Capitalism means different things in different circles. It means something different in neoclassical economic theory than it does in Marxist economic theory, for example. Here, I consider it only in terms of neoclassical economics.
Let's say you have a piece of land. It's cleared, it's well-irrigated, and you're ready to farm. You reckon you can grow about five bushels of wheat, weather willing. You are the producer.
I have a granary. It's got a lot of dried wheat in it. I'm the capitalist.
The scenario that is familiar to us is that I come to you and I say, "I will give you three bushels of wheat for your whole crop." Now, on the face of it this seems exploitative. How can I think I can get five of your bushels for only spending three of the same good? This is the outrage that the early socialists pointed to as an indication of the fundamental unfairness of the capitalist system; the extra two bushels of wheat that I take from you are the "surplus value" that I, the capitalist, exploit from you, the simple farmer.
And yet, many people will quite possibly agree to the deal. They do so voluntarily, and they do it to improve their quality of life. How? Why?
Two reasons. First. You expect to grow five bushels. But nothing is certain. You have to make judgment calls about the right way to go about growing food, and you have to do so while remaining ignorant of certain factors that will affect your success, like the future weather. When you're trying to grow your own food, you bear the burden of your own speculations and expectations. A bad choice, or a choice that turns out to have been bad, threatens your ability to feed yourself at all. But I'm offering to guarantee to you three bushels. The only condition is that I get whatever you grow, however much that turns out to be. I take on the burden of speculation – a burden I can easily bear, because I have a big silo and I can feed myself fine throughout the year anyway, but which you can't bear. If you succeed in growing five bushels, then under the new agreement, you would have less than if you hadn't made the agreement; but, if you fail in growing five bushels, then under the new agreement, you do not suffer for that failure.
Under the old arrangement: If you grow five bushels, that's pure profit for you, and I lose nothing. If you fail to grow five bushels, then the loss is your life. Under the new arrangement: If you grow five bushels, you still get to have three bushels; my profit is two bushels. If you fail to grow five bushels, then the loss is merely my three bushels; you still get to eat.
Second. You have land; you don't have grain to eat yet. You won't have grain until it grows. It won't grow until fall. But you have to eat in the meantime. Getting three bushels now means you'll eat quite well for the whole year – not as good in the winter as you would have with five bushels of your own, but quite a bit better than you would be while waiting for your crops to grow. You prefer some now to more later. The difference, the "surplus value," reflects our interest – the ratio by which present goods are valued over future goods. In our present case, if we assume that you grow five bushels, the interest on my capital gains will turn out to be 67% (two extra bushels later on top of the three now, or 2/3). It's a high interest rate, sure, but it's probably still a much better offer than trying to grow your food on your own, without any support at all.
There are circumstances under which you might want to agree to an interest rate instead of an all-or-nothing exchange. Under the all-or-nothing arrangement, then if you grow more than five bushels, you don't get to keep them. On the other hand, if you grow less than three bushels, then I've taken a loss. Since either circumstance would be undesirable to one or the other of us, we might agree to a different arrangement that goes like this: we might agree to a certain rate of interest (eg. premium plus 33%, or four bushels), and any gains you make above your debt are yours to keep. That's a way for both of us to hedge our bets a little bit. It solves the time preference problem, but it requires a certain amount of confidence with respect to the speculative burden problem.
Now, the important thing to note about these kinds of capitalist arrangements is that they are voluntary on the part of both parties. We only strike an agreement together when both of us believes that the outcome leaves us in a better position with respect to the uncertain future. If either of us feels that this is not the case, then we can't make any voluntary arrangement. Now, some people think that this is still unfair. My advantaged position, they may say, gives me "economic power" over you, because you have to agree to whatever I offer you, under pain of death. I'm responsible for your circumstance insofar as I have grain that I can withhold from you. This is true, in a way. Now, an alternative situation would be if I am forced to give you a bushel that I grew or acquired through voluntary trade, without you having to offer me anything in return; and it's not clear to me that that situation is fair either. In any event, economics is not ethics. It doesn't have anything to say about the relative fairness or unfairness of different arrangements. What it does say is that, although a voluntary capitalist arrangement doesn't offer unconditional gain to either party (you don't get to take any bushels from me without offering me something back; and I don't get to take any of yours without offering you something back), nevertheless the deal is still beneficial to both parties, according to their own respective assessments at the time of the deal.
