What Defines Capitalism?

A major topic of debate among economists is whether Adam Smith was a proponent of capitalism. We argue that he was not, simply because his core ideas are very different from those of capitalism, which is merely mercantilism with slight or superficial changes. The source of the confusion is the unclear definition of the word ‘capitalism’. The most concise definition is:

An economic system based on the private ownership of capital to produce goods and services for profit.

Based on this defintion, can we conclusively answer if the following are capitalist?

  • A baker who grows his own wheat, employs a few assistants, and bakes his own bread to be sold for profit?
    • According to the definition, Yes.
  • A corporation that is unable to make any profits or just breaks even for a long time?
    • Yes, since the profit intention is there.
  • A holding company or shell company that produces nothing?
    • No, since nothing is produced.
  • A day trader who uses his own money to buy stocks in the morning and sell in the afternoon for profit?
    • No, since nothing is produced.
  • A long-term investor that uses his money to buy and hold stocks in a company that sells products  profitably?
    • Yes. All criteria are met.
  • A corporation that makes profits but gives it all back to society?
    • Yes because the motive was there, but no since the profits were lost.

Obviously, the above is not a clear definition of capitalism since we do not regard the bakers of 1,000 years ago as capitalists, and the shell companies of today as non-capitalists. To get a clear definition, we follow David Hume’s method of breaking down the compound idea of capitalism into its basic parts.

The five basic ideas in it are: private ownership, capital, production, goods & services, profit. We remove the capital, production, goods & services, as they are common to every economic system. How else can goods & services exist other than by production through capital? Thus, private ownership and profit remain as the noteworthy basic ideas possibly unique to capitalism.

PRIVATE OWNERSHIP?

Private ownership alone cannot be capitalism’s defining characteristic since feudal lands and even a whole country like North Korea can be said to be under private ownership of their ruling class, yet are still able to produce goods. This leaves us with profit or the profit motive as its possible defining characteristic. This is strengthened by the fact that the ruling class usually lives by rent or taxes and not by profits.

However, the problem with this is that the profit motive also defines mercantilism. Merchants in the 18th century lobbied for tariffs, exclusive privileges, and subsidies in order to get higher profits. Thus, those absurd regulations associated with mercantilism were merely the effects and the profit motive was the cause. They set up mercantile companies to profit from the production of tea and opium, just as Apple funded factories in China to produce iPhones, to take advantage of price differences. Then and now, this profiteering can only be done through big business organizations. In Book 5 of The Wealth of Nations, corporations or firms were known as joint stock companies which were big business organizations that ran on the same basic ideas:

Joint stock company (Book 5, Chap. 1) Corporation or firm
trade on a joint stock90, on a large capital100 trade on a common or preferred stock representing a large capital
each member shares in the common profit or loss in proportion to his share in this stock95 Stockholder’s liability is limited to his stock investment
Member can transfer shares, introduce new members without the company’s consent105 People can buy and transfer shares of publicly listed companies
Value of a share is always its market price and is different from the stated value105 Stock price can be different from the IPO price or par value
The joint stock company is always managed by a court of directors.107 The corporation is managed by executives under a CEO
The court of direcors is frequently subject to a court of proprietors. But most of those proprietors seldom pretend to understand the business of the company 107 The CEO is managed by a board of directors from various backgrounds

Mercantilism = Capitalism (Sort of)

This sameness of essence between capitalism and mercantilism is proven by the fact that the former’s producers and the latter’s merchants actually form a single sub-order of society which live or maintain their existence by profits:

“Merchants and master manufacturers are the two classes in this order who employ the largest capitals… Their thoughts and judgement commonly revolve around the interest of their own business, than around the interest of society.” (Simple Wealth of Nations, Book 1)

But different words exist only to express different ideas. Even if the basic idea of capitalism and mercantilism are the same, there must have been a secondary basic idea to differentiate their expression, otherwise, they could’ve been used interchangeably. To find this secondary idea, we retrace our steps back to private ownership to see if there is any difference in that idea, between them.

