously unqualified, and indeed they knew that originating loans for unqualified people who were likely to default on their loans was bad for the industry and was in fact bad for their own business. However, the problem was that due to market competition, if a mortgage broker or loan originator didn't issue loans to individuals that other mortgage brokers were willing to, then they would lose business, and in the short term market competition would drive "responsible" brokers out of business. You can hear more about this here: The Giant Pool of Money.

So, the lack of regulation meant that mortgage brokers were forced to engage in business that they knew was going to eventually sabotage their own business down the road because if they didn't do it at the time they would go out of business immediately. Had regulations been in place at the time to prevent the type of irresponsible lending that was taking place a lot of mortgage brokers that have gone bankrupt over the past few years would still be in business today.

This type of scenario is prevalent throughout the economy, and in some cases the capital owners are smart enough and disciplined enough to recognize the problem and they appeal for regulation to prevent markets from being driven by short-term interests that run counter to their long-term interests. And again, such regulations are counter to the interests of those who are pursuing only short-term gains, so they are against the interests of some capital owners, but in the interests of other capital owners, and these types of regulations get passed when the capitalists with long-term interests are more powerful than those seeking short-term gain.

When businesses interact with and depend on other businesses

Many regulations in place are the result of capital owners in some industry seeking regulation of other industries that they depend on, for example grocery store owners' support of food safety and labeling regulation for food processors and farmers. Virtually all businesses support certain regulation of banks in various ways. Property owners support regulation of the construction industry. Auto manufacturers support regulation of the petroleum industry, etc., etc.

A recent example of this has played out in the battle over debit card usage fees. The regulation of debit card swipe fees, as with most regulation, is typically presented as a case of "government vs. business", but really the government is just a tool, which does the bidding of whomever the most powerful groups in society are. Sure there may be some cases where individual legislators or elected officials take a stand against some powerful interest group in favor of doing "what's right", but generally speaking any government is merely an instrument being wielded by interest groups. In the case of debit card fees, the primary interest groups are the banks and retailers, capitalists vs. capitalists, with both sides appealing to the government to write the rules of the game in their favor.

As it turns out the retailers won this legislative battle with the addition of the Durbin Amendment to the Dodd–Frank Wall Street Reform and Consumer Protection Act, which requires that large banks only charge debit card processing fees to retailers that are "reasonable and proportional to the actual cost". This legislation was lobbied hard for by retailers like Wal-Mart and Target, among others, including the Small Business Association. The retailers, which have a long history of legal actions against MasterCard and Visa, argued that the duopoly power of MasterCard and Visa, which combined process virtually 100% of debit cards in the United States, enabled them to charge inflated processing fees due to lack of competition. With the passing of the legislation restricting what the processors could charge retailers for processing fees, the processors, Visa and MasterCard, increased the fees that they charged to banks, which some banks have then passed on to consumers in the form of new fees for checking accounts or debit card use.

See:
Banks vs. Wal-Mart: Round Two
The Big Retailers Versus the Big Banks: It Makes a Big Difference

When capital owners seek additional control over capital controllers

In many cases capital owners seek additional control and legal power over those whom they entrust with the administration of their capital; essentially investors seeking additional control over corporate boards and executives. Investors have the ability to sue corporations and their executives and officers. Such suits are typically brought by large institutional investors, such as pension or mutual funds. In rare cases they are also brought as class action suits by individual investors.

However, investors obviously seek ways to prevent the need for lawsuits in the first place as well, via regulations. The most common of these types of regulations are regulations requiring corporate transparency. Publicly traded companies, i.e. companies which openly sell shares of their stock via official markets, have many reporting requirements. They are required to submit an annual report to share holders and to submit a Form-10K to the Securities and Exchange Commission. The most recent major regulation put in place on behalf of investors is the aforementioned Sarbanes–Oxley Act of 2002, which increases transparency of corporate accounting.

The regulatory oversight of the SEC is essentially a subsidy to investors, who benefit from the (albeit inadequate) tax-payer funded oversight provided by the government agency.

Licensing and certification

Milton Friedman famously campaigned against licensing and certification, especially in the medical profession. Friedman mostly considered licensing and certification in relation to workers, not capital owners. Friedman, somewhat correctly, regarded the American Medical Association as a union, and viewed government required licenses or certifications as a means by which laborers could restrict markets and thereby reduce the supply of laborers in their profession, thus enabling them to charge higher prices for their labor, and that as such licensing and certification was against the public interest.

One of the things that Friedman fails to address in his arguments against licensing is that one of the strongest reasons for licensing is the ability to revoke a license. As Friedman notes, it is true that having a license is no guarantee of quality, but when an entity or individual fails to meet the quality standards of a licensing program the ability to revoke their license to prevent future harm is very powerful, and even the threat of that force can serve to keep practitioners on "the straight and narrow". Sure it's obviously not 100% effective, but there is no doubt that it has an impact.

Nevertheless, much of what Friedman says is true regarding the impact of licensing on prices, but that doesn't necessarily mean that licensing isn't still in the public interest. I'm not going to address Friedman's arguments against licensing, since that is not the point here. The point here is that while Friedman's opposition to licensing and certification focused primarily on skilled professionals, i.e. laborers, licensing and certification applies to corporations and capitalists as well, in multiple ways.

For one thing licensing doesn't just apply to individuals, there are forms of licensing and certification that apply to corporations themselves, an obvious example being liquor licenses, which are held by businesses. The other issue is that many of the individuals most highly involved in the ownership and allocation of capital are licensed professionals, for example stock brokers, bankers, and financial advisors have to be licensed.

So here is the issue. Milton Friedman makes all kinds of arguments as to why professionals support licensing and use it as a means to manipulate the market in their favor, and all of his arguments in that regard are true, but these arguments apply just as equally to businesses and those who are entrusted with the holding and allocation of capital. The point here is that whatever the merits or demerits of licensing may be, it is something that capitalists themselves want, in part for the very reasons that Friedman is against it. Licensing programs exist because capitalists want them to exist.

Tariffs

The very first source of revenue for the federal government of the United States of America was tariffs. The predecessor to what would become the U.S. Coast Guard was originally established primarily to police the waters to enforce customs duties and facilitate the enforcement of tariffs. Indeed tariffs remained the main source of revenue for the United States until the establishment of the income tax in 1913. The interesting thing about tariffs is that they are another form of economic regulation that pits capitalists against one another. Capitalists decry or support tariffs depending on their impact or potential impact upon their business. Tariffs, of course, are essentially fees, or a tax, levied on goods when they are imported into a country. Now the interesting thing about the United States and tariffs is that the United States pursued a strongly protectionist trade policy up until the 1940s, and a moderately protectionist trade policy up until the 1980s.

The pattern of protectionism during the phase of economic development and then later trade liberalization as the economy matured is a familiar pattern that many countries follow. Tariffs and protectionism encourage domestic production. High tariffs on imported finished goods encouraged the development of capital within the United States by encouraging manufacturers to relocate to the United States in order to setup manufacturing here in order to be able to sell to the American market without paying the tariffs. This policy in fact worked and is credited with accelerating the pace of American industrialization, much to Britain's chagrin. In fact the British had laws against the export of industrial technology to developing nations and against the immigration of knowledgeable individual to America. Nevertheless, such individuals and technology made their way to America despite the British restrictions because the opportunities were too great. But while the United States of America levied tariffs on goods imported to America, the British had a more open trade policy as international British companies sought to bring goods back into Britain from around the world.

Tariffs were almost universally supported in America by all capitalists until the later part of the 20th century, at which time America's maturing corporations sought to go international and be able to import foreign made goods back into the United States.

Subsidies

Last but not least I'll mention subsidies. American capitalists have long been highly subsidized. Indeed Alexander Hamilton himself laid the groundwork for the public subsidy of American private business. Alexander Hamilton had a profound impact on the economic policies of the early United States, with influences that last to this day. Hamilton's fundamental strategy for strengthening the American economy was the use of tariffs on imported goods and the use of a portion of tariff revenue to subsidize domestic manufacturing. This was laid out in Hamilton's Report on Manufacturers and these policies were officially adopted by the federal government. The issue of subsidizing industry was one of the central points of division between Thomas Jefferson and Alexander Hamilton, who famously feuded with each other on many topics.