In any event, the kind of arrangement we're talking about might still be quite a good deal, even if you have bushels of your own and can eat alright without my capital. Let's say you have one bushel of grain now, and expect to grow five. You can survive until harvest on your one bushel. I offer you three bushels, in exchange for your five. Now, even though you're not desperate to eat like you were in the last example, you still might consider it a good deal. You could eat before, but now you an eat better, or you can save some grain for a bad year.
Now, let's apply this situation to the industrial mode of subsistence. Everything I've already laid out is enough to show the kinds of circumstances in which a wage system is beneficial to the worker as well as the employer. But even under an anarchistic socialist system where workers own their factories, you still might have capitalist arrangements spring up spontaneously. Let's say that you are the elected spokesperson for a syndicate of workers who jointly own a factory. You can produce whatever you want (let's say it's a widget factory), and you can keep and divide amongst yourselves whatever revenue you generate from selling the widgets in the end. You have the factory floorspace, you have the capital goods (the machinery), you have the raw resources that will be combined to make the widgets, and you have your own sweat and your own brains. You have everything you need to make the widgets. Me, on the other hand, I represent a capitalist. With quite a bit of money, let's say. Maybe I'm another worker-owned factory, which has been more successful and has some profit revenue to invest. Or maybe I'm a private individual.
You are free, in your jointly-owned factory, to make and sell your widgets for the people on the market. You are your own bosses. But.
First, you do not know how well your widgets will sell. You can guess, but it's a guess. It might be a good guess; it might not be so good.
Second, you get nothing, not one red cent, until you actually sell a widget. That means you have to produce the widget, alert potential customers to the existence and quality of your widget, make the widget available, and put the widget in the customer's hands before you get any money whatsoever. Depending on the specifics of your product and the demand for widgets on the market, you might have to wait a very long time indeed. In a modern economy, especially in the manufacture of machinery or other production goods (whose revenue can only accrue on the basis of a value imputed by the sale of the final consumer good), it could be a matter of years.
Now I come to you, and I say I'll make sure all of you eat okay, have adequate places to live, etc. etc., if you give me all the widgets you make (or a certain proportion of widgets you make, etc., depending on some of the considerations I suggested above).
Even though you're free workers, owners of the factory and owners of the full product of your labor, this might look like an okay deal.
A complication. If I'm the one with the "economic power" in this situation, then what is my incentive to give you enough to eat well, to live well, and to have a standard of living above the most meagre existence? Why should I give you any more than what it takes to keep you just barely alive and able to make widgets?
Two factors. First, you won't agree to a standard of living lower than the one you'd already lead while waiting to sell the full product of your labor. In fact, you will always want at least a little better than that. If you have any savings whatsoever, if you can accommodate yourself in any level of comfort at all, however mean, I would have to offer you something at least a little better than that for you to agree to my deal. It'll never be as much as the revenue I expect off the widgets, but it'll have to be at least a little bit better than your own standard of living, however high or low that is. Otherwise you could just go ahead and be your own capitalist.
Second, I am probably not the only rich guy around. There are other people with their eyes on your widgets, and they'll be willing to make offers just like me. We are competing to employ you. Any offer I make has to be at least a little bit better than any other offer anybody else makes. Again, it'll never be quite as much as you'd get selling the widgets yourself later – because then why would we bother offering you anything? In fact, the amount we offer will never even be as much as we could get on any other investment on the market, discounted by the interest rate for that particular investment. However, my offer will always have to be a little bit better than anyone else's, all things considered (salary, availability, perqs, etc.), if I expect you to take it. We'll be trying to out-bid one another, because we want those widgets. We want them bad.
A tendency therefore prevails for the venture capital that we forward to you (the money we give you now) to be significantly better than you could do on your own in the meantime, and not significantly worse than what you'd get in the end anyway. What's more, the benefit you get from this second factor (the competing capitalists) will help you accrue some savings, which will spur on the first factor (capitalists bidding up your standard of living).
That's capitalism.
I shouldn't need to mention that in either of these cases, and in almost all economic scenarios in general, when predictions about the future are basically accurate then there is more by the end than there was in the beginning – more wheat, and more widgets. There is more to go around in the end than there was before. Neither party suffers a diminution of their standard of living; both parties improve their situation. It's easy to forget this when we think of wealth as being something that is "pushed around," "circulated," or "attracted," instead of being something that is produced, and distributed by the very arrangement that produces it.
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