Outside Private Ownership

The main difference between mercantilism and capitalism is the prevalence of regulated companies (government-owned corporations) in the former and their lack in the latter. The most significant characteristic of regulated companies is their exclusivity.

“The object of most of the bylaws of all regulated companies and all other corporations, is not so much to oppress existing members. Its object is more to discourage others from becoming members… The directors of a regulated company, have no common capital to manage. They have no other fund to use for forts and garrisons other than the casual revenue from: the admission fines, the corporation duties”99 (Book 5)

Thus, in terms of the difference in private ownership in mercantilism and capitalism, the former limits private outside ownership in big, for-profit organizations (thus it has smaller capital) but the latter allows it too much (as equity or stocks leading to bigger capital). This looseness and freedom of ownership leads to big capital by allowing a lot of resources to be pooled. Thus, we say that ‘equity’ is the cause of a very obvious effect of big capital, which we speculate to have led to its naming as ‘capitalism’.

 

Let’s Compare our definition with the historical definition

Capitalism: Born Between 1800-1830

Capitalism’s birth in England and/or France can be narrowed down to after Smith’s death in 1790 to before 1830 when its idea was already written about, as explained by Marx:

Gustav von Gülich in his “Historical description of Commerce, Industry,”..in 1830, has examined at length the historical circumstances that prevented, in Germany, the development of the capitalist mode of production.. Thus the soil whence Political Economy springs was wanting. This “science” had to be imported from England and France as a ready-made article.. Since 1848 capitalist production has developed rapidly in Germany, and at the present time it is in the full bloom of speculation and swindling. (Marx, Capital, Preface)

James Mill was a friend of Jeremy Bentham, a liberal

James Mill (1773-1836), creator of modern capitalism, was a friend of Jeremy Bentham, a liberal

Incidentally, this period is also when JB Say, a French businessman and our proto-capitalist, published A Treatise on Political Economy (1803), which has all the basic ‘seed’ ideas for the current idea of capitalism. However, the single idea that sparked the growth or served as the genesis of the modern version of capitalism is the definition by James Mill in Elements of Political Economy (1821) as someone who owns the produce of the work of others, without actually working himself:

In this sense of the term “owners of labour,” the parties, concerned about production, are divided into two classes, that of capitalists, the rich men who supply the materials and instruments of production; and that of the workmen, who supply the labour. (Mill, Chap. 1, Sec. 2) 

Note that in this sense of capitalist can only apply if the workers are actually slaves:

“The great capitalist..if he operated with slaves instead of free labourers..would be regarded as owner both of the capital, and of the labour.”

However, Mill makes the hugely erroneous but not obvious assumption that the workers of today are equal to slaves:

“What is the difference, in the case of the man, who operates by means of labourers receiving wages? The labourer, who receives wages, sells his labour for a day, a week, a month, or a year.. The manufacturer, who pays these wages, buys the labour, for the day, the year.. He is equally therefore the owner of the labour, with the manufacturer who operates with slaves. The only difference is, in the mode of purchasing. The owner of the slave purchases, at once, the whole of the labour, which the man can ever perform: he, who pays wages, purchases only so much of a man’s labour as he can perform in a day, or any other stipulated time. Being equally, however, the owner of the labour, so purchased, as the owner of the slave is of that of the slave, the produce, which is the result of this labour, combined with his capital, is all equally his own. In the state of society, in which we at present exist, it is in these circumstances that almost all production is effected: the capitalist is the owner of both instruments of production: and the whole of the produce is his.” (I.2.19)

 

Karl_Marx

In Das Kapital, Marx (1818-1883) attacks the capitalist system that emerged from England and France