Hamilton argued that the subsidies were essential to lure capital away from developed nations like Britain and France, while Jefferson argued that the subsidies would lead to corruption and bring about undo influence of private industry on the government. Jefferson also argued that the subsiding of manufacturing would lead to concentration of capital ownership and a disenfranchisement of the agricultural South. Jefferson believed that an economy based on the widespread distribution of land ownership was essential to democracy and that concentration of economic power within corporations would lead to political corruption and the establishment of an American aristocracy that would undermine democracy. Hamilton, on the other hand argued that a diverse economy with a mix of agriculture, manufacturing and finance would be more robust and lead to a more economically independent nation. Hamilton saw the "free trade" policies of the British empire as merely a tool of imperialism and thus argued that in order for America to truly break free from British imperialism the United States would have to adopt economic protectionism and subsidize its manufacturers to gain independence from imperial European powers who had a more advanced manufacturing base and more robust financial systems.

In reality both were right of course. Hamilton's views were right, but Jefferson's were as well, and the corruption that Jefferson foresaw has plagued the country since the first days of its founding.

Hamilton also oversaw the establishment of a highly subsidized industrial center in New Jersey through the Society for Establishing Useful Manufactures. The Society had tried and failed on its own to establish a manufacturing center and so they appealed to Hamilton to subsidize their efforts through various tax breaks, grants and rights-of-way. Hamilton agreed and the industrial center was a success in the sense that a significant manufacturing base did grow there and the center became highly profitable. The area remained a major manufacturing site up to the 20th century, when the waterfall driven power became obsolete.

The subsidizing of business remained prevalent throughout America history. The railroad corporations of the later 19th century are a classic case of the subsidization of capitalists by government. Arguably the government subsidies for American railroad barons did increase the pace of industrialization and accelerate the expansion of the nation and the growth of the American population and the economy as a whole, yet at the same time the interactions between the government and the railroad barons were rife with corruption and untold billions of dollars were wasted and misallocated and a significant portion of the wealth of the railroad barons was a product of public subsidy.

Today well over $100 billion a year in direct subsidies are provided to American capitalists through local, state, and federal government; this doesn't count things like the 401(k) tax code which itself is essentially a subsidy for institutional investment companies or the fact that capital gains are taxed at a lower rate than wage income. This also doesn't count the emergency loans of over $1.6 trillion provided to financial institutions at below market rates and very favorable conditions by the Federal Reserve and TARP programs.

The point here is this: capitalists will always welcome subsidies, and in any political system where political power is a function of wealth, as most systems are, those with the wealth, i.e. capitalists, have the power to appeal to government for subsidies, and they currently do so in the United States to great effect. Capitalists have basically two forms of leverage that they use to appeal for subsidies. The first is the most obvious, their wealth, which they can use to "lobby" (essentially bribe) politicians who control taxpayer funds to subsidize them. In essence government officials are gatekeepers, so spending a few dollars "lobbying" them can result in them providing access to many more dollars, since the money that the government officials preside over isn't theirs, it costs government officials nothing to provide subsidies to capitalists. If capitalists spend a few million of dollars a year "lobbying" government officials this can result in hundreds of millions or billions of dollars in subsidies. The second form of leverage is perhaps even more important however, and that leverage is capital ownership itself. Concentration of capital ownership means that a relatively few individuals have control over vast amounts of capital, and this control itself can be used, and is used, as a form of threat. Capitalists threaten to lay off workers or move their capital or do this or do that with their private capital if politicians don't give into X, Y, or Z demand, and this is very powerful.

This is what drives many of the state and local subsidies for corporations in America, competition between localities to attract capital results in subsidizing capital. With increasing globalization the same has become increasingly true at a national level in America and around the world, with national governments around the world essentially competing to out-subsidize capital in order to attract it. Since capital owners are relatively few and capital is so important for economic productivity, this puts capital owners in a powerful position, a position which only grows increasingly more powerful as capital ownership is consolidated. The result is increasing pressure to subsidize capital owners via resources acquired from non-capital owners, i.e. taxation of workers and small capital owners to provide the revenues needed to subsidize large and powerful capital owners.

The types of regulations cited above are only a small sampling of the types of  regulations favored by capitalists. Overall what we can plainly see is that while people often associate "free-markets" with capitalism and claim that capitalists don't like regulations, this is in fact not true. Specific capitalists don't like specific regulations, but they clearly favor many other regulations. In some cases regulations that capitalists approve of are generally beneficial to consumers and society as a whole, in other cases they are not. Many economic regulations actually pit capitalists against capitalists, they are put into place at the request of some capitalists because they benefit them, while the same regulations may harm other capitalists. Governments enacting such regulations are merely acting at the request of capitalists themselves; government regulation is merely a tool used by capitalists to peruse their interests and increase profits in capitalist societies.

Capitalists do not like efficient markets

It's not just that capitalists don't like unregulated markets, they don't like efficient markets either. In fact, capitalism could not exist in a so-called "perfect market", which is a theoretical 100% efficient market. This is extremely important to understand, because it gets at the heart of the misconceptions about capitalism and the motives of capitalists.

When Adam Smith wrote The Wealth of Nations over 200 years ago the economic systems of Europe were highly inefficient. Smith observed that within an inefficient system businesses could be driven by profit motive to increase efficiencies, i.e. that by better serving the public interest a business would yield higher profits. This is true, but Smith was really only dealing with one half of the equation. The reality is that the rate of profit is determined by the relationship between business efficiency and market efficiency. It's true that a business' profits can be increased by increasing the efficiency of the business, or rather by the business more efficiently meeting market demands than competitors, but that is only one way that profits can rise; profits can also rise if the market itself becomes less efficient. Profits are just as much a measure of market inefficiency as they are of business efficiency. The best way to understand this is simply to look at it in terms of a mathematical formula, as stated below.



Technically, business efficiency over market efficiency gives us the profit factor, and by subtracting 1 and multiplying by 100 we get a true "rate of profit". We can consider "efficiency" to be a value that ranges from 1 to 100, with 100 being either a perfectly efficient business or a perfectly efficient market. What we see is that it doesn't require a perfect market in order for businesses to be unprofitable; if a business is less efficient than the market then the business will be unprofitable.

Let's look at the examples above. If "the market" has an efficiency of 20 and a business has an efficiency of 25, then every dollar invested will yield one dollar and twenty five cents, the rate of profit is 25%. If the business is equally as efficient as the market then for every dollar invested the business will yield one dollar in return, in other words, the actual rate of profit is zero. If the business is less efficient than the market then for every dollar invested less than a dollar is returned, so the actual rate of profit is negative. So basically, a business has to be more efficient than the market in order to be profitable, and this is true whether the market is highly inefficient or not, but the fact is that as markets become more efficient it of course becomes increasingly difficult to be more efficient than the market, and under the condition of a theoretical "perfect market" it would be impossible for any business to be more efficient than the market. Thus under perfect market conditions profits would always be zero or less than zero, hence it has long been predicted that profits would decline in capitalist economies as they matured under the assumption that markets would become increasingly efficient.

But the point is that perfect market conditions don't have to be reached in order for profits to fall to zero or less than zero, business efficiency just has to be less than or equal to market efficiency, even if market efficiency is only 10 or 20, or whatever.

So let's look at the qualities of an efficient market. Market theory is predicated on the assumption that markets work efficiently when individuals are well informed, make rational decisions, act in their self-interest, there are low barriers to entry, no individual has the power to set prices, everyone has access to technology, and there are no externalities. A perfect market then, a market with 100% efficiency, has the following qualities:

Every individual is omnipotent (knows everything about the market)
Every individual makes only rational decisions
There are no barriers to entry
All prices are determined by individuals engaged in specific transactions (no price fixing)
Every individual has equal access to technology
There are no externalities
So basically, while those theoretical conditions may never be fully met, as markets come closer to those conditions it becomes increasingly difficult for businesses to maintain their rate of profit. In mathematical terms, as markets come closer to those conditions their "market efficiency score" (the denominator in the profit equation) gets closer to 100.

Let's use a concrete example. Let's say that widgets can be produced and brought to market for $10 each, meaning that when every single cost is factored in, the cost of the machines, the materials, the labor, the facilities, the shipping, etc., the cost is a total of $10. Now let's say that these widgets can be sold for $15. In that case there is a profit of $5 per widget.

