Apparently, Not Everybody Gets This…

In addition to having an *awesome* beard, Marx also understood what makes capitalism so dynamic.

In addition to having an *awesome* beard, Marx also understood what makes capitalism so dynamic.

Markets (even free markets) are not the same thing as capitalism.

Yet constantly people, even economists (who should really know better), conflate the terms. They’ll start a sentence by saying ‘capitalism has been promoted throughout Africa…’ and end it talking about ‘… despite extensive market liberalization, poverty reduction remains slow’ as if they are still talking about the same thing.

Entrepreneurship is not the same thing as capitalism.

I’ve often heard people say ‘Africa is one of the most capitalist places I’ve been to – everywhere I went someone was trying to sell me something!’ More news – that’s commerce and entrepreneurship. Neither of those things are the same as capitalism.

The existence of private property is also not sufficient to indicate capitalism.

Private property exists in almost every form of economic organization beyond the most primitive economies. Capitalism isn’t defined by private property either.

Most people understand there is an economic form called ‘capitalism’ which is distinct from and more dynamic than other economic forms. However, they define capitalism against a limited sample of comparators. Most people conceive of only two types of economic organization in any detail: capitalism and socialism (in its extreme form, communism). This is partly a product of the era in which we have grown up. The Cold War and the conflict between Capitalism and Communism so defined modern international relations until recently that the end of this conflict prompted Francis Fukuyama to declare ‘The End of History’, with the triumph of Capitalism (and liberal democracy) representing the end of modern development.

Thus, most observers define capitalism not by its most individual characteristics, but by those that best set it apart from communism: free markets, unfettered entrepreneurship (in the sense of freedom to pursue economic self-realisation) and the existence of private property. This has had serious effects on our ability to diagnose and define policy in less-developed countries. Economic policies attempt to manipulate or take advantage the underlying laws of motion of an economic system; if we have misunderstood that system, our policies may not have their intended effects.

An important first step, therefore, is to understand what sets capitalism apart. Karl Marx was the classical economist most concerned with the logic and design of capitalism, an understanding based on his interest in pre-capitalist economic forms. His typology of such forms included a primitive ‘communal’ form of organization; a more developed stage of property relations characterized by the differentiation of agriculture from industrial and commercial production, a stage that could take various forms; and feudalism, the form that gave way to capitalism in Europe. In his introduction to the first English edition of Marx’s Pre-Capitalist Economic Forms, Hobsbawm noted that it’s a very incomplete typology. However, his analysis, augmented by a cursory glance at historical materials, demonstrates that other economic forms have also been characterized by the supposed ‘defining characteristics’ of capitalism often cited.

  • Specialisation and exchange in relatively sophisticated markets existed very far back into the history of both the currently developed and the currently less-developed world. To give a random example, I recently finished reading a book about Sunjata Keita which incidentally remarked upon the specialisation of professions that existed as early as the 13th Century in modern-day Mali.
  • Entrepreneurship has also historically existed deep into the past; the willingness to produce and attempt to trade goods is recorded well before the advent of capitalism. Arab traders undertook long and treacherous journeys to establish homes in Africa as far back as the 11th century in order to establish markets to supply inputs and purchase their finished goods, attesting to a profoundly brave and entrepreneurial spirit.
  • Private property backed up by either a formal state or an informal threat of violence and retribution was a also characteristic of most feudal societies, in the form of dwellings and landholdings, as was remarked upon by Adam Smith in the Wealth of Nations.

What then does define capitalism? Smith offers us little of use in this regard, which is not surprising, since the Wealth of Nations was published in 1776, comfortably before early capitalism reached it’s zenith in the United Kingdom. Hernando de Soto offers an explanation, though. His book The Mystery of Capital (published in 2000) argues that profession of economics has en masse forgotten what capital is, and how it is created. Capital, according to de Soto, is not physical assets owned by people, but their representation in an abstract legal sense. This legal ‘parallel life’ both describes the essential, valuable features of the asset and assigns its ownership rights. This is what creates capital, as this information allows people to access resources for economic activities based on their assets and thus participate in the economy.

However, even this isn’t the whole story. De Soto has explained what is special about ‘capital’, or rather how to create it. He hasn’t described the system in which capital (and indeed labour) have the greatest material impact. He quotes George Soros as arguing that Marx’s understanding of capitalism was rather more sophisticated than Smith’s, and I’m inclined to agree, with the proviso that we see the distinction between Marx as an economist (who was a brilliant and precise thinker) and Marx as a historian  and social theorist, whose idealistic and determinist vision of social progress is forced and unconvincing.

What Marx shows is that the central defining characteristic of capitalism is the ownership structure. Under capitalism, labour is divorced from property. Those who own property (and capital) apply wage labour to this property, mediated by capital, in order to generate revenues; that which exists over the costs of maintenance of capital and wages is called ‘surplus’, which is basically profit. What’s special about this relationship is that the incentives in place are uniquely dynamic. Because the capitalist does not use his own labour and takes the excess of revenue after wages are paid, his incentive is always to apply more capital, or better capital, to his property and labour force to increase the amount of revenue generated from the same amount of wage labour. There is never any contradiction between this incentive, and for example, the incentive to rest or recreate, because the labour is performed by other people. The divorce of capital from labour also makes it easier to accumulate capital: resources are concentrated in the hands of a relative few, and the scale of the property they have (given the conditions identified by de Soto) allows them to access much larger volumes of capital.

This kind of dynamism does not exist when property and labour are tied together. Take the example of a smallholder. His labour is tied to his property. While it is clearly in his favour to apply capital to the land, there are two restraints: the size of his landholding limits how much he can access (and if he increases the landholding, he needs more labour – and becomes a capitalist) and secondly, if he himself is the primary source of labour, his incentives as a landowner and as a labourer are not in harmony.

The reason this is so important in development is that most African countries are not fully capitalist. While in most cases there are aspects of the economy that demonstrate capitalist ownership patterns, there are many other sectors or regions where this is not the case. Complicating this, the legal definition of property that gives rise to capital is also weak. In such circumstances, economic development policies that blithely assume that capitalism is already in place (as virtually all economic theories post-Ricardo do) are not necessarily useful. It may be that we are putting the cart before the horse in our reform programmes.

None of this is very complicated, but it seems that critics on both the right and the left have trouble with this. I recently read this from a commenter on Aid Watch:

The state is, by definition, ‘uncapitalistic’, as it is, by definition, an infringement upon private property. If private property is compromised, then the possibility for the private ownership of capital goods must be at least as compromised as the institution of private property in general.

This is just wrong. As De Soto has shown, a functioning state bureaucracy is absolutely crucial for private property to take on any of the useful characteristics of ‘capital’. It represents a way of thinking about capitalism that seems lazy and insufficiently defined.

And on the left, there’s this (from the recent G20 protests in London):

A clearly thought out policy, based on a sound understanding of capitalism.

A clearly thought out policy, based on a sound understanding of capitalism.

Yes. Let’s return to barter. That’ll solve our problems.

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