“Capitalism – A Treatise on Economics” by George Reisman – A Review

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It is not often that the present author is moved to review any particular publication by a specific author, let alone one that was published nearly twenty years ago. However, Capitalism by George Reisman, at more than one thousand pages long, is the first major treatise that is at least related to the “Austrian” tradition since the publication of Murray N Rothbard’s Man, Economy and State in 1962.

Although Reisman is a contemporary of Rothbard and a fellow student of Ludwig von Mises, Reisman’s approach to economics is markedly different from either. Indeed, armed solely with knowledge of his pedigree one might be forgiven for wondering why more attention has not been directed towards to Reisman’s work from within “Austrian” circles. It is only after having read this treatise that one can see why. Although Reisman claims that Mises is his primary intellectual influence, there is very little of this treatise that could be regarded as distinctly Misesian. Rather, Reisman’s direct influences are the classical economists (especially Smith, Ricardo and J S Mill, upon whom he relies for support to an extent far beyond his reliance upon Mises) and Ayn Rand. Reisman specifically rejects the categorisation of economics as the science of human action, and prefers, instead, to regard it as “the science that studies the production of wealth under the division of labour”. He therefore willingly abandons any analysis of individual values, means, ends, and choices, and restores economic theory to the study of holistic aggregates; indeed we might say that his definition of economics, which views wealth as an entity possessing some kind of objectively determinable magnitude, demands such a restriction. Reisman positions the businessman, rather than the consumer, as the centre of the economic system, stating that consumers (as a whole) are largely dependent upon businessmen (as a whole) rather than vice versa. While, according to Reisman, consumers provide the direction of economic activity (i.e. the precise direction of resources to fulfilling specific industries), businessmen and capitalists are responsible for its extent, i.e. the limits of saving and capital investment. In other words, it is the decisions of capitalists that determine the extent of “economic progress” (a term Reisman prefers to “economic growth”) rather than those of consumers. A corollary of this is that production and producers are reinstated as the keystones of economic activity rather than consumption and consumers (there is at least an implication in parts of the treatise that production is good and proper whereas consumption is bad and wasteful, although this is much muted compared to the same in Reisman’s classical influences). Furthermore, it is clear that Reisman does not regard his approach to economics as a wertfrei science and, instead, believes his economic theory to be a rigorous promoter and defender of the capitalist system – an attitude that cannot be avoided by his definition of economics as the study of the accumulation of wealth under the division of labour, a division that he says is only possible under private ownership of the means of production. Thus, in Reisman’s world, a discussion of economics is a discussion of capitalism which, presumably, explains the book’s title.

What can we say about Reisman’s approach? Without beating about the bush we must state at the outset that Reisman, who is thoroughly acquainted with “Austrian” economics, has jettisoned a tremendous degree of sound theoretical understanding from the science. Although Reisman, who self-identifies as an “Austro-classical” economist, endeavours to restore to economics many of the (in his opinion) sound doctrines of the classical economists that were allegedly rejected following the discovery of the law of marginal utility and the backlash against Marxism, we must conclude that the result is something of a retrogression rather than a synthesis of two, hitherto quite disparate, schools of thought. In Reisman’s world, the achievement of all ends and their associated costs never advance deeper than the objective measurement of exchanges for money. He never advances any exposition of individual ends and subjective costs (indeed, he explicitly rejects the doctrine of opportunity cost). Hence the entire purpose of the economic system as serving the needs of individuals and the types of decisions that individuals must make in order to achieve these ends is missing, subsumed by the supposedly limitless need of man as a whole to accumulate “wealth” in perpetuity. In other words, Reisman’s restoration of the primacy of the production of “wealth” overlooks the fact that all production is ultimately aimed at providing for consumers and that it is the ends of consumers to which the economic system is geared. It is perfectly consistent to state, as does the wertfrei “Austrian” school, that the purpose of all economic endeavour is to provide for consumption while on the other hand remaining firm that the means of achieving this consumption can only be served by increased production. Therefore, while we can hold that the desire for consumption is the ultimate cause of economic progress, we can also state that production is the proximate cause. Thus, while Reisman’s categorisation of economic theories under the headings of either “productionism” or “consumptionism” – the former of which involves the promotion and encouragement of increased production as the means towards economic progress, the latter the promotion and encouragement of increased consumption – provides an instant and convincing cognitive aid, it obscures the clarity afforded by this insight of the “Austrian” school.