What market theory says is that competition will drive profits down in an efficient market. In an efficient market someone will begin producing those widgets for the same $10 and selling them for $14 each, netting $4 in profits, then someone will come in and sell them for $13, then $12, then $11, etc. Now, in order to maintain higher profits two things can be done: either the cost of producing a widget can be reduced or market efficiency can be reduced. If the cost of producing the widget is reduced then that can temporarily yield profits, but market forces would again result in the same downward pressure on prices, driving the profit margin back down toward zero. This is considered one of the positive aspects of a capitalist market system. Profit motive provides an incentive to find more efficient, i.e. less costly, ways to produce commodities and it provides an incentive to accept lower profits per unit in order to undercut competition, thus bringing the price of commodities closer to the cost of production.

However, instead of developing better widgets or a more efficient way to produce widgets, to get higher profits a capitalist could externalize part of the cost by doing something like dumping all of the waste from the process into a river instead of paying to dispose of the waste responsibly. In addition to that, instead of trying to lower the cost of production a capitalist could engage in a marketing campaign that costs about 20 cents per widget which portrays the widgets as cooler than other widgets, thus enabling them to be sold for $13 even while others drive the price of comparable widgets down to $11. In an efficient market there are low barriers to entry, so another thing that a capitalist might do to maintain profits is appeal to the government to require licensing for widget makers or appeal to the government for new safety standards for widgets that his widgets are already designed to meet, etc. Several widget makers may get together and agree to fix prices, i.e. agree that none of them would sell their widgets below $13 in order to maintain a profit margin. Patents can be used to maintain a monopoly on technology, and on and on.

Since it becomes increasingly difficult for businesses to get a profit as markets become more efficient, capitalists are driven by profit motive to undermine market efficiencies. It is also important to remember that in a capitalist economy "the market" has two underlying components, the commodity market and the labor market, so capitalists seek to reduce efficiency in both of these markets. They do this through secrecy or spreading misinformation, by encouraging emotional decision making among others, by erecting barriers to entry both privately and through government regulation, by attempting to collude and/or use government regulation to set prices, by using patents, by using contracts to reduce access to technology, and by using the legal system and public subsidies to engineer the externalization of costs.

The reason that profits have not actually declined in capitalist economies around the world is that capitalists have continuously undermined market efficiencies using these mechanisms and others in order to maintain profits. These actions have become so ingrained in our culture that many Americans now accept many of them as "normal". Let's look at some ways that capitalists do some of these things.

Fostering irrational decision making

There is advertising and then there is marketing. Advertising is arguably simply making the public aware of the products or services that a business or other entity offers, while marketing is arguably the attempt to actively encourage individuals to purchase or consume those goods and services. The reality is that marketing is all about encouraging irrational decision making. The whole objective of marketing is to get people to make irrational decisions, to get people to become emotionally attached to brands and commodities, or as Kern Lewis, director of marketing for CMG Financial Services, put it in Forbes magazine, "[to] inspire 'loyalty beyond reason.'" This isn't to say that marketing only involves emotional appeals, clearly objective facts are sometimes used in marketing, but the function of marketing is to encourage consumption and brand loyalty beyond reason.

This topic can easily be a book in itself, and many, many books have been written on the topic, so I'm not going to go into too much detail here, but a quick internet search brings up plenty of reading material: Google: marketing emotional appeal.

Emotional appeals aren't only a component of the marketing of commodities however, they are also a component of human resource management as well, i.e. the labor market component of the equation. Employers do this through appeals to loyalty among employees and by engaging employees in various activates from pep-rallies to "team building" to "employee appreciation" parties to involvement in charity events. While some of these actives may seem benign or even good, the reality is that employers engage in them because they appeal to emotions to encourage irrational acceptance of lower compensation by workers. Wal-Mart famously refers to their employees as associates, which implies that the employees are partners, though they clearly aren't. This is another example of ways in which employers try to make employees feel more enfranchised than they actually are.

At an even broader level, the entire American mass media fosters irrational consumerism. All major media outlets, especially those involved in television, are dominated by for-profit corporations, and in many cases the media companies are owned by larger corporations, for example NBC and MSNBC are owned by General Electric. This isn't to say that those in charge of running these companies have explicit goals of fostering irrationality, but anti-consumerist programming or programming that takes a critical look at the corporate structure of the economy, or programming that fosters a rational and objective understanding of society and the economy, or of economic choices, is clearly not going to be produced and aired by the very corporations upon which the critical eye would be turned. Wacky teen dramas with kids doing crazy things and toting around a lot of accessories are great in the eye of the corporate media executive, teen programming that portrays teens being responsible, shunning materialism, and critically evaluating the problems in society, not so much... At this point all corporate produced media is a massive marketing campaign for the status quo of American life, of a status quo rooted in irrational consumerism and a capitalist economy. Virtually all corporate produced media reinforces this worldview.

The fact is, though, that market theory is predicated on rational decision making, and the whole objective of market theory is supposedly to facilitate the efficient use of resources. The claim (whether true or not) that markets are the most efficient way to allocate resources is a primary defense of market systems, yet one of the most fundamental pillars of market theory, that individuals act in their rational self-interest, is a primary target for being undermined by capitalists. It is a primary target precisely because profits can be increased when consumers and wage-laborers don't make rational decisions; which is why capital owners encourage irrational decision making, thereby undermining market efficiency and increasing the rate of profit. But increasing the rate of profit in the short-term isn't the only effect of this corporate fostered irrationality, because irrational worldviews and irrational decision making affect all aspects of society. It undermines our democracy and it undermines the overall economy as a whole long-term because irrational individuals are generally also less productive individuals, at least less capable of developing scientific advances, new technology, and processes which can lead to increased productivity in the future. Thus, capitalists themselves, in the pursuit of profit motive in the present, undermine the society's ability to develop economically in the future. Capitalists have the competing interests of wanting consumers to be irrational, ignorant and self-absorbed, and wanting workers who are rational, well educated, and capable in order to be productive (but still ignorant of labor rights and the value of their own labor).

Secrecy, lack of information, and misinformation

Secrecy and misinformation are integral to profit generation within capitalist systems. Protecting information is seen as a normal part of business operation for maintaining a competitive advantage in the market place, and indeed that is exactly what it can do. Secrecy reduces market efficiency, which helps to boost profits. Secrecy is used in many ways, from protecting trade secrets to hiding financial information from competitors to hiding illegal activity to hiding employee compensation from other employees to providing one-sided information on products to consumers.

Going back to marketing, when a for-profit entity attempts to sell a good or service, they don't lay out an objective body of information with the pros and cons of the product; they provide a highly biased one-sided set of claims. All marketing is essentially corporate propaganda. Thanks to the internet it is becoming easier for consumers to find more objective reviews of products, but even then in some cases corporations pay to have fake reviews posted on product review sites.

There are really too many ways that secrecy, lack of information and misinformation are used to protect profits within capitalist systems to go over them all here, but let's simply use the commercial food industry as an example. Despite the fact that there are now many regulations forcing food processors and packagers to disclose ingredients and nutritional information on products, consumers still lack a lot of vital information about food products when making purchasing decisions. For example, how different would individuals' food buying choices be if people were able to watch all of the food that they buy being made at the time of purchase? Obviously there would be many challenges to this in a modern economy, but the food industry benefits from this lack of information and to some degree the way that modern food supply systems function has been engineered to purposely remove consumers from the food production setting.

For example, meats are packaged in grocery stores in America in such a way as to essentially remove them as much as possible from the context of their animal origins. A century ago all meat was acquired at a butcher or on a farm, where people witnessed the treatment of the animals and the handling and processing of the meat. Today people simply buy fully butchered meat in shrink-wrapped packages where the realization that it even comes from a once living and breathing animal is no longer obvious. How was the animal treated? How was the animal slaughtered? Was the animal diseased? How was the meat processed? Did it get dropped on the floor? Did someone sneeze on it? Did it lie out with flies all over it? Did the butcher wash their hands? The consumer will never know, and what's more the seller is not only happy that they'll never know, they want to remove the product from the context of those concerns as much as possible altogether.

