Freedom and Economic Order

by Linda C Raeder

  In a capitalist system, however, the proletariat, the laboring class of workers, does not receive wages or compensation equal to the value of its contribution to production but rather is subject to systematic exploitation. The capitalist, as the owner of the firm and means of production, sells the final product, distributes a portion of total revenue to the workers in the form of wages, and retains the remainder for himself. Moreover, competition among workers, who are in abundant supply and have no choice but to work for the capitalists, ensures that their wages will not rise far above subsistence level.

  If Marx’s argument is correct, it is difficult not to concede the injustice of capitalist economic relations. If workers exclusively produce all the value inherent in any good or service, then justice requires that they receive all the value in return—”to each his due.”[58] According to Marx, however, workers receive only a fraction of the value they produce; the lion’s share is retained by their capitalist masters, justified on the specious grounds of “property rights.” In their failure to distribute one hundred percent of total revenue to the workers, capitalists thus violate the most elementary standard of justice. Capitalists not only exploit the workers, that is, pay them less than the value of their contribution to production, but, even more egregiously, effectively confiscate (“appropriate”) what rightfully belongs to the workers. The greedy capitalists, who contribute no labor and thus no value to production, simply appropriate or steal the bulk of value created by the workers and belonging to them by right. A system that permits such monstrous wrong must be rectified. It is time, Marx suggests, to re-appropriate the appropriators. Indeed it is time for revolution: “Workers of the world unite! You have nothing to lose but your chains!”[59]

  By such reasoning, Marx successfully persuaded significant numbers of people of the profound injustice of the capitalist system. One readily understands how workers might feel resentful and exploited under capitalism as portrayed by Marx and inspired to rise against such unspeakable injustice. Despite the undoubted efficacy of Marx’s rhetoric and reasoning, however, the greater issue has yet to be addressed, namely, whether he accurately captured the nature of capitalism and the manner in which income is determined by the market process. The short answer is that he did not. The fundamental error in the Marxian critique of capitalism derives from its erroneous labor theory of value. Economic value is not, as Marx and the classical economists believed, an objective entity determined by the value of the labor involved in the production of a good or service. The economic value of any good or service, as we have seen, is always subjective, that is, based upon the personal values, beliefs, and circumstances of the individual perceiver. The value of any economic good—consumer, intermediate, or producer—is always imputed value, attributed to the good or service in question by its observer. Economic value never inheres in a good or service; it is never intrinsic or objective but rather subjective, as beauty is said to be, lying only and always in the mind or eyes of the beholder.

  We recall in this context our previous example regarding the value of a bottle of spring water. The value that an individual attributes to the water will vary considerably depending on his particular circumstances. A person in possession of a plentiful supply of bottled water will place far less value on another bottle than the value he would perceive if dying of thirst in a desert. Moreover, the value of the labor that went into its production is irrelevant to the prospective buyer in either situation. What matters is his subjective assessment of present need or desire in light of his present circumstances. Indeed the individual rarely if ever evaluates any good or service on the basis of its cost of production, whether labor or other cost, but rather upon his particular needs, circumstances, tastes, and preferences; as these change, the value of the perceived item to the individual changes. A potential buyer does not generally base his decision to purchase or not purchase a good on the value of the labor that produced it but rather asks himself, “What is it worth to me?” Economic value is never objective.[60] Marx and the classical economists were simply wrong.

  In fairness to Marx, however, it must be said that the correct theory of economic value, subjective value, was not discovered until the great bulk of his corpus had been completed. Its discovery—bound up with the so-called “marginal revolution” in economics—involves one of those remarkable coincidences in human history that thrill the imagination. Between 1871 and 1874 three economic theorists—Carl Menger in Austria, Leon Walras in France, and Stanley Jevons in England—independently and more or less simultaneously formulated the theory of subjective value that is universally accepted within the discipline of economics to the present day.

  The Function of the Capitalist

  We have seen that, according to Marx, labor not only objectively determines the value of an economic good or service but solely determines such value. The capitalist, he maintains, contributes no value to the final product, all of which is ultimately reducible to the value of the labor involved in its production. Such a claim, like the labor theory of value more generally, is false. The source of Marx’s error can be brought to light through an examination of the function of the capitalist in a market economy. We shall see that the crucial purpose he or she serves not only justifies retention of profit but also explains why a worker or employee is justly entitled only to wages or salary.