Furthermore, Reisman’s repositioning of the capitalist/businessman as the driver of economic progress relies upon capitalists providing the bulk of investment funds, i.e. that it is the consumption/saving decisions primarily of businessmen that determines the extent of economic progress. He argues that the wages of labourers do not provide a significant source of investment funds and are usually consumed either immediately or are saved in order to purchase durable consumer goods such as housing or automobiles. Any investment saving that labourers do happen to undertake is likely to be wholly disinvested at retirement, thus netting out the saving of younger generations. However, there is no reason for Reisman to think that this this must be the case. It is just as possible for investment funds to come from the savings of everyday individuals that are then lent to businessmen for them to deploy in their enterprises via a conduit such as bank savings accounts (and such a view would greatly undermine any opinion that capitalism keeps the masses in servitude as wage labour). The distinctive role of the businessman is that he provides entrepreneurial talent in order to generate economic progress by directing those saved funds to where they are most urgently desired by consumers. Yet Reisman’s treatise lacks any extensive theory of entrepreneurship and only passively recognises the need for superior decision-making in order to fulfil the ends of consumers. This lacuna in Reisman’s theory means that in order to position the businessman as the driver of economic progress he has to paint him as the primary provider of investment funds. This contrasts greatly with Reisman’s mentor, Mises, who makes entrepreneurship a hallmark of Human Action, thus giving us an insight into the economic significance of the businessman that extends far beyond the fact that he simply didn’t consume his wealth. (Some of Reisman’s views on what determines an individual’s consumption/investment preferences, which inform his theory here, are also incorrect and we will explore these below). In any case, however, Reisman seems to support his theory through a blurring of economic categories, such as labourers, consumers, capitalists, etc. (something which, irritatingly, is done all too frequently). In reality, all individual people in the economy participate in different categories at different times – a man is clearly a labourer when he goes to work, a consumer when he spends his wages in the shops, and a saver when he buys a corporate bond. However, when we are discussing, for the purposes of conceptual clarity, the roles of individuals in these economic categories, we isolate those specific roles from other categories and thus we always talk of labourers qua labourers and consumers qua consumers, etc. So even if it may happen be true that the particular people who are businessmen are responsible for the greater part of saving and investment, businessmen are consumers too and considering them as consumers qua consumers it is their decision to refuse to consume their wealth today in favour of accumulating greater wealth for consumption tomorrow that provides the source of investment funds. It is therefore true to state that it is the choices of consumers who determine both the direction and extent of economic progress. Moreover, as Mises also recognises, any consumer who is currently a wage earner can transform himself into a businessman, entrepreneur or capitalist by saving and investing his wages (while, equally and oppositely of course, any businessman who decides to consume his fortune may end up as a wage earner).

Finally, it is one thing to state that the preoccupation of the economic activity of any one (or even most) individuals may be with the accumulation and augmentation of their own wealth. But it does not follow from this that the science of economics itself concerns the accumulation of wealth. Animals preoccupy themselves with the need to attain food and shelter but this does not mean that the focus of zoology is with the achievement of these things.

Examining Reisman’s treatise on its own, non-wertfrei terms as a rigorous defence of the capitalist system, much of its earlier part is a detailed offence against the fallacies of socialism, collectivism, interventionism and environmentalism (and later, Keynesianism and inflationism). These devastating, if often heavy handed, critiques are likely to be viewed as by Austro-libertarians as Reisman’s greatest achievement in this work, even if some of it was previously published as The Government Against the Economy. A specific and lengthy chapter is possibly the most passionate assault against the ecology movement, a chapter that could easily be expanded and published as a separate treatise (Reisman’s stress of the anti-human zeal of environmentalism resonates with that of environmentalists, such as former Greenpeace Canada President Patrick Moore, who have become disillusioned with the movement). Reisman’s explanation of various forms of government intervention, such as price fixing, with reference to specific notable examples such as the oil recession of the 1970s, in which he traces out all of the effects (and effects of alternatives to) government meddling have rarely been matched. Yet much of the remainder of Reisman’s exposition does not in fact read as a promotion or a defence of the capitalist system; rather it is more akin to an aggregative, accountancy-laden explanation of what the capitalist system does, much like a description of some giant machine that swallows up inputs measured in numbers and churns out some kind of output, also measured in numbers. Reisman categorises an endeavour as productive according to its ability to earn money voluntarily through exchange. Hence all government functions, relying upon taxation, must necessarily be classified as consumption and not production. In other words, government can never produce and must always be a leech on the genuinely productive, capitalist system. Moreover, his excellent critique of socialism recognises that socialism must entail tyranny and a replacement of the ends sought by individuals with the ends sought by leaders. However, Reisman’s aggregative, accountancy approach never builds upon this insight. In the depths of the latter half of the treatise one almost forgets any connection between these accounting entries and how the capitalist economy serves the needs of individual people. One of Reisman’s stated aims in the treatise is to show how a proper understanding of the capitalist system should prevent one from feeling any kind of “alienation” from or subjugation by the capitalist system – something which Reisman comes closest to achieving through his analysis of the division of labour. Yet in the main it would appear that the Mises-Rothbard approach of detailing the economy as a network of bilateral, voluntary exchanges between individual people striving to meet their own needs through voluntary co-operation (and how these disparate and often conflicting goals and purposes nevertheless mesh into a harmonious, productive society) is much more conducive to achieving this than is Reisman’s aggregative, accountancy method. While it is true that the ability of capitalism to manifestly increase the standard of living and the degree of material wealth lends it a tremendous amount of moral weight, we can suggest here without too much elaboration that any rigorous defence of capitalism and, moreover, freedom can proceed only by focussing on the primacy of the needs of each individual person, not all of which can be measured or attained though objectively viewable exchanges for money. This omission in Reisman’s work also weakens the distinctly economic flavour of this treatise, as individual choices, desires, wants, decisions and actions do not seem to matter.