Would a consumer really opt for the cheapest package of chicken breasts as opposed to the one that is 50 cents more if they had "full knowledge of the market", i.e. if they knew every aspect of how the animals were treated, slaughtered, and processed by the different sellers? Would they even buy chicken at all if they knew all of that stuff or would they opt for a vegetarian alternative? We haven't even gotten into sausage making and hotdogs. And don't think that the lack of information about food processing is simply a matter of circumstance either. The fact is that animal farming, slaughtering, and processing is one of the most secretive industries in America, virtually on par with the military industry. Our entire food supply chain is owned and controlled by private for-profit businesses, and as private businesses they have a tremendous amount of control over what the public is allowed to know about their processes and products.

Not only is it already very difficult for the public to learn anything about how the meat we consume is raised and processed, even with very considerable effort, but there is an on-going effort to further restrict public access to information about animal farming and processing. Several states are working on legislation, at the behest of the livestock industry, to ban and criminalize the documenting of conditions on farms without the consent of the farm owner. Support for this type of legislation has grown among farmers after multiple incidents where individuals, either workers or otherwise, have recorded animal cruelty and sanitation violations on farms. In this case farmers are essentially trying to make it illegal to document illegal or publicly frowned upon activity at their operations. The legislation is designed to target whistleblowers working on the farms as well as activists and outside journalists.

The level of secrecy surrounding American livestock farming and processing is truly astounding when you are fully aware of it.  This segment from a PBS investigative report in 2006 states that they were the first journalists ever allowed to film inside the largest pork processing plant in the country.



Now think about that. The largest processing plant for pork in the whole country, which at the time was slaughtering and processing 33,000 hogs a day, had essentially no public access, and even the access that was granted to PBS was very limited. We are talking about a facility that produces what we eat, arguably the most fundamental requirement of life. This is a product that goes into our bodies and we aren't even allowed to see how it's made!

A recent investigation into several diseases at a Hormel hog processing facility revealed that at that facility the pig's guts and brains go down onto the floor where they slide into a drain through which they are caught in vats underneath the floor. The material is later used for food products. The pig's brains are blown out using an air compressor, after which they slide down through the drain in the floor. In this case workers in the "brain blasting" area developed a rare autoimmune disease due to inhaling vaporized pig brain. And as the cases mounted the company was, of course, very secretive about what was going on and about the operation of the plant in general.

So, owners of capital are often collectively driven by profit motive to reduce the amount of information that consumers have about commodities, in terms of the actual cost of production, how the commodities are made, and the true quality of the commodities. While some producers who produce high quality items may seek out ways to provide consumers with more information on the quality of their products, and may even want to provide consumers with information on how the products are made, there is a general collective secrecy among all capitalists within the market regarding actual costs of production and meaningful information on how products are made.

This brings us to the other major area of secrecy within capitalist systems and that is compensation secrecy. Virtually all private businesses tell employees not to discuss compensation with other employees, in fact non-disclosure of compensation is often written into employment contracts and can be grounds for termination. When a prospective employee applies for a job in the private sector, the employee isn't given a spreadsheet with the compensation for all of the employees at the company, nor are they told about any compensation negotiations with other prospective job applicants. Even more importantly, workers have no information telling them the value of what they produce or are expected to produce. Workers may get some idea of the value that they produce, but the estimates workers are able to formulate are highly subjective a not likely to be well-informed. Employees basically have no idea what the profit margin on their labor is for their employers, and employers want to keep it that way, unless perhaps the employer is unprofitable.

A reporting rule included in the recent Dodd–Frank Wall Street Reform and Consumer Protection Act requires that public corporations report the ratio between the compensation for the CEO and the median worker. This is meant to be a point of information for investors, workers and economists, and corporations are vigorously fighting the implementation of this regulation.

One of the roles of unions is precisely to address this market inefficiency, this lack of information on behalf of workers. On the one hand unions violate the efficient market principle of individually determined prices, but this is done in order to rectify other market inefficiencies such as lack of information by workers and disparities of power.

Many capitalist societies have implemented regulations and mechanisms intended to increase market transparency, under the understanding that transparency and information are essential to any reasonable operation of markets and that capitalists themselves have incentives to undermine market transparency. Nevertheless, capitalists have been successful in all countries, to varying degrees, in protecting certain levels of secrecy, both on a broad scale and on cases-by-case bases, and there are perpetual on-going efforts by capitalists to reduce market transparency whenever possible.

Externalities

Externalities are a huge component of profit generation. Externalities are one of the most important phenomena in economics and are a massive subject in and of themselves. Ultimately, externalities are one of the key factors which undermine classical and neo-classical market theory, which are predicated on decisions made out of individual self-interest.

There are both "negative" and "positive" externalities. Negative externalities are those things which incur a cost or harmful effect to a third party. Positive externalities are those things which bring about a benefit to a third party.

A positive externality is something like the way in which improvements to one's home can result in increased home values for surrounding neighbors. Another example of a positive externality is the impact that using solar or wind power has on both pollution levels and energy markets as a whole. For example, when someone switches from using fossil fuels to something like solar power, they are reducing demand for fossil fuels, which ultimately makes fossil fuels cheaper than they would otherwise be, so in fact people who do things reduce their use of fossil fuels make fossil cheaper for those that continue to use them. Thus, users of fossil fuels benefit from positive externalities generated by adopters of alterative energy or people who reduce their energy consumption.

Positive externalities generally result in under-production of goods and services or under-adoption of practices because the individual bearing the cost pays for benefits that are received by others who don't pay.

Negative, externalities, however, tend to have the opposite effect. Negative externalities are things like pollution and health problems. Negative externalities tend to cause goods and services to be "overproduced" because the full cost of goods and services are born by third parties, neither the producers nor consumers of the goods and services.

As a result, negative externalities are major drivers of profits because in effect they result in inherent subsidies. A polluter for example can reduce their manufacturing costs by simply dumping waste on public property instead of incurring the costs of properly disposing of it. Negative externalities are most prevalent when the harm done to others is indirect, difficult to quantify, or difficult to identify, yet negative externalities are ubiquitous in modern economies and forcing businesses to compensate for externalities that they benefit from in capitalist economies is often very difficult because of the disproportionate political power wielded by capital owners.

Putting it all together

So now that we've examined many aspects of capital ownership and market theory in detail, let's put it all together to get a comprehensive understanding of how capitalist economic systems operate, their advantages and disadvantages, and the ways in which capitalist systems inevitably lead to concentration of capital ownership.

First let's talk about profits. Profits are essentially the spread between the costs of commodity production and the revenue from sales of said commodities, which goes to the owner of the capital used to produce said commodities. Profits can also be described as the spread between the purchase price of property and the sale price of property. Thus profits are a form of income that is determined purely by ownership of property, not by work done. An owner of capital may also perform work that generates revenue, in which case the distinction between profits and wages becomes a blurry one, but profits in the truest sense are derived solely from capital ownership rights.

In essence, profits are a measure of market inefficiency because profits are not a product of value creation, they are a product of price disparity between market participants.

The more efficient a market is the smaller the disparity between costs and revenues will be, thus capitalists, i.e. the recipients of profit income, are driven by profit motive to undermine market efficiencies. Capitalist business owners are inherently motivated to maximize the efficiency of their own businesses, while minimizing the efficiency of the market. The market inefficiency that has the biggest impact on income distribution in a capitalist system is the inefficiency caused by the separation between labor markets and commodity markets. In their capacity as employers capitalists are driven by profit motive to make businesses a form of black box that obfuscates the relationship between labor markets and commodity markets.

Labor markets are less than optimally efficient for a wide variety of reasons, including some that are not under the influence of capitalists. In addition to factors such as employers' withholding of information from workers and barriers to entry imposed on job markets by employers, factors such as workforce mobility, worker desire for stability, worker avoidance of risk taking, etc. all play a role in reducing labor market efficiency in ways that tend to benefit employers.

When an individual owns their own capital and works for themselves they are neither a wage-laborer nor a capitalist, and their income is always a product of the full market value of the commodities that they produce and sell, i.e. 100% of net revenue goes to the individual who performs the work. Thus, working for one's self is the only way to ensure that a worker can receive the true value of their labor, but individual production is almost always less efficient than collective production, thus individuals are driven into collective production by market forces in an industrial economy. This is a really critical point to understand in relation to capitalism and the history of the American economy.

