The beginnings of capitalism

In the times before when capital accumulation became significant and capitalist systems developed, the standard of living of the general public didn’t improve in their lifetime. From birth to death, people had a constant experience with respect to the material possessions and comforts. Among the non-aristocratic who were poor, people were born poor, lived poor and died poor. Whereas the aristocrats, were born rich, lived rich and usually died rich. The motivation, labour, industriousness, capability and other attributes of individuals didn’t matter much. These traits couldn’t really alter one’s fate.

Society was ossified under two categories – the aristocratic rich and the rest who were poor. In short, poverty was the norm while being wealthy was the exception.

The economic activities in a society happened along two broad categories. There were manufacturing industries which catered exclusively to the rich: these industries supplied luxury products. The poor lived in rural areas and were excluded from associating with these activities; not even in the form of labour. They lived in rural areas working in agriculture, on land that they didn’t own. The rural economy was decoupled from the urban economy. The rural population slowly expanded and by the 18th century, the governments such as in Europe, were about whether the rural land and economy could 'accommodate' the burgeoning population.

The numbers under discussion (in the 18th century) were in the order of millions. England had a population of 7-8 million and the USA had about 5 million. The numbers were daunting for the government. Keeping the population fed and employed were considered necessary to avoid any uprising against the ruling aristocracy.

The solution to the problems finally - as always - were solved by the people themselves instead of the government. The outcasts who were relegated to the villages set up small units that processed simple products for use by the masses. These 'industries' would cater to what is called in sophisticated terms today – the bottom of the pyramid.

The beginning of mass production was, in fact, the starting point for what we can discern in today’s context as capitalism. While the manufacturing industries catering to the gentry and nobility continued, the new rural enterprises almost exclusively served the rural population. The latter was typically mass production for the needs of the masses. Soon enough, these rural enterprises overtook the size of their urban counterparts.

Businesses that serve a large consumer class always trumps those that serve niche segments.The rural industries became the cynosure of all. Before the socialists would detest the success of these entrepreneurs, condemnation firstly came from the aristocrats who now felt their societal position on shaky ground. Interestingly, this precedes all other forms of attack on the principles of free markets and capitalism.

From worrying about the population that was in the order of 5-8 million each, today the US has a population of 330 million and England 56 million. It is capitalism that has enabled vast numbers of people to be fed and sustained. In most countries, over the past two centuries, the population has grown by 10x aided by the growth of industrial capitalism. The leftists of today may well consider their own existence due to the fruits of capitalism which allowed their forefathers to earn a living and maintain families.

But, the present status of societies didn’t happen overnight. As said before, poverty is the norm; being wealthy is the exception. The right question is not why some societies are poor, but how some have become rich? When factories first employed men and women, those people didn’t come from comfortable homes. They lived in the open streets. That they looked decrepit while performing the daily tasks wasn’t an evidence for the factories keeping them poor. Instead, the fact that they took up the factory job was due to their preexisting poverty.

This is a simple fact, yet, intellectuals of the leftist variety would simply, by the gift of gab, turn these factories and its owners into 'leery predators'.  A connected argument about allowing apprenticeships in emerging markets was made in an earlier post [Why Apprenticeship is Necessary for Developing Human Capital].

Big businesses cater to the masses; in the initial stages of capitalism, this was by definition necessary for its survival. There is no other business model that ensures mass production and consequent attainment of company size. Feudalistic principles stand in no comparison to free markets where businesses serve large swathes of society instead of small segments.

But the owners of these businesses have been vilified in history and even in the present times. ‘Robber baron’ of the 19th century US or being addressed as ‘kings’ or ‘captains’ are descriptive terms to often mislead public discourse. It is not that these ‘kings’ ruled over any particular territory. In each of these cases, the ‘robber baron’ and the ‘king’ simply sold a commodity in a market where consumers voluntarily paid a price in exchange. One can’t find fault if millions of people voluntarily felt their wants satisfied by using the products sold by these companies.

Today, a more sophisticated term - vetted by university departments - called a monopoly, has taken hold. Ironically, a monopoly occurs when a business steadfastly serves its customers and the latter remain loyal to it for a very long time - much to the dislike of its competitors and new entrants. At least, the tapestry of modern laws seems to suggest such an explanation. These ‘monopolists’ are vilified under a left-leaning narrative aided by the media and particular party interests.

By the passage of time, many of those so-called monopolists have been upended by the forces of competition - before it was even necessary for the competition commission to reign them in. If it was the railroad companies in the early 19th century, it was the automobiles in the early 20th century, or the big-box retail or computer manufacturers in the later part of the 20th century, or the internet search company or the e-commerce giant of this century. By the forces of competition, dislocation of leaders is happening faster than in earlier times. Companies that have become extinct is a familiar theme.

Businesses need customers

Unlike in the aristocratic times, businesses today survive only by serving its customers. There is no difference between the worker and the consumer. When we claim the ‘customer is king’, it is the same consumer who also dons the role of a worker in a factory setting. He helps produce the goods which he, in turn, demands in the marketplace. As a worker, he negotiates for the highest possible wages he can get. As a consumer, he bargains for the lowest prices he can pay. There is essentially no third person involved here.