Turning now to some of Reisman’s theoretical contributions to the science of economics, there are two that stand out in particular. The first is his attempted demolition of the “conceptual framework” of the Marxist exploitation theory by asserting the primacy of profit rather than of wages. In Reisman’s view, critics of Marxism, including Böhm-Bawerk, have accepted the categorisation, originating with Adam Smith, of profits paid to capitalists as deductions from wages, and have sought explanations in order to justify this deduction. Reisman, however, asserts that wages, paid to labourers, are, in fact, a deduction from profits. If profits are calculated by subtracting business costs from business revenue, it is clear that if a person undertakes an enterprise to achieve, say, 100 units of revenue then every monetary outlay he expends in order to achieve that 100 units of revenue must count as a deduction from it. The fewer costs he has the more profit he is left with. Thus it is profits that represent the primary economic income, not wages. It is conceivable for the economic system to have profits but not wages in the event that every individual person operated as a sole trader and employed no other individuals. If, however, a businessman hires labourers to assist in his enterprise, the wages he must pay to these workers for their assistance are deducted from the ultimate sales revenues. Therefore, according to Reisman, wages only appear in the economic system on account of the help that other people provide to a businessman’s enterprise, and their help stakes a claim on his revenue. Thus it is wages that are deducted from profits, not vice-versa.

Whatever the merits of this view we must conclude that, to the dyed-in-the-wool Marxist, it is likely to be beside the point. The source of contention in the exploitation theory is that the businessman doesn’t do anything and simply leeches off the productivity of the worker; in other words by hiring labourers the businessman simply abdicates any participation in the act of production yet still gains an income. Reisman himself provides the answer to this by pointing out that labour is not the only source of productivity in a division-of-labour society and that it is, in fact, decision making, risk-taking, management and oversight that are also essential – in other words, entrepreneurship. And yet, as we noted, any extensive treatment of entrepreneurship is precisely what is missing from Reisman’s theory. Therefore, it must be submitted that an understanding of entrepreneurial profit and loss and the insulation of the labourer from business risk coupled with the time preference theory of interest provides a more effective demolition of Marxism than the primacy of profit theory which, if correct, provides only additional ammunition for it.

This brings us to Reisman’s next theoretical contribution which is his net-consumption/net-investment theory of aggregate profits, profits which he tries to explain in an environment of an unchanging supply and flow of money. The attempt to explain profit in terms of physical goods is relatively straightforward. Goods, of course, can increase or decrease and thus there can be absolutely more (profits) or fewer (losses) of them across society as a whole. We can also understand clearly, across the time structure of production, how the consumption of a smaller quantity of physical goods can be foregone today in order to produce a larger quantity of goods tomorrow. This is not so when it comes to accounting for profits and losses in terms of money which is assumed to be fixed in supply and flow. For every transfer of money that represents a credit to ones businessman’s income must show up as a corresponding debit to another businessman’s costs. Hence, while some individual businesses would earn profits and others would suffer losses, all profits and losses across the economy as a whole would net out and hence any question of aggregate profit would be impossible. The only method of solving this conundrum is to somehow, on the societal balance sheet, create a credit entry to income/equity without a corresponding debit entry to costs. It is the explanation of how this is possible that Reisman sets out to achieve.

The first element of aggregate profits – “net consumption” – derives from the fact that business revenues from consumption spending by labourers (and, as we noted, Reisman categorises all spending by labourers as consumption spending) shows up also as a business cost in the form of wage payments. Therefore, revenue and cost cancel each other out on the societal income statement. Similarly, business to business spending will be counted as both an equal and opposite revenue and cost and will net to zero. However, “the payment of dividends by corporations, the draw of funds by partners and proprietors from their firms, and the payment of interest by business firms” (which Reisman regards as “transfers”) to business owners, which provide the latter with a source of consumption spending, does not show up as a business cost yet does, once spent, show up as a business revenue. Thus the rate of profit is determined solely by the desire of the capitalists to consume. This element of profit has, Reisman claims, the ability of providing continued aggregate profits in an environment of unchanging money. For example, if the volume of spending is 1000 units of money each period, business costs could be 900 while business revenues could be 1000 and profits 100 in each and every period. (Reisman uses similar reasoning to explain how the rate of profit is increased by taxation as all taxation is consumption spending). The second element, “net investment”, derives from the fact that business spending on assets to produce business revenue are capitalised as assets and only later depreciated incrementally as a business cost. Thus, in an environment where the volume of spending is the same, business revenue exceeds business cost. For example, if 100 units of money are expended on capital assets, 800 units are spent on business costs, and there are 1000 units of business revenue, profits would be 200 as the 100 units spend on capital assets are not charged as a cost. Reisman believes that net investment provides a finite outlet for aggregate profit because, eventually, depreciation charges from assets previously capitalised will equal the value of new assets capitalised. For example, if 100 units of monetary spending on assets per year are capitalised and then depreciated at an uncompounded, annual rate of 10%, depreciation charges will be 10 units in year one, 20 units in year two, 30 units in year three, and so on until, in year 10, depreciation charges will exactly equal the 100 units of additional investment and so net-investment will provide no source of aggregate profit in that year. Thus, Reisman believes, only net consumption is capable of providing continuous, aggregate profits period after period. Net consumption and net investment are, however, joined at the hip. Reduced net consumption provides increasing funds for net investment to be capitalised on the balance sheet and charged as business costs only at increasingly remote points in the future.