  The capitalist, by definition, is the owner of the means of production—material equipment such as tools, factories, machines, and so on. Such so-called producer or capital goods cannot be consumed to satisfy immediate human needs such as food, clothing, and shelter but rather constitute the means by which such consumption (consumer) goods are brought into being. Tools and other producer goods are no more free gifts of nature than consumption goods, which means that scarce resources must deliberately be allocated to their production. The “capitalist” is the individual (like Robinson Crusoe in our previous example) who saves a portion of his personal resources and decides to invest such savings in the production of non-consumable capital goods. The ability to save, as previously discussed, depends upon fulfillment of two necessary conditions. First, a would-be capitalist must produce more than is necessary for his daily subsistence (produce more than he consumes); and, second, he must conserve the excess of production over consumption (his “surplus”), which can only be accomplished by foregoing or curtailing immediate consumption. Obviously an individual who is unable to produce more than is necessary to survive will be unable to save. An individual who chooses immediately to consume his entire productive output will similarly be incapable of saving. The capitalist can only emerge in a society if one or more of its members are simultaneously capable of producing more than necessary for daily subsistence and willing to curtail immediate personal consumption in favor of saving.[61]

  A capitalist, then, is an individual who meets both necessary conditions of capital formation, as well its final or sufficient condition, namely, the decision to employ his savings (“capital”) toward production of goods that cannot be immediately consumed, the producer or capital goods that constitute the means of production. The incentive to do so, as we recall, is the marked increase in the productivity of labor that arises from the use of capital goods (tools, machines, and the like). It is far more productive and efficient to build a house with a hammer than a rock found in a stream. Resources, including human labor, are scarce. A rational society aims to employ scarce resources as efficiently as possible, that is, obtain maximum production with minimum expenditure of labor and other scarce resources. A hammer or other capital good will greatly facilitate that goal. Economically under-developed societies are typically characterized by both low productivity of labor and the inability to produce much more than required for mere subsistence. Such conditions are cause and effect, respectively, of a lack of savings or capital. Low productivity means that individuals must expend the vast bulk of their labor producing items necessary for their very survival. As a result, they have limited labor resources available
for the production of either higher-order consumption goods or producer goods. Low productivity prevents them from achieving the excess of production over consumption necessary for saving and thus capital formation (cause). Enhanced productivity would require the acquisition of tools and other capital goods but such is precluded by the prevailing low productivity of the populace (effect).

  The ability to produce capital goods is a mark of economic development that benefits every member of society. Such goods enormously enhance the productivity of labor, which means more can be produced with less expenditure of labor. The less labor employed in the production of one good or service, the more labor is available for the production of other needed goods and services. An individual or a society, however, that spends every last penny on immediate consumption, whether due to low productivity or lavish consumption expenditure, will be unable to acquire the savings (capital) requisite to the production of non-consumable tools such as hammers. Capital formation can only be accomplished with savings—resources over and above that which are used for immediate consumption. In a market economy, such savings constitute the funding source for all “investment.” “Capital,” in the end, is nothing more than savings, which, in the end, is “investment.” In a market economy the provision of such investment funds (savings/capital) is among the major functions of the “capitalist.”

  The capitalist, as we have seen, must forego immediate consumption in order to accumulate funds for saving or investment. Delaying gratification of present needs and desires is prerequisite to the accumulation of capital and production of capital goods. A person who invests $10,000 in the production of hammers cannot use that same $10,000 to satisfy immediate consumption needs or desires. In the formal language of economics, the action of the capitalist indicates a particular “time preference,” more particularly, a greater preference for future than present satisfaction. By the act of saving and investing, the capitalist demonstrates his preference for foregoing present consumption in anticipation of increasing his consumption in the future. The anticipated increase in his future consumption is to be achieved by the profits he hopes to make in the production and sale of hammers. Let us assume that our capitalist plans to sell the hammers he has produced with his savings to the building trades. It would seem he has good prospects of success: the introduction of hammers to the market means that builders will be able to construct more houses, or the same number of houses with less input of labor, than prior to their production. If the capitalist does achieve success in selling his hammers, he will be rewarded for his efforts by earning profit. If total revenue from sale of the hammers is greater than total cost of production, his income after producing and selling hammers will be greater than prior to his investment in hammer production. He will thus be able to consume more in the future than would have been possible had he not chosen to invest his personal savings in the production of hammers.

  Such a possibility is the motivating force driving capital formation and investment in a market economy. The actual achievement of profitable investment, however, depends on many factors, including the capitalist’s initial ability to produce more than required for subsistence, his willingness to curtail immediate consumption, and, equally important, the extent of actual demand for his product. The final condition of success—the existence of demand—means that the capitalist must be willing to assume risk. The producer in our example has invested his personal savings in the production of hammers, anticipating that such investment will lead to future profit. As we have seen, however, the market is a process that unfolds over time. Human existence is not static, and the future, including the actions of other human beings, is difficult to predict with certainty. With respect to the present example, such uncertainty means that the hammer producer may have to contend with various unanticipated events that may significantly affect the outcome of his business venture. To take just one possibility, perhaps our producer will be challenged by other investors and entrepreneurs pursuing plans of their own. It is possible, for instance, that during the period required for production of the hammers, another entrepreneur invents an even better tool, one that will render the building of houses even more efficient than a simple hammer. If such should occur, our producer’s hammers may be obsolete by the time they come to market and thus impossible to sell. Such of course may not occur, but it is clear that our capitalist runs the risk of losing his entire investment in hammer production.