America's distinctive economic feature early in its history was the almost universal rate of private capital ownership among free white families. Private capital ownership ensured that individuals kept the fruits of their own labor. From the colonial era up to the Civil War America's economy was dominated by home-based production and small family businesses, where husbands owned their own capital and worked with their wives and children to create value and generate revenue for the family. Since all or most of the workers in these businesses were family members, the entirety of the income stayed within the family, and thus private capital ownership served to ensure that workers kept all of the value that they created since they employed their own labor on their own property, unlike feudal societies where all of the property was owned by an aristocracy, upon which masses of unpropertied peasants worked, with much of the fruits of their labor going to the property owners.

This condition of family based production was excellent in terms of ensuring that individuals kept the fruits of their own labor, and thus excellent in terms of creating a "just" economic system for white families (which was of course extremely unjust for Native Americans, African American slaves, and single women), but it was also very inefficient. The reality is that while individual capital ownership and individual production ensures that workers keep the full value of what they produce, collective capital ownership and collective production are far more efficient.

Capitalism is a system for facilitating collectivization of production. After the Civil War, with the rise of industrialization in America, individual and family-run businesses gave way to the market efficiencies of collective capital ownership and production. This is the real driving force of capitalism. Profits are inherently maximized when capital ownership is concentrated and production is highly collectivized. What the capitalist system does is it provides a profit motive for individuals to privately collectivize production and minimize the number of individuals who own capital. The countervailing market force to capital ownership concentration is risk sharing. While capitalism creates an incentive to concentrate capital ownership on the one hand, the ability to amass capital and the risk of doing so provides an incentive for collective capital ownership as well.

This is where corporations come in within the capitalist framework. Corporations are legal entities that have been designed to minimize the risks of capital ownership while allowing individuals to pool their resources to collectively share ownership of capital, thus facilitating a more rapid collectivization of production. Individuals and families who directly owned and operated their own capital were at a market disadvantage against corporations through which resources could be pooled and the risks of capital ownership could be shared among more individuals. However, though corporations facilitate collective capital ownership, the efficiencies of collective production and the mechanisms of collective ownership meant that in fact collective capital ownership through corporations facilitated a concentration of capital ownership.

This is due in part to the fact that by pooling resources a relatively small number of capital owners could out-compete a larger number of independent capital owners. In other words, in a market with 100 independent owner-operators, a corporation collectively owned by 10 people could generate enough efficiencies to put all 100 of the independent owner-operators out of business, and thus by pooling resources 10 capital owners could force 100 capital owners out of positions of ownership. Typically, the result is that many of those 100 former capital owners would then become wage-laborers working for the 10 capital owners, while some would pool their resources together to form larger competing corporations, and some would simply become destitute, retire, or go into a different line of work.

The important thing to understand is how in this manner collective private capital ownership can actually reduce the number of individuals who own capital.

In addition, through "public ownership" corporations are able to spread large portions of risk across a large population by selling tiny fractional shares of ownership to many, many people, while retaining controlling shares of ownership among a small number of people. This works to concentrate control of capital among a very small number of owners, while spreading risk among a larger number of individuals. In addition to risk reduction through collective capital ownership, controllers of capital in capitalist societies like America have been able to further reduce their individual exposure to risk via their disproportionate influence over legislative bodies, thus ensuring that the laws further protect them from risk exposure.

The reduction of risk exposure among capital owners and controllers thus further facilitates the concentration of capital, because as was previously stated, the countervailing force to capital concentration within a capitalist system is risk sharing. As the risks of capital ownership are reduced via government protections for capital owners through so-called "business friendly" legislation, the risks associated with capital concentration are minimized, thus enabling further capital ownership concentration. This concentration of ownership then has a snowballing effect, leading to growing influence of the capital owners over governments and economies, inducing governments to offer increasing protections to the capital owner's ever-larger institutions both due to the growing influence of their financial power and out of real fear of the impact that a failure of their institutions could have on the overall economy. Such protections, of course, then continue to facilitate further concentration of capital ownership, which is further evidenced by the large scale of corporate stock-buy backs since the beginning of the 2008 recession.

This effect can also be seen in the consolidation of banking in America in the wake of the "great recession" of 2008, during which a large number of banks failed and the government provided unprecedented protections for the largest banks.

The concentration of capital has a significant impact on labor markets as well. Today over half of the American workforce works for large companies, i.e. businesses with more than 500 employees. These businesses represent just 0.3% of private employers in the country. This means that 0.3% of the nation's private employers employ over half of the American private industry workforce.


source: http://www.census.gov/econ/smallbus.html#EmpSize

The fact that over half of the private American workforce is employed by less than 1% of the nation's businesses provides significant wage-setting power for those large employers and creates significant political leverage as well.

As capital ownership is concentrated, capital owners increasingly benefit from market inefficiencies, which is to say that the incomes of capital owners become increasingly a product of market inefficiencies, which is to say that the wealth of the wealthy increasingly represents graft from society as opposed to the creation of value.

The most difficult thing to understand about this situation, however, is that it isn't a black and white scenario. The incomes of capital owners and the super-rich are not purely graft. Capital owners and the super-rich typically do create real value and are often very high value creating individuals; the issue, however, is that while they may create large amounts of value themselves, their incomes also include large amounts of value that they didn't create, but that is instead redistributed from workers, taxpayers, and other property owners via various market inefficiencies. Not only this, but there is a high degree of variability in the ratios of real value creation to graft among the super-rich. The incomes of some of the super-rich are almost entirely graft, while others are mostly products of real value creation.

The diagram below is a crude representation of this concept. The blue diamonds represent value that is both created and received by an individual in the form of income. The red diamonds represent value that is created by an individual, but is redistributed to capital owners, and the green diamonds represent capital income that is received by capital owners. The reality is that the green diamonds are the red diamonds that were created by workers which have been transferred to the capital owners. Yet, when looking at this diagram we see that the capital owner is actually creating value themselves as well, in fact they are creating more value as an individual than the others are, but the amount of additional value they are creating relative to the others is relatively modest, yet their total income is much greater than the others because they are receiving such large amounts of capital income, which is value that is being redistributed from other workers to them.



This is, to a great extent, what makes understanding this issue so complicated; the super-rich are for the most part both the highest value creators in our economy and the largest recipients of redistribution. In fact, the super-rich are large recipients of both pre-tax redistribution and after-tax redistribution, but of these the pre-tax redistribution is by far the most important and least recognized. Pre-tax redistribution in a capitalist economy goes overwhelmingly from workers to capital owners. After tax redistribution in the current American system goes primary from middle-class and high income workers to both the poor and super-rich capital owners.

The most visible aspect of redistribution in the American economy has long been after-tax redistribution to the poor, yet much of the need for after-tax redistribution to the poor is a product of the pre-tax redistribution from the poor in the first place, who typically see the largest portion of the value that they create going to the profits of capital owners.

This redistributive effect, then, in addition to the forces of competition, industrialization, economies of scale, market inefficiencies, and government subsidy of capital owners, results in increasing concentration of capital ownership over time in capitalist economies.

Problems and Solutions

The most fundamental criticism of capitalism as an economic system has always been that over time there would be an inherent tendency toward concentration of capital ownership, and that this concentration of capital ownership would, in the end, undermine not only the very basis of the economy, but the entire social and political system as well, indeed undermining democracy itself. Concentration of capital ownership within the capitalist framework is predicted by fundamental economic theory and this prediction is further strengthened by social and political science in that social and political understanding easily explain how the inherent economic tendencies toward capital ownership concentration within a capitalist system will be compounded by social and political institutions as a result of the growing power and influence of capital owners as they consolidate ownership over capital.

America's own history, as arguably the world's flagship capitalist society, confirms this prediction of increasing capital ownership concentration within capitalist systems. The economic reforms of the 20th century in America and Western Europe never changed the underlying fundamentals of capitalism, and as a result, concentration of capital ownership continued unabated throughout the 20th century, even after the rise of so-called welfare-state systems in America and Western Europe. Indeed welfare-state systems enabled the continuing growth of capitalist economies amid increasing concentration of capital ownership.

What the economic reforms of the 20th century did in capitalist economies is they enabled the existence of a non-capital owning middle-class. The welfare-state reforms, by ensuring that workers would receive a greater share of revenue and by creating social safety nets, broke the very strict relationship between capital ownership and compensation, which, while leading to real improvements in quality of life for the working class and sustaining economic growth over the relatively short-term (a few decades), ultimately enabled continuing concentration of capital ownership.