What can we say about this theory? It should not be surprising to “Austrians” that Reisman’s theory is based upon net-consumption and net-investment as it those elements that are determined by the “Austrian” theory of time preference, which affects the rate of interest. (What Reisman refers to as “profit” is what most “Austrians” would refer to as “interest” – Reisman offers no explicit distinction between entrepreneurial profit and loss on the one hand and what “Austrians” would regard as interest on the other). Yet Reisman regards his theory as standing in opposition to the time preference theory and, moreover, the older productivity theory of interest. However, Reisman’s approach, characterised as simply a description of accountancy practices and the summation of money flows, does not challenge the time preference theory at all. The primary question of profit and interest that is answered by this latter theory is why do businessmen not impute the full value of the final product to the factors of production. In other words, why, even after businessmen are compensated for their managerial or oversight activities as a factor of production, is there always a further residual surplus that is not eliminated by competitive bidding amongst entrepreneurs? Why is there, to use Reisman’s terminology, a “going rate of profit” at all? The net-consumption/net-investment theory, while explaining that rises in net consumption will increase the rate of profit while reductions in them will lower it, only really explains how, from an accounting point of view, profits are possible. Reisman offers no extended treatment of the motivations of capitalists in paying (and of labourers in accepting) a sum lower than the total of business revenues and thus it is difficult to regard this as a distinctly economic theory. A more convincing explanation of his theory would detail how, with decreasing time preference, more funds are advanced to factors of production yielding revenue in the future, thus diminishing net consumption and the rate of profit, while these expenditures will be capitalised at increasingly higher amounts, depending on the time period when they come to fruition, relative to the ultimate business revenue that is earned. Thus Reisman’s accountancy-laden approach would, in this way, be fully reconciled with the “Austrian” approach to profit, or, rather, to what “Austrians” would call interest.

When Reisman does address the motivations that determine net-consumption and net-investment he does so erroneously. Reisman defines time preference as the determinant of “the proportions in which people devote their income and wealth to present consumption versus provision for the future.” It is Reisman’s link between this posited desire to provide for the future and net-investment that causes him to declare that net investment can provide only a limited contribution to net profit. To quote: “As capital and savings accumulate relative to income, the need and desire of people to increase their accumulated capital and savings still further relative to their income diminishes, while their desire to consume their income correspondingly increases”. In other words, the more saving and capital people possess the more they have provided for the future and thus productive expenditure will fall and consumption will rise, choking off net investment in the form of further additions to the asset side of the balance sheet. Thus depreciation charges begin to equalise new investments and aggregate profits from net-investment begin to fall. This view, however, is mistaken. Time preference has nothing to do with the desire of people to provide for the future. The need to provide for the future is always a present end just like any other and could be achieved by plain saving rather than investment. Time preference, rather, is the rate at which individuals prefer a larger quantity of goods available at some point in the future ahead of a smaller quantity of goods available today. It is perfectly possible for people to continue to invest sums of capital that will not produce consumer goods for well after they are deceased. Indeed, this is precisely why people have inheritances to bequeath. Many of the buildings, factories and infrastructure we have today were created not in our own lifetimes but were handed down to us from past generations. And it is further possible that capital accumulation and technological progress, which Reisman himself stresses enhances the ability to produce capital goods, will enable the production of capital goods that last further and further into the future. People would not even need to create capital goods that last so long with the purpose that they do so – in other words they could be perfectly limited in their own time horizons and yet still produce capital goods that yield a product well after the elapse of this time horizon. Let’s say, for example, that the current rate of time preference means that the produce from all assets appearing after thirty years hence is fully discounted to zero. In other words, only what the assets can produce in the next thirty years is valuable to present persons. If a capital good was created that could yield produce for sixty years, after the elapse of each year, another year’s discounted produce would be capitalised as this year is drawn into the thirty year time horizon. Therefore, such assets will provide a continued source of credits to business equity (and, thus, profits) without corresponding business costs. This is precisely the case with some of the most valuable patches of urban land which, for all intents and purposes, will go on producing well beyond the lifetimes and time horizons of any living person. Thus there is no reason for net-investment to be so limited in its contribution to aggregate profits in the environment of unchanging money. Moreover, we can see in this way how accumulating, aggregate profits that are capitalised for longer and longer periods is the hallmark of an economically progressing society – one where more and more capital is invested for longer – while the opposite, aggregate losses, represents retrogression through capital consumption.

Finally, as we noted above, there is no reason to discount saving by labourers a source of investment funds. This would divert spending from business revenue as the funds would be lent to businesses who would then spend it on “productive expenditure”. Without any corresponding business revenue the rate of profit would fall. (Thus we can see why increased funds that are made available for lending must be made at increasingly lower rates of interest).

There are one or two further disagreements we can cite here. First, “Austrian” business cycle theory, the jewel in the crown of “Austrianism”, is never explained at length and instead takes its place in a wider treatment of the effects of inflation. Second, his treatment of neoclassical price theory is too aggregative and does not explain how individual bidders and suppliers bring about a harmony between the quantity demanded and the quantity supplied. Third, as in his critique of the time preference theory of interest, Reisman often perceives differences or disagreements where there are none, such as that alleged between his productivity theory of wages and the marginal productivity theory of wages, the latter of which he describes incorrectly. And finally, in spite of having been the translator of Mises’ Epistemological Problems of Economics, Reisman has little to say concerning method – something which perhaps descends from his rejection of economics as the science of human action, which underpins Mises’ methodological dualism that divides economics from the natural sciences.