  He is not the only producer to face such a possibility. All capitalists assume unavoidable risk when making investment decisions, risk that involves the possible loss of their personal savings or resources. A rational society will nevertheless encourage potential investors to assume such risk; if they are successful, their actions benefit society as a whole. Everyone is better off if more houses can be built with fewer resources; resources are scarce and should be used as efficiently as possible. The less labor required for building houses, the more is available to produce other needed or desired goods and services. The essential activity of saving and risk-taking (“investment”) is thus encouraged in a market economy by permitting the capitalist/investor to reap the potential rewards of his actions, rewards that constitute “profit.” Imprudent or thoughtless risk-taking, which would needlessly waste scarce resources in the production of unneeded or unwanted items, is simultaneously discouraged by penalizing reckless or incompetent capitalists with the risk of punishment, punishment embodied in “loss.” As previously discussed, both profits and losses of capitalists or investors are essential guides to production in a market economy.

  Marx not only mischaracterized the nature of capitalism in general but the “capitalist” in particular. Contrary to Marx, capitalists not only contribute to the value of goods and services exchanged in a market economy but make an indispensable contribution to market-based production. Moreover, the Marxian vision, as we recall, perceives inherent and perpetual antagonism between “capitalists” and “workers,” the two classes said to constitute modern society. The capitalists, on such a view, gain only at the workers’ expense.

  No such antagonism, however, exists in a market economy, which rather ensures a pronounced harmony of interest among all members of society, capitalist, worker, or other. Indeed among the greatest beneficiaries of capitalism are workers themselves: in the absence of capitalists, they would have no machines or other tools to assist their labor. Tools, as we have seen, dramatically increase the productivity of labor. In a capitalist economy, wage rates are a function of the productivity of labor. Ceteris paribus, the higher a worker’s productivity, the higher his wage rate; the lower a worker’s productivity, the lower his wage rate. Consider the difference between typical wage rates of workers in the automobile industry and workers who wash dishes at the local restaurant. The former employ highly complex and sophisticated capital equipment, while the latter employ relatively simple capital equipment, perhaps running water and a dishwashing machine. (Of course even a simple dishwashing machine greatly enhances the productivity of labor: compare washing dishes by hand with washing them in a machine.) The disparity in the income of autoworkers and dishwashers does not entirely stem from differences in the intrinsic abilities of workers in the two industries; many dishwashers could probably learn the skills needed to operate the sophisticated equipment at Ford Motors. The wage disparity largely stems from the great advantage the automobile workers derive from enormous capital investment in their industry, an investment funded in a market economy by capitalists motivated by anticipated profit. Profit is not stolen from workers but is rather the incentive and reward to the capitalist for saving and risking personal savings in the act of production.

  Marx’s general critique of capitalism, like his labor theory of value, is simply false. Capitalists are not monstrous exploiters who steal what rightly belongs to workers but, on the contrary, the great benefactors of workers. The capital goods they provide through their saving and investment in so-called means of production enormously heighten the produc
tivity and thus wages of labor. Laborers in less developed economies, those with minimal capital formation, uniformly receive significantly lower wages than their counterparts in developed capitalist economies. Such, however, is not a matter of justice or injustice—the result of just or unjust human action—but of economic reality, that is, the low productivity invariably linked to inadequate capital formation.

  Despite both the theoretical refutation of Marxian economics masterfully accomplished by various twentieth-century economists and the massive historical evidence of its catastrophic consequences throughout the same era, Marx’s caricature of capitalism continues to captivate the imagination of many members of contemporary society.[62] Its enduring popularity no doubt stems from its appeal to the “lower angels” of human nature. The characterization of workers as oppressed victims of exploitative and greedy capitalists resonates with the human propensity to feel undervalued and unappreciated; few people feel their personal worth is sufficiently reflected in their paychecks. Marxian victimization also feeds on what Friedrich Nietzsche (1844-1900) famously termed ressentiment—the low-level and chronic anger many individuals feel toward their general lot in life. Individuals prone to such resentment may feel that life itself is unfair. They may experience themselves as powerless, victims of forces over which they have no control, including the overarching economic order of society. Others succumb to simple envy of the more successful. Marx provided an easy target for resentment, envy, and other forms of chronic existential dissatisfaction in the symbol of the capitalist “Lord of Labor.” Capitalists or the capitalist system itself is to blame for one’s personally unsatisfactory economic circumstances or those of one’s fellows, in particular, those workers who possess relatively less material wealth.