Wages are not paid by businessmen. Consumers pay wages. Also, the same consumer earns his wages by playing the role of worker. In capitalism, it’s a misconception to think of a third class, called the businessman who independently pays the worker. Such distinctions, in theory, serve a purpose, but those distinctions have been wrongly cast to serve certain socialist narratives.

A worker who believes he ought to get more wages because of his peculiar circumstances (say a large family to support or a handicap or belonging to a certain race) should answer the question if he is willing to pay a higher product price to a producer who makes a similar claim of an esoteric burden. It is quite easy to imagine that the worker, who now is a consumer, would quietly go to the next trader to pay a lower price; presumably, that trader was a bachelor and ambiguously happy-go-lucky in his personal affairs.

The wage theory

The genesis of capitalism is capital accumulation aided by savings [refer our earlier post – The Genesis of Capitalism]. When an individual saves, an entrepreneur borrows the same for investing in a business venture. He purchases raw materials, hires labour and then manipulates the material so that a product required by consumers is made. In performing such activities, he pays the raw material supplier before his product is ready.

He also pays the labour irrespective whether the product has been sold. The price he pays for the raw material and the labour is the discounted value of the product (minus entrepreneur profit and bank interest). The discount is the reason factors of production appear ‘underpaid’ in comparison to the product price. The discount reflects the uncertainty of the venture; profit is always an after-effect and not determined in certainty ahead of time. An entrepreneur is always speculating if his combination of factors of production (in the past) will result in products that consumers will certainly desire (in the future). This uncertainty combined with the advanced nature of payment of wages is the reason why wages are disputably ‘lower’.

On the other hand, as capital accumulates more competitors enter the market and bid these wages higher. Competition among employers to hire labour pulls wages upwards. An entrepreneur will then have to price the products appropriately and pay the right level of wages that can help him manufacture those products.

Countering the dystopian view

The Marxian socialists viewed human beings in a biological setting where many compete for limited resources. Malthus was one such, who viewed population as first increasing due to increasing prosperity and then catastrophically declining when faced with the limitations of earth resources. The ‘iron law of wages’ was another outgrowth of such thinking. It’s the belief that worker’s wage must rise initially, which increases family size. The children would then enter the workforce competing amongst themselves driving down wages (wage-rate). Thus, wages move below subsistence level.

Such reasoning is not different compared to deductions from mice behaviour in a colony. If you increase the quantity of food available in the colony, mice would procreate and increase its population. The opposite would happen if the quantity of food were to be decreased.

This is a woeful misunderstanding of the real world. There is no doubt that scarcity exists; economic theory fully recognizes that. But under capitalism, factors of production combine to increase productivity. Therefore, the output of goods keeps increasing even though input is limited. This happens because savings causes capital accumulation. The long line of capital goods allows greater proportion of output for a given increase in input. Higher output causes reductions in unit prices.

Even though, cumulatively more output has been extracted out of the ‘limited resources’, and as time passes the remaining stock of earth’s resources must only be declining, yet, progressively product prices have been only getting cheaper. The answer being capitalism and concomitant productivity.

The incomparable standards of today

As described in the above passages, much of the increase in population has been supported by the rise in the standards of living thanks to capitalism. In the current age, many of the material comforts enjoyed by the middle and lower classes could be enjoyed only by the rich and the noble two hundred years ago. For the rich, the kings and the aristocrats many of the modern services (received by the middle and lower classes of today) were rendered to them by personal servants. For instance, for the rich having a washing machine would make no difference because the job of washing clothes was done by his servants. The ‘working class’ then could afford no such pleasures. Instead, now there are affordable washing machines in most homes. A similar analogy can be extended to several services – such as walking and transport, cooking and ordering food, education and free online learning, entertainment etc.

These developments happened due to businesses catering to the bottom of the pyramid. Much to the dislike of the rich aristocrats, the common population began enjoying a similar degree of comfort. In reality, today’s people enjoy services that the kings of yesteryear's cannot even fathom – such as online information retrieval, walking-music, a litany of vaccines etc.

Free market capitalism

Capitalism is the reason behind prosperity in capitalist societies. In India, for example, capital goods entered the economy significantly after the opening up of borders in 1991. Till such time, capital accumulation had been feeble. Due to developments in healthcare globally (aided by generous research in capitalist economies and donations to needy countries), India’s population increased steadily with no commensurate capital accumulation. The juxtaposition of human resources with capital could take place only after the liberalisation of the economy with the influx of foreign capital and the simultaneous creation of institutions necessary for channelling capital.  Much of the post-independence period were experimented away with socialistic planning devices. In comparison, for instance, post-war Germany enjoyed an economic miracle; much of which is the outcome of the application of free markets principles.

An expectation of a miracle for an economic turnaround is unwarranted. What appears as a miracle is due to the wide gulf in outcomes between countries that pursued divergent economic policies. When the right set of policies are pursued, economic prosperity ensues. That right set of policies consists in adhering fully to the principles of free market capitalism.