Overall, therefore, the question of whether Reisman’s approach to economics has successfully synthesised the “Austrian” and classical schools, and, moreover provided a progressive outlook for the science of economics must, regrettably, be answered in the negative. Rather, Reisman’s positive economic theory in this treatise comes across more as a restatement and re-polishing of classical economics (with some corrections to that school of thought), peppered with insights from neoclassicism and the “Austrian” school. Reisman’s rejection of the primacy of human action as the subject matter of economics has been at the expense of not only losing a great deal of theoretical understanding in the wertfrei science that this affords, but also weakening any positive promotion for capitalism and freedom.

Nevertheless, while this review has been mainly been critical of Reisman’s positive economic theory, we must end by celebrating the fact that our author has, in this treatise, many great things to say concerning socialism, environmentalism, interventionism, inflationism, Keynesianism and all other manner of false doctrines rejected by “Austrians” and libertarians alike. What Reisman has put to paper here are among the finest critical analyses of these areas ever written and, even if one cannot agree with Reisman’s specific, economic outlook, these contributions alone place Reisman in the top rank of economists whose work should be studied avidly.

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Economic Myths #8 – Capitalism is Exploitative

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The myth that capitalism is exploitative – or rather, that capitalists, the private owners of the means of production, and entrepreneurs – exploit both workers and consumers is as old as the history of this political-economic system itself and has been a primary driving force behind the growth of the state and, indeed, of outright socialist and communist revolution. Although much watered down from those early days, the idea that there is some kind of antagonism between the capitalist “class” and the rest of us persists.

As “Austrian” economists we know, of course, that it is absolutely and undeniably true that any free and voluntary exchange, upon which capitalism and private property must rely, only takes place because each party expects to benefit from the transaction. This alone is sufficient scientific proof to dismiss any idea that capitalism exploits one party for the benefit of another. Nevertheless we should, of course, tackle directly the specific incarnations of this myth as they appear today.

The myth has its roots in the Marxian confusion of political castes with economic classes – the idea that the relationship between capitalists and workers, which is free and voluntary, was akin to that of king and subject, or landed aristocracy and peasant – relationships that were involuntary and subjected the masses to servitude. Caste systems were static and designed to keep people in their place; under conditions of free exchange, however, economic classes have a continually changing membership based upon one’s ability to serve consumers. This ability varies from person to person, of course, but nobody is legally prevented from becoming an entrepreneur and nobody, once they are a successful entrepreneur, has their wealth and status legally protected. A wealthy capitalist might find his fortune decimated when he loses this crucial ability to serve consumers and the latter turn to other suppliers for their wares; he may have to re-join the ranks of salaried employees if he is to make ends meet. On the other hand, an ordinary worker may see a gap in the market unnoticed by the current entrepreneurs of the day and set up a successful business accordingly. This does not mean say, of course, that political castes do not exist today. We can see quite clearly from bank bailouts that there are a distinct upper caste that is protected from its mistakes and is able to retain its wealth and status at the expense of the rest of us. Indeed all the similar injustices that did occur during the early history of capitalism were not owing to the capitalists’ reliance upon genuine private property and free exchange – rather, they used the power of the state to enforce their illegitimate property interests. The mercantilist corn laws, for instance, which artificially propped up the price of corn for the benefit of cereal producers are a good example from the early nineteenth century. Capitalism itself, however, does not produce these injustices.

Moving on to some more contemporary arguments, do businesses exploit the “needs” of consumers for whatever it is that the latter want? Do they withhold “vital” and “necessary” wares releasing them only at extortionate prices thinking only of their selfish greed for profits? The argument is ridiculous because all trade and exchange relies upon the desires of the trading parties – whether it is for food, housing, cars, computers, or trips to the cinema. The entrepreneurs in business exist to fulfil and satisfy, not exploit these needs. If they are able to charge high prices it is only because the supply, relative to demand, is low and has to be rationed to those who value the goods the most. This argument regarding exploitation usually surfaces today in one of two situations. The first is during sudden supply shocks or demand spikes that send prices soaring and allows suppliers to book large profits as they obviously paid for the inputs at much lower, wholesale prices. As these usually occur during times of emergency or crisis, aren’t the businesses exploiting the dire need of the consumers for such staples as water, canned food and fuel? Such an argument ignores the fact that it is not the businesses driving the demand – it is the other people who are willing to pay more to get their hands on the suddenly scarce items. The only options are to allow other entrants into the marketplace to bring more resources into the production of scarce goods and lower their price, which would satisfy everyone with more supply of those goods that are most needed in these crisis situations; or, to fix the prices of the wares below their market clearing level which would lead to guaranteed shortages. Needless to say, government always opts for the latter. The second situation that attracts criticism is when the entrepreneur is in the business of providing something “essential” such as energy or healthcare. Yet these businesses are almost always cripplingly regulated and interfered with by government that it is impossible to define them as anything approaching free markets. Britain’s Energy market is a case in point. Apart from the vast government bureaucracy that oversees the industry, idiosyncratic interferences such as the announcement by the leader of the opposition Labour Party, Ed Miliband, that his government would freeze energy prices if his party wins the 2015 general election also take their toll upon consumers. Firms are not passing on the reduction of wholesale Energy prices to consumers and are booking profits now for fear that they will be locked into furnishing energy at low tariffs in a period when wholesale prices are rising, should Miliband make good his threat. In contrast if you look to any industry that government tends to leave alone you do not find the same criticisms hurled at the dominant suppliers. Up until now we have seen that supermarkets, although subjected to food standards regulations that no doubt have raised prices, have benefitted from relatively less government interference and, apart from a few murmurings from food purists and local activists, inexpensive food has ensured that they have never been a serious political issue. However, now that food prices are starting to rise can we expect government to start poking its nose increasingly into the food industry and blaming the resulting shortages and disarray on the “exploitation” of the big supermarkets? Furthermore, given that trade is always a two-way process we could also say that the consumers “exploit” the need of businesses for money. These entities have suppliers and employees to pay and they are often desperate to get their hands on your cash – if someone else offers a lower price they could be left high and dry by your decision to shop elsewhere, threatening the employment and livelihoods of all of those people that work in the business you shun simply because you have the guile to want to pay less! It is partly for that reason that the supply curve for consumer goods is generally vertical, with merchants selling goods for any price they can get simply to shift them and have at least some cash to meet their future outgoings.