This is reflected in the chart above in the growth of non-capital wealth owned by the bottom 90% of households in America following the New Deal reforms. What the economic reforms did was lead the middle-class to believe, in both America and Europe, that the fundamental structure of capitalist economies was sound and that capitalist economies could be equitable. This was really a facade, however, with the continued functioning of capitalism only made possible by both the re-distributive welfare-state reforms and massive debt, both private debt and government debt, used to prop-up both the welfare-state and capitalists themselves.

Meanwhile, throughout the latter half of the 20th century, actual capital ownership continued to be consolidated behind the facade. As capital ownership became increasingly concentrated both the incomes and political power of capital owners increased exponentially, leading to the resurgence of economic inequality in capitalist economies. The fundamental "flaw" of the economic reforms of the 20th century was that they did nothing to address the underlying structure of capital ownership, hence the equitableness of the reforms was merely superficial. It was always inevitable that without reversing the concentration of capital ownership, eventually capital ownership would become so concentrated that the political and economic power of capital owners would become so consolidated and so great that they would be able to use that power to undo the reforms that enabled a non-capital owning middle-class to exist. In addition,  even without the intentional elimination of these reforms, preventing on-going economic crises in capitalist economies would require continuous expansion of the welfare-state.

Capitalist economies around the world are now faced with a battery of internal contradictions. Both the governments and the workers/consumers in capitalist economies are saddled with large amounts of debt, while at the same time the portion of economic output going to workers/consumers is also falling as the effects of concentrated capital ownership play out, thereby reducing the ability of those entities to generate economic demand.


source: http://www.pbs.org/newshour/businessdesk/2013/01/merle-hazard.html

Therefore, despite continuous increases in productive capacity, consumptive capacity is stagnating or falling in mature capitalist economies, which may not be a bad thing from an environmental perspective, but it is undeserved from an economic perspective.

The effects of highly concentrated capital ownership are not only economic, however, they are also societal. As capital ownership is consolidated a smaller and smaller portion of the population gains increasing influence over culture and conversely communities lose control over culture. As control over culture becomes consolidated, the relationship between producers and consumers becomes increasingly predatory, because producers are increasingly removed from the community. Producers become less and less concerned with community standards, morals, and concerns because they are less and less impacted by them.

In a local economy where production takes place within the community and producers and consumers live in contact with each other, producers are a part of the community and affected by the impacts of their own products, both directly and indirectly via their relationships with community members. When producers are far removed from consumers, then the impacts of their production on the community are not felt by producers and of less interest. As a result, the relationship between producers and consumers becomes one driven purely by profits.

As an example, a local clothing maker with a family living in and serving a local community market would not be very likely to make sexually provocative clothing for young teenagers and market that clothing directly within the community, yet that same clothing maker would be much more likely to produce sexually provocative clothing and market it to young teenagers if they were serving a global market of millions of consumers, because the scale of the market and the separation from the community insulates them from the societal impact of their own production, and the economic benefits to themselves from increased sales outweighs any negative social reaction since they are removed from it.

Likewise, whereas the parents of teenagers might feel empowered to confront a local producer and have market power to effect a small local producer, thereby putting pressure on a local producer not to make and market sexually provocative clothing to their children, consumers feel disempowered, and are in actual fact disempowered, in their relationships with large multi-national corporate producers. So the parents of children don't have the same type of control over large multi-national corporate producers and marketers that they do over small local businesses, and likewise, large corporate producers don't have a localized community relationship to the markets that they serve, and are thus differently incentivized than producers who live and produce within local communities of which they are members.

Ultimately what this means is that as capital ownership becomes consolidated, fewer and fewer individuals have control over capital, which means that fewer and fewer individuals have control over production. Culture is largely a product of production; the things that we produce define our culture. This means that our culture becomes defined by a smaller and smaller portion of the population as capital ownership is consolidated, which of course means that families and communities have diminishing control over culture.

Maintaining control over the means of production is a key part of how the Amish preserve their culture. Amish society is a communal society in which they forego the use of most modern technology. Foregoing the use of modern technology preserves a pre-industrial economic structure, helps to ensure relatively equal property distribution among the Amish, and preserves their communal way of life. The Amish also preserve their culture by producing the commodities that they consume themselves, within their pre-industrial communal framework. This is what gives them control over their culture. The entire economic system of the Amish is designed to foster communal cohesiveness and to preserve the traditional values and way of life of the Amish people. This is a key understanding, because the Amish demonstrate the critical role that the means of production and the economic system plays in determining culture.

The approach that the Amish have taken to preserving their culture and communal economic system is a Luddite type of approach. Though the Amish are an extreme example of this type of opposition to industrialized capitalism, it is also common for liberal opponents of capitalism to view technology as a part of the problem. It is certainly true that advances in technology can facilitate consolidation of capital, but let's not forget that capital ownership was highly concentrated under the feudal system, and capital ownership was consolidating rapidly in the American South under the plantation system prior to the Civil War as well, so concentration of capital ownership can occur even without advances in technology.

The "traditional" approach to serving the interests of workers in capitalist economies has been to try and protect the "jobs" and wages of workers. Within the capitalist framework workers often view their interests as being in opposition to technological advances because the focus is on "preserving their jobs" and preserving the value of their labor. There is the view that as technological advances are implemented in the workplace, and the workplace becomes more efficient, fewer workers are needed to produce the same or more output, and thus workers will lose their jobs, which is their primary or only source of income. As such, there is a tendency among workers to oppose significant labor saving efficiencies in order to preserve their jobs, and thus their source of income. This is an even more common phenomenon in Europe where unions and tradition are more powerful than in America.

There is also a tendency toward "smallism" within capitalist economies, which is favoritism of "small" or "independently owned" businesses. There is a recognition that owner-operators truly "earn" a larger portion of their income, and a belief that small businesses better serve the local communities, etc. Small business have less individual power over workers and often tend to be more concerned with community standards and community interests.

The problem is that opposing technological advances in production in order to preserve jobs stifles efficiency which ultimately undermines the economy, and small businesses tend to be less efficient than larger businesses that can take advantage of economies of scale. This ultimately ends up leading to lower productivity and lower incomes for workers. The central problem goes back to the distribution of capital ownership. As businesses increase in size and market share, ownership and control over capital is naturally consolidated, and as production processes become more efficient fewer workers are needed to produce the same quantity of goods and services.

Opposing technological advances and favoring small businesses (in some cases through economic subsidies or regulations) are ways of trying to reduce capital ownership concentration within a capitalist framework through structural constraints, which necessarily reduce productivity and economic efficiency. Conversely, maximizing efficiency through capital improvements and allowing capital ownership to become concentrated not only undermines economic fairness and invites corruption, but also ends up undermining economic potential as well since the consumptive capacity of the working class is reduced as they inevitably receive a diminishing share of the wealth created by the economy as the share of wealth creation going to capital owners increases.

This is why capital ownership has to be broadly shared in some way in order for an economy to maximize its potential over time, and in order to reduce economic exploitation and unfairness as well as undo influence of a relatively small number of individuals over the economy and culture. The question is how to achieve this? The major Communist and Socialist regimes of the 20th century all basically sought to do this by making "the state" the sole or major owner of capital, and thus calling the capital owned by the state "publicly owned". These implementations are often considered "State Capitalism" because the government essentially took on the role of "capitalist", owning and directing the use of capital, managing labor relations, and setting wage compensation, using the "profits" from enterprise as a source for government funds, which were in theory intended to be used to provide benefits to the citizens.

The problem with this is somewhat obvious, especially with historical hindsight. Principally, capital ownership is still concentrated under such a system and many of the same problems with private capital ownership concentration persist, on top of additional problems created by the politicization of essentially all employment and economic activity, and a host of other issues that go without saying.

An alternative to this is something called Distributionism, which essentially means ensuring that capital ownership is widely, almost equally, distributed among all individuals in the population. The Distributionist movement was originally started by religious conservatives in the 19th century, and was at that time a somewhat anti-industrial movement, however the basic principle of equal distribution of private capital ownership can be applied within a progressive pro-industrial framework as well, as I lay out in A Progressive Foundation for America's Economic Future in the section titled Implement a National Individual Investment Program.

