What is Capitalism?

 A friend emailed me this morning to inform me that the Stanford Encyclopaedia has entries for socialism, colonialism, and exploitation, but nothing for capitalism. This is funny because economists often complain that sociologists and other disciplines that focus on things like colonialism throw around the word "capitalism" without ever really defining or explaining its causal levers. My friend and I eventually tracked down a definition in the encylopaedia entry for "markets": The concept of “capitalism” includes a reference to markets, but as a socio-economic system, it is broader; its defining feature is the private ownership of capital (see e.g., Scott 2011). This seems a very thin definition to me (though not erroneous). In this blog I want to offer a different one: capitalism as a socio-economic system is defined by the prioritisation of returns to capital over other means of production, notably land and labour. 

Defining capitalism as merely the private ownership of capital tells you little about capitalism, notably what drives socio-economic and especially political behaviour under capitalism, and provides a shallow foundation upon which to mount the classic critiques of capitalism. It also makes capitalism too shiny. If you read and agree with Acemoglu and Robinson's (and North and others') work on the history of economic liberalism (Why Nations Fail and The Narrow Corridor) you likely believe that the advent of private property rights backed by the rule of law was perhaps the single most emancipatory institutional change in human history. If you then define capitalism as private property, it seems to make capitalism lovely by tautology. I am quite fond of capitalism relative to other systems that have actually existed, but this is going too far. 

So what's an alternative definition? It is worth revisiting the classic definition in Marx. He defined socio-economic systems in terms of who controls the means of production. In his thinking, feudalism is defined by the primary means of production being land, and this land being controlled by a hereditary aristocracy. Capitalism involved both a shift in the primary means of production from land to capital (machines and money) and a shift in the control of those means from hereditary aristocracy to the merchant class. Communism would be the next phase of socioeconomic change and would involve the workers taking over the (capital) means of ownership, thereby creating "collective" ownership of the means of production. 

While plenty of people still believe the Marxist notion that capital does not contribute to production (it is the workers who do everything and therefore 100% of production is about labour), prevailing orthodoxy in economics strongly disagrees with this proposition. In economics, we tend to think of output as a function of many different inputs, which can be grouped into different means (or "factors") of production. The big ones are labour and capital, but you can also add land, genius, collective culture, and a host of other factors. Furthermore, economics tends to think of efficient pricing of the means of production in terms of whether labour and capital are paid their marginal products in the form of wages and rents, respectively. Your marginal product is what you contribute to final output. So for example, if I have 1 unit of capital but nobody to work it, the capital produces 0. If I add a worker, then we get 10 units. The marginal product of the worker is 10. If I then add a second unit of capital, perhaps total output increase by 5. The marginal product of capital is then 5. Say I now add a second worker and output rises again by 5. One could approximate the marginal product of labour and capital at 5 in this case, and rent and wage should thus be 5 to efficiently attract labour and capital to producing this particular good. 

Note that rents have two meanings. In the paragraph above, rents are wages paid to capital. But rents also refer to "unearned income". The classic case is rent paid to land in feudalism. Aristocrats inherited the land through no effort of their own, just luck, and then extracted rents from serfs who worked on that land but had no political power (and because of a lack of armour and weapons, little physical power either). Rents in the form of unearned income are a critical component of the history of political-economy, and of my proposed definition of capitalism. It seems to me that most critiques of capitalism, including that of Marx, stem from concerns about extraction: the taking of marginal product from one means of production and giving it, unearned, to the owners of some other means of production. In feudalism, the marginal product of labour is transferred to the owners of land. In capitalism, the marginal product of labour is transferred to the owners of capital. 

This leads to the definition: capitalism is a social, political, and economic system that prioritises returns to capital over other factors of production. 

"Prioritise" is left largely value neutral, but is typically negatively connoted. Consider some examples. In China, returns to capital depend on access to bank credit, which is controlled by the CCP through state-ownership of the banks. In America, returns to capital are increased artificially through privileged access on the part of corporations and other owners of capital to the political process (e.g. lobbying, but also just by way of government consultation with major stakeholders). In almost all capitalist countries, labour power is systematically reduced, notably by banning unions (in China) or severely curtailing their actions (USA). If you hadn't guessed already, I consider China to be highly capitalistic. Indeed, it is perhaps a paradigm case of a capitalist nation. This is partially very sensible: development economists will tell you that in order to spur economic growth in very high risk underdeveloped environments, you have to all but guarantee high returns to capital to encourage capitalists to risk their assets in investment. The tricky point is the transition from this early hyper-capitalist mode to a more competitive system around middle income. Many countries fail in this transition (I would bet huge amounts that China will fail) and get stuck in what is called the Middle Income Trap. 

My definition of capitalism puts front and centre the extractive quality of capitalism, which is what defines the "bad" in capitalism and points to the superiority, at least at this advanced stage of our development, of post-capitalist "market socialist" states (as we describe in our book on Hybrid Policy Designs). The extractive aspects of capitalism can be tolerated to spur economic development; they are superior to temporally parallel systems like autocracy, and systems that are superior to capitalism overall are largely unfeasible at low levels of development (like early 20th century America). For example, you cannot have a system of unemployment insurance, or even sophisticated public health, until you have a competent bureaucracy and electronic welfare tracking (which requires a fairly advanced financial sector and a highly banked population i.e. everyone has bank accounts).      

All socio-economic and political systems to date have been coopted (or indeed designed) to some extent by powerful interests in order to extract rents. Despotic rulers extract rents through conquest. Theocracies through cultural cache. Feudal lords through serfdom. Capitalists through bailouts, union suppression, patent law, lobbying, and other means. What's unique about capitalism is that the extraction, the rentierism, serves the owners of capital at the expense of other means of production (such as physical force, cultural cache, or artistic genius).

Defining capitalism in terms of returns to capital allows you to explain why America, China, and Turkey are more "capitalistic" than say, Denmark. A larger share of the total value of output is captured in capitalist countries by the capital owning class. The more capitalistic, the larger this share. Market-socialist countries get closer to splitting the value of output according to the marginal product of the means of production that went into its production. A corollary point is that defining "capitalism" in this way opens a conceptualise space in which to advocate for a superior future society, namely market socialism. Such a system adopts the attractive qualities of capitalism like markets and private property while dispensing with the bad, like monopoly, lobbying, etc. 

The definition also speaks to the essence of most of the major critiques of capitalism. Communism believes that we need collective ownership of the capital aspect of production so that rents are not extracted by capitalists but instead distributed to "the workers" (which is presumably a proxy for all citizens). Left-anarchism argues that all private property is bad because it inevitably leads to extractive regimes. Cultural theorists argue that private property in a capitalistic context is dehumanising because it leads to all individuals being defined in terms of their productive capacity. Sustainability types argue that capitalism over values market goods and undervalues unpriced items like the environment, care, work-life balance etc. This is because only market goods have a return on equity i.e. only they create value for capitalists.