In a genuine free market businesses can never exploit anyone or hold anyone to ransom. A consumer would have the power to take his custom elsewhere if the business failed to meet his needs at an agreeable price. Although businesses as a whole set prices for consumer products and wages, no one individual business can do so and each one must be prepared to sell goods for, at most, as much as the next business, and to pay wages at least as high. These boundaries can be crippling if the selling prices are lower or insubstantially higher than the prices the business must pay out. Businesses, unprotected by government privilege, therefore have to be on their toes constantly in case someone comes along with a better offer. The beneficiary of this process is the consumer-employee, who always knows he is paying the lowest price for what he buys and receives the highest wage for his work that can ever be paid.

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Labourers, Capitalists and Entrepreneurs

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Libertarians are well aware of the Marxist myth that labourers or employees are “exploited” by the capitalists, the entrepreneurs, the employers and the bosses, the former producing all of the valuable output in society and only permitted to consume enough to keep them at bare subsistence while the latter cream off the fat and live a life of carefree opulence.

The details of the economic fallacies of this position we will not explore here. Rather, the issue we wish to concentrate on is the common misperception that is “easy” to be a capitalist-entrepreneur (whom, hereafter, we will refer to as a “businessman”) and back-breakingly “difficult” to be a labourer. Such an impression is hard to dispel when, after all, the majority of the population are labourers, only a slim minority are businessmen and the relationship between the two is nearly always at arm’s length. Don’t the businessmen have the luxury of dictating to us the terms of our employment, our wages, what time we have to be there in the morning, what time we can leave, when we can have lunch, how often we can go to the toilet? And don’t they then decide when they’ll let us in to the shops to buy the stuff we need, setting the prices we must pay to ensure themselves enough profit, and us having to choose from whatever they have decided we can buy? Aren’t we just lucky to have whatever scraps that they throw down to us from their table? Although there will always be a natural antagonism between boss and employee the latter should think twice before becoming too envious of those who offer him work by failing to realise the pitfalls of becoming a businessman and ignoring the advantages of remaining as a labourer. Let us explore some of these in detail.

First of all, as a labourer you have the advantage of receiving your income first and incurring your costs later. The businessman pays you immediately once your work is complete and then you have a definite amount of money in your hand right now that you know you can spend on whatever you like. Furthermore, you do not have to wait until the product that you are working on for the businessman is completed before receiving this income, which might be weeks, months or even years before it reaches the hands of the consumer. No, you get your money now, cash in hand, with no waiting. And once you go to the shops you know the prices that you will pay so you can estimate easily how much you can spend and how much you can save in order live sustainably. In short, living as a labourer has a high degree of certainty. Labourers do, of course, partly share in entrepreneurial burdens. Not only do they have to know which skills are the best to offer prospective employers but they also bear the risk of redundancy in the event that the employer is forced to cease trading, or if the entire industry in which they work should become obsolete. But his entrepreneurial risk is greatly diminished compared to that of the businessman. Moreover, as a labourer, there is normally a strict starting point to your day and a strict ending point. Yes, you have to turn up and work for those eight or so hours in the day between those times but the time outside of that is yours and work, except for the very highest salaried employees, does not have to interfere with your leisure time.