The critical aspect of a progressive distributionist system would be that the government, instead of owning or controlling capital, would be used merely to ensure equal distribution of capital ownership to individuals, but capital ownership would remain private. Far more needs to be done than the National Individual Investment Program that I described in the aforementioned article, but the central point is that capital ownership has to be far more equitably distributed. As technology and efficiency progress it is imperative that everyone have significant capital income so that capital income can become an increasing share of national income.

The traditional situation in capitalist economies pits the interests of wage-laborers against capital owners, whereby the gains of one are essentially the losses of the other. What we see in capitalist economies around the world is that the share of income going to capital is increasing, while the portion of the population receiving that income is decreasing, so a larger and larger share of income is going to a smaller and smaller portion of the population. The reaction to this situation by many people who oppose growing income inequality has been to advocate for reversing this trend by increasing labor's share of income, but this is an entirely wrong approach. Instead of increasing labor's share of income, what needs to be done is that capital ownership should be more broadly distributed so that the increasing capital income goes to everyone instead of just to a small number of people.


source: http://www.theatlantic.com/business/archive/2013/02/the-mystery-of-the-incredible-shrinking-american-worker/273033/

The problem with the traditional dynamic within capitalist economies is that it induces workers and policy-makers to try and sustain or prop up labor's share of income, a tactic which is ultimately unproductive. If everyone is an equal owner of capital, however, then the share of income going to labor becomes significantly less important. The problem with a low share of income going to labor in a traditional capitalist economy is that labor is the only meaningful source of income for the vast majority of the population. The middle-class exists on labor-income and essentially only makes use of capital income in retirement, while the poor have essentially no capital income throughout their lives. Without the income from labor capitalist economies would collapse, but this is only because capital ownership is so concentrated and the fact is that in a "free-market" capitalist economy increasing capital ownership concentration is inevitable, as we have seen.

This puts capitalist economies in a position where "jobs" have to be created and maintained purely for the sake of distributing income, not for the sake of production. The purpose of an economy is not to "create jobs", the purpose of an economy is to create wealth. Jobs are merely a means to that end. Jobs are something that we should be working to eliminate, not create. The only reason that there is any talk of "creating jobs" is because jobs are the means of distributing wealth to the poor and middle-class within capitalist economies, but if everyone actually owned meaningful capital, i.e. if everyone were a real "capitalist" instead of just 1%-2% of the population beings capitalists, then creating jobs would not only become unimportant, but in fact everyone would benefit from the elimination of jobs and the economy would be on sound footing to truly embrace efficiency. Productive automation and maximizing efficiency can only be fully embraced when the dependency on "jobs" as a means of distributing wealth is eliminated.

This doesn't mean that jobs or working would be eliminated overnight; what it means is that the share of income between labor and capital would become far less important and eliminating jobs would become a means of increasing everyone's income, not just the incomes of a tiny minority of super-rich capital owners. If, in theory, capital ownership were truly equally distributed what that would mean is that no individual would have massive capital income, but everyone would have moderate capital income. Even with equal distribution of capital ownership, given the current state of technology the majority of everyone's income would still come from labor, but instead of having some people who receive billions of dollars a year in capital income with capital income making up 99% of their income and other people having no capital income at all, everyone's income would be roughly 10% to 30% from capital and the rest from labor. But that means that even if you lose your job, you would still retain 10%-30% of your prior income automatically, which is far better than losing 100% of your income as is the case for most poor and middle-class workers, and this in turn would reduce the need for government-provided safety nets (unemployment benefits, welfare programs, disability benefits, etc.).

Some people would still be paid millions of dollars a year in labor compensation and some people would still only be paid minimum wage, so income inequality would still exist and "reward" for an individual's contributions would still be a part of the economic system, as it should be, but the current massive income inequality which is a product of capital ownership concentration would be greatly reduced.

But truly equal ownership of capital would never be achieved at any rate; all that could ever be achieved is a "far more equal" distribution of capital ownership. That is because the only form of capital ownership that could easily be distributed would be shares of corporations. Individuals would still directly own private capital even in a distributionist system, meaning that small business owners would still own their small businesses independently and retain full ownership. There is absolutely nothing wrong with that, because small business ownership is actually just another means of distributionism - in fact it is the original means by which capital ownership was widely distributed in America in the first place.

The important aspect of a progressive distributionist system is that it embraces industrialization, automation and economies of scale, while ensuring universal capital ownership.

Many other reforms of capitalism are also needed, but the relatively equal distribution of capital is key to all other reforms of capitalism, because many of the problems inherent in capitalist economies are products of concentrated capital ownership and the motives that concentrated capital ownership inspire. In addition, capital ownership is a source of political power, so if capital ownership were more equitably distributed political power would be as well, which would in turn further facilitate democratic reforms of capitalist systems.

Summary and Conclusion

The United States of America has been, in many ways, the ideal test case for capitalism. The widespread ownership of private capital prior to industrialization provided an advantageous base upon which to build a so-called "free enterprise" capitalist system. It has to be recognized that the conditions which made widespread capital ownership possible in the United States of America were a historical anomaly - the result of a technologically advanced civilization invading a large land mass with a small and significantly less technologically advanced population which they essentially exterminated, making it possible for virtually all free families of those invaders to become property owners. In addition, the policies of the early American government aided widespread capital distribution through policies that subsidized individual capital acquisition and policies that were designed to ensure that capital (primarily in the form of land) would be at least somewhat equally distributed among individuals instead of concentrated into the hands of a few powerful individuals.

The relatively widespread prosperity present in early American society was a direct product of this relatively widespread capital ownership. In addition, the slavery system present in the early United States essentially subsidized all of white society, even non-slaveholders, by reducing the cost of materials for everyone. So freely available land/capital, along with "free labor", played a large role in making "white" society highly egalitarian in early America.

The question for capitalism as an economic system was, once the "free" capital (land) was all gone, an end was put to slavery, and industrialization had commenced, would the "free enterprise" capitalist system be able to continue to provide widespread economic prosperity? By the end of the 19th century many people in America and around the world had begun to doubt that it would, and these doubts were only strengthened with the global economic depression of the 1930s.

Many different solutions to the economic crisis of the 1930s were implemented in industrialized countries around the world, ranging from socialist to fascist to welfare-state capitalist systems. What essentially all of the major "solutions" had in common was that they increased regulation of the economy, created social safety nets of some kind for at least some subset of the population, and further centralized control and ownership over capital.

In the case of ostensibly socialist systems capital was centralized under government control, largely  against the interests of existing capital owners. In the case of fascist systems capital was centralized under government control largely in favor of the interests of existing capital owners, and in the case of welfare-state systems capital generally became more centralized under the control of private capital owners, while control of capital became more highly regulated and taxed by governments.

Arguably, the only systems under which capital control became more widespread were some of the socialist systems that "redistributed" land during the 1930s-1960s, but this redistribution wasn't entirely meaningful because in most cases the redistributed land became "collectively owned", or rather still owned by the state.

The welfare-state reforms which dominated "developed" capitalist economies like those of the United States and Western Europe had the effect of providing increased economic security and stability in capitalist economies and ensuring that prosperity was more widespread by improving the rights and protections of non-propertied workers and by increasing the share of created value received by non-propertied workers through regulation, as well as creating social safety nets for workers, non-workers, and capital owners.

These welfare-state reforms, however, treated the symptomatic problems of capitalism without curing the underlying causes of those symptoms. This actually enabled growth of the underlying root cause of imbalance in capitalist economies, namely concentration of capital ownership.

Ultimately what we see when looking at the economic history of the United States is constantly increasing concentration of capital ownership over time in the world's flagship capitalist economy, under every regulatory scheme and set of market conditions. We have to therefore conclude that increasing concentration of capital ownership is an inherent outcome of capitalist economies. We must also recognize that concentrated capital ownership undermines the very principles that the proponents of capitalism often espouse. However, it would be incorrect to claim, as Karl Marx did, that capitalist economies will "destroy themselves" or that they will cease to be able to function. That isn't true. After all, feudal economies persisted for thousands of years. Will capitalism inherently reach a state of "crisis"? Not if by crisis we mean a state when the economic system will completely fail and the ruling class will lose power much like the ruling aristocracies lost power with the end of feudal economies. No, that won't inherently happen. It might happen, but it isn't inevitable.