Thus, in modern or Mill’s capitalism, workers are actually slaves in essence, different from the capitalism of Turgot, Say, and Ricardo. Ask any employee if he feels like a slave to his boss nowadays and he will likely reply yes. So we can say this idea of Mill destroyed the socio-economic freedom espoused by Smith, which gave importance to wage earners, profit earners, and rent earners. This in turn became fuel for Marx, attacking James Mill’s ideas which were by then more fully developed by his son John Stuart Mill:

Men who still claimed some scientific standing and aspired to be something more than mere sophists and sycophants of the ruling classes tried to harmonise the Political Economy of capital with the claims..of the proletariat. Hence a shallow syncretism of which John Stuart Mill is the best representative. It is a declaration of bankruptcy by bourgeois economy.. which the great Russian scholar and critic, N. Tschernyschewsky (explains) in his Outlines of Political Economy according to Mill…

Under these circumstances its professors fell into two groups. The one set, prudent, practical business folk, flocked to the banner of Bastiat, the most superficial and therefore the most adequate representative of the apologetic of vulgar economy; the other, proud of the professorial dignity of their science, followed John Stuart Mill in his attempt to reconcile irreconcilables.* (Marx, Capital, Preface)

Note that 'reconciling irreconcilables' was also more recently done by Paul Samuelson in his 'neo-classical synthesis'.

 

However, Marx’ main description of capitalism as a system where resources are amassed through centralization for private gain is consistent with our definition of a system of pooling resources together through equity, or shares of stocks:

Capital grows in one place to a huge mass in a single hand, because it has in another place been lost by many. This is centralisation proper, as distinct from accumulation and concentration. ..accumulation..is a very slow process as compared with centralisation.. The world would still be without railroads, if it had been obliged to wait until accumulation.. enabled a few individual capitals to undertake the construction of a railroad. Centralisation, on the other hand, accomplished this by a turn of the hand through stock companies. (Marx, Capital, Preface)

Nowadays, almost anyone can own stocks and some people, like pensioners and insurance buyers, don’t even know that they are indirectly owning stocks, and are in effect getting a steady revenue from the work of others without working themselves. More obviously, the most common buzz in today’s business news are stock prices, proving the importance of equity to capitalism. Turn on CNBC and Bloomberg and you will see stock information everywhere.

fm50

Stocks and stock prices are inseparable from modern capitalism just as commodities and commodity prices were inseparable from mercantilism

 

Basic Definition of Capitalism

With these ideas of centralization, private gain, and the ownership of other people’s work, we can thus define capitalism very basically as an economic system that uses outside ownership to amass private profits. It is through the ownership of stock by people outside or unrelated to the company’s operations that they get rich through the accumulation of profits via retained earnings and rising stock prices. By simply making the right bet, a stock trader or investor can suddenly multiply his small money or nominal value into big money, or his weak command of other people’s labor into a more powerful command, with far less effort or labor himself. This is one of the main expedients that fuels inequality, as it allows people to feed off the work of others legally and is the root of economic injustice. When left unchecked, it destroys societies via bubbles (when people try to increase their nominal value way above the real value) which lead to recessions or depressions, best seen after 1929 when nominal value crashes back to its real value.

This definition distinguishes it from mercantilism and answers the earlier questions:

  • A baker who employs his own assistants and bakes his own bread for profit is not a capitalist.
  • The following are capitalist if there is outside equity and is for-profit:
    • A corporation that is unable to make any profits or just breaks even for a long time.
    • A holding company or shell company that produces nothing.
  • A day trader who uses his own money to buy stocks or commodities in the morning and sell it in the afternoon for profit is a merchant or speculator, not a capitalist.
  • A long-term investor who uses his money to buy and hold stocks in a company that sells products  profitably is a capitalist.
  • A corporation that makes profits but gives it all back to society is not capitalist.

The next task is to define outside equity, which will be discussed in future posts.

 


 

Edit 9/2015: Added Mill’s definition of capitalism as the origin of modern capitalism

Edit 11/2015: Added Marx’ attack on Mill

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