Let us contrast this with the position of the businessman. He does not have the benefit of receiving his income first and incurring his costs later. Rather, he must first of all save and then burden himself with costs (including your wages) on an operation without knowing precisely how much this operation will yield in income. Indeed, the whole operation might bring him a net loss. He doesn’t know precisely what the outcome will be and he is, indeed, taking an enormous risk by entering this venture. It is simply anticipation on his part. Yet you, even if you participate in his operation, have been insulated from this by being paid up front. The businessman doesn’t come back to you after the end of a loss-making year and demand some of your wages back. You get to keep everything whereas he may lose a significant portion of his wealth. Equally and oppositely, therefore nor should he be expected to give you some of his surplus at the end of a profitable year. Furthermore, while businessmen as a whole “set prices”, any one of them does not do so as he pleases. Rather, he has to compete with what other businessmen are willing to pay for their inputs on the one hand and sell their outputs for on the other. The prices he pays for goods, raw materials and your wages to produce the goods he will sell are set not by him but by the bids of all the other businessmen who wish to uses these resources in their competing operations. Our businessman must be prepared to pay at least as much as they are if he is to secure the inputs necessary to run his business. Indeed one of the great Marxist myths – that the capitalists drive down wages to the lowest possible – is made plainly untrue by this fact. It is the competition between businessmen that drives up the wages of labour as it increases the demand for it. What is likely to reduce wages, on the other hand, is the existence of other workers as each new labourer adds an additional supply of labour, especially in particular industries where certain skills are necessary for which there is a finite demand. Indeed one of the reasons why unionised labour has always supported the minimum wage is to make the lowest skilled workers unemployable and reduce the competition for their more highly skilled members, thus raising the wages of the latter at the expense of the former. So much, one might say, for the collective interests of each class. When it comes to the prices of the product to be sold, the businessman must similarly compete with all of the products offered by his competitors for the contents of the consumers’ wallets and purses. His prices will therefore be determined by all of the other asking prices of his competitors and he must be prepared to offer a low enough price to draw consumers away from these other businesses1. Once a product is produced it is normally in a businessman’s best interests to sell it as quickly as possible. He does not have the luxury of “un-producing” it, winding back the clock and choosing to do something else. Rather, he is stuck with it and the longer he holds onto it the more likely it is that perishable items will simply be wasted and more durable items will incur further costs of storage. The only option, barring the possibility of personal use (which is obviously impossible for any large scale business) will be to sell it. Very often, therefore, the supply curve for a businessman will be vertical, meaning that he is prepared to take whatever the consumers will pay for his wares. If this is not enough to cover his costs then he will go out of business. He only earns a profit if the consumers are prepared to pay more than the product cost to produce. Occasionally a business may hold onto goods in the anticipation that their prices will rise at a later date, but this is normally the function of speculators in commodities and raw materials which have a diverse range of potential uses and not the function of manufacturers and vendors of highly specific, consumer goods. While businesses as a whole set prices, therefore, any one business is highly restricted in the prices it pays for its inputs and the prices it receives for its outputs and it takes tremendous skill and foresight to ensure that the latter is higher than the former.

Furthermore, the profits that a businessman will earn if he is successful in this regard are in no way “deductions” from wages. Rather, properly considered, wages are deductions from profits. When an businessman brings his produced product to market on a certain day, it will sell for whatever people are prepared to pay for it that day and the businessman will consequently earn certain revenue. If, for the sake of argument, he had been able to bring that product to market without incurring a single cost then his profit would be his entire revenue. In the real world, however, he must incur costs and every single cost, including wages, that has brought him to the position of being able to sell that product is a deduction from that revenue and only the remainder is the resulting profit. If the deductions are too high then he makes a loss. Indeed, this is precisely how a company’s income statement is laid out – revenue at the top followed by costs deducted leading to the final figure which is the profit; hence the expression “the bottom line”. If another businessman brought the same type and quantity of products to market on the same day he would earn exactly the same revenue as our first businessman, but if this second businessman had done so while incurring fewer costs then his deductions would be lower and his profit would be higher. Every time a businessman considers hiring one more employee he has to estimate whether the additional revenue gained from doing so will be higher than the deduction from that revenue he must pay out in wages. In short, your help in his enterprise allows you to pinch from his pie upfront, and only at the very end, after you have vanished, does he know how big the pie is. If he is unsuccessful you, the labourer, might well have left nothing for him.

Another myth we need to tackle is that capitalist-entrepreneurs automatically become rich. For every successful entrepreneur there are a dozen or more failures because the ability to judge, in advance, which products and services consumers will want to and how much they are willing to pay is a rare skill; hence it is very highly rewarded when it is successful. In a genuine free market there would never be a “class” of capitalists or of entrepreneurs. Rather, everyone would be free to risk his money in a new business if he believed that he had identified a marketable good or service. What gives us the illusion of a capitalist class today is the government protection accorded to large, established businesses and their owners and managers. Indeed the cash-bloated financial sector has only swollen to its titanic size because of the largess that government lavishes on this industry, whereas in a genuine free market financial services would earn the ordinary rate of profit. Furthermore, government makes it extremely difficult to start a new business, crushing it with the cost of crippling regulatory requirements before the budding entrepreneurs can give thought to more relevant things such as their product, their customers and their genuine costs. All this serves to make the businessmen an impenetrable caste of permanent membership, hence increasing the resentment of their position. Furthermore, it is possible to mistake the volume of money sloshing around in a business for the wealth that business possesses. It might be awe-inspiring to see a company’s bank statement raking in millions of pounds a month whereas you, as a little labourer, might only earn a thousand pounds in the same period. But deep pockets are usually raided by fatter hands; just as the income is much greater than yours, so too are the outgoings. It matters not a whit if a company is seeing income of £1 million per month. What matters is the differential between the revenue and the costs. If, in order to earn £1 million pounds the business had to pay out £1.1 million pounds then it would be left with a net loss of £100K. Just because lots of money is coming in to the bank does not mean that a company has endless amounts of cash to play around with and this is compounded by the fact we mentioned earlier of businesses having to incur their costs before their revenue is received. At least as a labourer if you decide to spend a bit more on some luxury in a certain month you still have the ability to calculate precisely what you will have at the end of that month. Businesses do not have this ability and particularly where profit margins are slim only a very slight tipping of the balance into the red can cause money to evaporate very rapidly.