What will happen, unless capital ownership itself is massively redistributed, is that economic disparity will increase, a ruling class will become entrenched, and the working class will receive an ever-shrinking share of the value created in the total economy. That condition can persist for centuries, just as feudalism persisted for centuries.

To understand the concentration of political power in America over time we have to understand that American economic populism was originally rooted in the socially conservative farming population. When America was founded the majority of the population were farmers and they owned the majority of the capital. As such, they had tremendous political power. As the farming population shrank, the political power of populism shrank, because what made American farmers a unique political force was the fact that they were populist capital owners. As farmers shrank from 85% of the population when the country was founded down to around 40% of the population  at the turn of the 20th century their political power was waning, but remained relatively strong, and it was the political power of the farmers that made many of the populist reforms of the early 20th century possible.

By the 1930s the political power of the farmers was growing weaker still, but remained strong enough to help usher through the major economic reforms of the New Deal. Without the political backing of America's farmers it is a virtual certainty that the populist reforms of the New Deal wouldn't have been possible. The fundamental reason that American economic populism died shortly after World War II is the industrialization of farming. By the 1970s farming had become an industrialized, dominated by corporations instead of individuals, and farmers had shrunk to about 5% of the population. Not only had the population of farmers shrunk, but farming was now dominated by corporations, so what political power was retained by the farmers became aligned with broader corporate interests.

This I think is key to understanding the transformation of American economic populism. American farmers were the only meaningful group of capital-owning populists. Once their political power waned and their interests became aligned with corporations, the only remaining populists were non-capital-owning workers, who, inherently, by virtue of their lack of capital ownership, had (and continue to have) relatively little political power. 

The failure of American economic thought is the failure to grasp and internalize the paradox of property rights. Yes, private capital ownership is what made America a great country and it is what made American society relatively egalitarian and it is what made America a land of opportunity, but that only worked because there was a large stock of "unclaimed" freely available capital, in an economy dominated by individual economic production. This situation, by its very nature, essentially negated the conflict between labor rights and property rights.

However, if we take John Locke's statement on property rights to be true, that the right to property is a product of labor, then it becomes obvious that owning capital necessarily deprives other individuals of their right to property. The only time that this isn't true is when every individual owns their own capital and all production takes place on an individual scale. Since that was largely the condition in the early American economy (for white males), the association between private capital ownership and retention of the products of one's own labor became ingrained in the American psyche. But as soon as an individual exercises their labor upon capital owned by another individual the paradox of property rights is raised. The early American economy did not resolve the paradox of property rights, it merely avoided the paradox (for white families) by virtue of having access to an essentially unlimited supply of free capital in the form of land, and American economic thought has failed to come to grips with this situation ever since.

It is clear that the incomes of today's large capital owners are not a product of their own labor, but rather their incomes are the result of redistribution of value created by millions of other people, ultimately workers all over the world. Today there are individuals, largely in the financial industry, with incomes of over a billion dollars in a single year, virtually all of which is derived from capital ownership. It is impossible to attribute these incomes to the labor of the individuals who receive them, yet I think that most people fail to grasp just how large these incomes are. The chart below provides a scalar comparison between 1 billion, 1 million, and 100 thousand for reference.



To claim that any individual creates billions of dollars of value in a single year with their own labor, while the average American creates around fifty thousand dollars a year, is a total farce, but that income has to come from somewhere, it has to be created by someone's labor if not theirs.

The reality is that the incomes of today's large capital owners are little different than the incomes of the feudal aristocracies. The only difference is that today it is easier for a non-capital owner to become a large capital owner than it was for a non-aristocrat to become aristocracy in the past and becoming a large capital owner is more merit based, but the incomes are still derived in essentially the same way: They are products of private taxation, the right to which is granted through property ownership. Property rights grant ownership of value created by other individuals to owners of capital. The incomes of today's large capital owners are products of concentrated property ownership taxing away value created by the majority of the non-capital owning population, just as they were in feudal times.

There is no easy resolution to the paradox of property rights, there is no meaningful way to determine the true "labor value" contributed by an individual in an industrial economy because the relationships between labor and value creation are far too complex and the collective nature of production necessarily produces value that is greater than the sum of the individual contributions. In addition, as technological progress continues, assuming that it does, automation makes reliance on labor as a primary source of income increasingly misguided anyway.

This is why the labor movement's efforts in capitalist economies to increase the wages of workers has been largely misdirected for the past half century. Instead of focusing on increasing wages, the focus should be on distributing capital ownership. However, the "blame" for this focus does not rest entirely on the labor movement, because capitalists themselves have intentionally kept the focus on wages as opposed to capital ownership. In other words, in capitalist economies advocating for higher wages is easier than advocating for capital distribution, because ultimately ownership and control of capital is what's most important to capitalists. Capitalists know that in the long-run retaining control of capital is more important than temporary wage concessions.

But in order to have an equitable economy that can maximize growth and efficiency, as well as democracy, capital ownership has to be relatively equally distributed in some way, via some mechanism. Capital distribution is ultimately far more important than wage distribution. This is the most important lesson that we can learn from America's economic history.

The realization that capital ownership inherently becomes more concentrated over time in capitalist economies is nothing new and has been theorized for over a century, but today the evidence for this has become overwhelming.

Private capital tends to become concentrated in few hands, partly because of competition among the capitalists, and partly because technological development and the increasing division of labor encourage the formation of larger units of production at the expense of smaller ones. The result of these developments is an oligarchy of private capital the enormous power of which cannot be effectively checked even by a democratically organized political society. This is true since the members of legislative bodies are selected by political parties, largely financed or otherwise influenced by private capitalists who, for all practical purposes, separate the electorate from the legislature. The consequence is that the representatives of the people do not in fact sufficiently protect the interests of the underprivileged sections of the population. Moreover, under existing conditions, private capitalists inevitably control, directly or indirectly, the main sources of information (press, radio, education). It is thus extremely difficult, and indeed in most cases quite impossible, for the individual citizen to come to objective conclusions and to make intelligent use of his political rights.
- Albert Einstein; Why Socialism, 1949

Recognizing and understanding the concentration of capital ownership that has taken place over the course of America's history, and the implications of it, is therefore of extreme importance.



America's economy has evolved over time. The conditions that existed in America's early economic history no longer exist today, and therefore many of the economic principles that ensured shared prosperity in America's early economic history no longer have the same effect today. The Communist  and Socialist movements of the 20th century may have ultimately been failures, but the problems of capitalism that they sought to address still remain. The failures of those movements don't vindicate capitalism, all that they do is show that those regimes were not the solution, but the problems inherent in capitalism still remain; they didn't go away because some alternative approaches failed.

The primary lessons that we learn from the failed Communist and Socialist regimes of the 20th century is that centralization failed, yet when we look at capitalist economies today what we see is that centralization has taken place as well. Today the global capitalist economy is as much or more centralized than the Soviet Union ever was, the difference is that the economy is centralized under the control of powerful private interests who exercise heavy influence over governments around the world, as opposed to being centralized under the direct control of government.

A 2011 study found that a mere 147 transnational corporations (less than 1% of transnational corporations) controlled 40% of global capital. The study found, "that network control is much more unequally distributed than wealth. In particular, the top ranked actors hold a control ten times bigger than what could be expected based on their wealth."

While this study examined only the relationships of transnational corporations, the findings can be broadly applied to conclude that generally speaking, control over capital is actually more concentrated than mere wealth distribution would indicate. This actually makes sense based on how controlling shares of corporations work, which is what allows entities to own less than half of the value of a corporation while retaining controlling interest. As capital ownership and control become increasingly concentrated, the ability of capitalists to undermine market conditions in order to preserve profits increases.

This is the reality that we have to acknowledge and face. Ownership and control of capital is far more concentrated today than at any time in America's history and this fact is a product of capitalism itself. Ultimately, attempts at economic and political reform which don't fundamentally address the distribution of capital ownership are doomed to be temporary and ineffectual at best. The underlying cause of economic inequality and political disenfranchisement in capitalist economies around the world, particularly in America, is concentration of capital ownership. This concentration of capital ownership undermines the principles upon which America was founded, and now creates the type of feudalistic social and economic conditions that early Americans fought so hard against.
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