Related to this aspect of the volume of cash in a business is the so-called “inequality of bargaining power” – that businesses, being so big and wealthy are more “powerful” than the tiny labourer who has to come, cup in hand, for whatever he can get. There is, however, no such thing as “bargaining power”. Each party enters a contractual agreement because they each desire something that the other possesses. The value of one party gaining what is yours is in his mind and is not inherent in you. If you are able to negotiate terms that are very favourable to you it simply means that he values what you have more than you value what he has. You have no control over this aspect and all it would take is for someone else to come along and offer something that is better than what you have. Secondly, and, ironically, it is not the growing and profitable businesses – the ones who have “bargaining power” – that tend to be restrictive on how much they are willing to pay in costs. The enthusiasm of a new entrepreneurial venture coupled with the either the anticipation or the reality of large profits results in a lower degree of scrupulousness in controlling costs and the very opposite of a Scrooge-like approach to hiring workers. Indeed it has been estimated that entrepreneurs as a whole pay too much in advances for their inputs and make an overall loss, with even the big winners failing to cancel out the losses of the big winners2. The point at which businesses become tight-fisted is when there is strong competition in a saturated market, driving down profit margins resulting in the need to cut costs in order to stay ahead. In other words it is when profits are low – i.e. when a business’s bargaining power is restricted – that causes a business to demand less favourable terms for its employees. There is also the alternative possibility that a business can grow so large that it soaks up the entire supply of an input and hence is said to be insulated from competitive pressure in setting the prices it pays. This is the frequent allegation that is made against large supermarket chains such as Tesco in their dealings with small suppliers. Of this we can say three things. First, in a genuinely free market, if a business has grown that large then it has done so because it has met the needs of consumers better than anyone else. Secondly, such a behemoth contains the seeds of its own destruction as size and domination leads to complacency and stifling innovation, giving opportunity for more nimble and enthusiastic start-ups to enter the fray and draw away suppliers with more favourable terms. Indeed the evolution of the technology sector may, perhaps, illustrate this. Microsoft dominated the PC age; Google the internet age; and Facebook the social networking era. No one firm was able to retain its dominating influence as consumer focus shifted from one thing to the next. Indeed already we are perhaps seeing a waning of social networking with Facebook’s acquisition of WhatsApp specifically for the purpose of attracting a younger audience for whom instant communication through smartphone technology has proven to be more important than creating a profile on a website. Who will dominate this latter era, if it proves to be one, remains to be seen. Thirdly the large corporate monopoly as we have come to know it is most often sustained by government and not by its consumers. Regulatory privilege, artificial barriers of entry and direct government contracts insulate these firms from actual and potential competition, meaning that their “bargaining power” is bestowed by nothing more than government force and fiat. Clearly this would not be the case in a genuinely free market.

What we have seen therefore is that being a businessman is far from easy. Yes there may be the reward of large profits but the path to success, in a free market at least, is fraught with uncertainty and difficulty. Life as a labourer may be relatively low paid, dull, repetitive but at least it is relatively secure and certain. We should end by reinforcing the fact that throughout this essay we have been talking about businessmen who earn their profits through serving the needs of consumers – those who have successfully determined the needs of their customers and directed the scarce resources available accordingly. We have not been referring to the government-protected or what we might call the “political” entrepreneur who has won his riches through lobbying and government protection. These latter creatures should be reviled for what they are and by pressing ahead for the establishment of a genuine free market we can enjoy watching their ill-gotten fortunes evaporate into the hands of those businessmen who truly know how to serve our needs.

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1Contrary to another popular myth competition is not restricted to particular industries. If you are sell apples then it is in your interests to draw people away from spending their money on, say, cinema trips just as it is on other apple vendors. All businesses are competing for the finite contents of consumers’ bank balances.

2Virginia Postrel, Economic Scene; a Vital Economy is one that Suffers Lucky Fools Gladly, New York Times, September 6th 2001: “If the few big wins cancel out the many losses, starting a business would be a risky, but rational, bet — the sort of investment a “cautious businessman” might make. But Professor [John V C] Nye [economic historian] argued that the wins and the losses probably don’t cancel out. Even the biggest winners don’t make enough money personally to cover the losses of all the individuals who went into businesses that failed. The big winners are usually people who, based on rational calculations, shouldn’t have bet their time, money and ideas. They overestimated their chances of striking it rich. But they were lucky and beat the odds. Even more important, the lucky fools create huge spillover benefits for society: new sources of wealth, new jobs, new industries offering less-risky opportunities, new technologies that improve life. Entrepreneurship does generate net gains, but most of those gains don’t go to the risk-takers. The gains are spread out to the rest of us. Capitalism, in this view, works by exploiting the capitalists themselves.”