Economics — Here’s My Take by Martin Kienitz

10 – CAPITAL

Capital is somethin’ else.

Capital is the soul, the engine, of capitalism. Capital is not merely wealth. It is wealth put to work to create more wealth. Without capital, the explosion of creativity and innovation, the dramatic increase in living standards in the past three hundred years could not have happened. Great wealth has often been accumulated in history but was spent on pyramids, palaces and wars. It required a change in thinking to deliberately use it as capital. At first, it was done by merchants and traders. It took a gradual cultural revolution to create capitalism, which changed the fabric of society and became a continuing, never-ending process.

Capital is wealth that is purposely used to create more wealth. J. S. Mill stated, “The distinction between capital and non-capital does not lie in the kind of commodities, but in the mind of the capitalist, in his will to employ them for one purpose rather than another.” Today’s economic actors count their capital very broadly. Farmers include their land; craftsmen, their skills; manufacturers, their factories; oil companies, proven reserves; peasants, seed corn; bankers, loans and treasury bonds. All such assets can be used to create more assets. I found out, however, that capital has become a very slippery idea. Modern ideas of capital have become far more sweeping and all-encompassing. Our concepts of capital have ballooned and now float in the upper reaches of the imagination. A penthouse apartment owned by a corporate CEO for his mistress might be counted too. He makes millions for the company so the apartment could be an asset helping him to create more wealth. Perhaps. In its most extreme statement today: Capital is anything that can be used to produce more of something that people want.

That’s Far Out, as they say. Such a vague definition is practically useless. Some have tried to give capital a precise meaning that everyone can agree upon but without success. Others have modified its definition, trying to narrow it a bit. They understand that capital is not merely wealth. Wikipedia defines capital as follows:

(Capital is) “Human-made goods used in the production of other goods. Money is not considered to be capital as it is not used directly to produce any good. Some consider money, including borrowed money, tied up in a business to be financial capital.”

Another definition is found at Econospeak:

“Capital, including machinery, consists of instruments of production utilized by human beings for the production of wealth.”

I can’t see how to sharpen up these statements without big caveats. Are only material things to be counted as capital? If things like patents can be capital, what immaterial things cannot be? What should be excluded or included? Must capital be only human-made or can other things be included? Is money capital? Are human skills capital? Questions like these persist but there are no agreed-upon answers. Businessmen, investors, and third-generation scions of inherited fortunes all have their own ideas of capital, what it is, and how it works. They define it as they please, usually reflecting their attitudes toward capitalism and the economy. “It’s just simple supply and demand.” “Corporations are people too.” “Live off the income but preserve the capital.” Even economists who’ve grappled with the nature of capital can’t decide what kind of bird it is – if it walks like a duck and quacks like a duck – maybe it’s anything that flies.

Economist Thomas Piketty used the words capital and wealth interchangeably in his best-selling 2014 book, Capital in the Twenty-First Century. He defined National Capital as “the total market value of everything owned by the residents and government of a given country at a given time, provided that it can be traded on some market.” He further limited such ownership to only ‘non-human assets’ to exclude so-called human capital and slavery. Like him, many people from individuals to corporate CEO’s, think of capital as wealth that is marketable in some way.

In finance, capital is monetary investment in any form – stocks, bonds, derivatives, options, etc. Accountants further include physical items in capital: offices, factories, machinery and so forth. Businesses add intangibles into their notions of capital. Here are some kinds of capital that are supposed to be part of a business enterprise these days:

There’s no doubt that all of these can be “used to make more of something that people want” so they must be capital in the broadest sense defined above. But they don’t fit together; they’re incoherent and incommensurable. They can’t be combined to make a unified thing called ‘capital.’ Two units of employee education can’t be added to three units of trademarks to make dollars. It’s hard to communicate about them so assumptions or ideology are brought in to compare them, and everyone is happy with what they’re accustomed to. Someday better ideas may be invented that all can agree on. Maybe the economists will do it. Their field is ripe for it.

The classical economists postulated that there were three Factors of Production: land, labor and capital. All three were needed to make a product, though it wasn’t specified how it was done. Land included all the resources of nature: air, water, timber, oil, etc. Labor covered the muscle, skill and inventiveness of people. The classical economists defined capital in a way that kept it distinct from land and labor. It was held that:

• Capital was used in the production of goods, (making it a factor of production), and,
• Capital was human-made, (so that labor and naturally occurring resources were not considered to be capital), and,
• Capital was not used up in the process of production. (Raw materials were used up, for example, but plant and equipment were not.)

With this clever definition one could determine what was or was not capital. A mill by a stream was capital: it was human-made, it was used, but not used up, in production. The stream powering the mill was considered land, not capital. The mill hands were labor. All three factors were needed to produce flour. With this definition one could also create sub-categories such as working and circulating capital, and also could make use of mathematics. Economics took a great leap forward. There were skirmishes over the nature of money; whether it, too, was capital. At first it was only a lubricant improving barter by eliminating a “double coincidence of wants.” It was a veil covering the details of trade, a mere medium of exchange. Money from the sale of goods was thought to be used only to buy other goods and was therefore unimportant. Then it was realized that money had to be capital. When used to finance commercial ventures it could generate more money. So it was brought into the fold and economics was further advanced. But debt, its evil twin, was left outside because “every man’s debt is another man’s asset” and thus of no effect. Economics was set back a hundred years or more.

All of the above term for capital; physical, financial, intangible, intellectual, social and human, are still used and abused today. Different authors and schools of thought are fighting it out. So be warned: when you encounter terms like bank reserve capital, market capitalization, capital expenditure or human capital, beware – they’re not the same kinds of things at all. Human capital is still argued about; is it capital or part of labor? Intellectual property is a hot issue today, at the core of lawsuits and trade negotiations.

This confusion isn’t new, however. The textile mill owners of 19^th century England paid workers “what they were worth,” i.e., not much. Their cost was simply the hours worked multiplied by the wage rate. But how about unpaid labor? The mills were supplied by slave-owning cotton growers in Georgia. Slaves were not paid. They were bought and sold in markets, and not used up in production. Thus they were like depreciable capital equipment with operating expenses – food and shelter. That was a conundrum. Workers were labor on one side of the Atlantic and capital on the other.

Author Henry George, in his 19^th century book Progress and Poverty, considered capital to be a subset of wealth. Capital is, “wealth used in the process of production, which includes wealth in the course of exchange.” This is quite different from today’s idea of capital as being any asset that will yield its owner a return. He noted that workers were normally paid their wages after they’d done their work, not before. The capitalist paid labor from the value of work already performed, which value has accrued to the capitalist who paid nothing out of his previous capital stock. That is, money paid to the workers was equivalent to the value the workers had contributed to the capitalist, for free: [1]

“. . . so are we justified in saying that the laborer receives in wages the wealth he has rendered in labor. . . This universal truth is so often obscured, is largely due to that fruitful source of economic obscurities, the confounding of wealth with money.”

I doubt that Henry George ever heard of the squeegee men of New York City who ran out to cars stuck in traffic, washed and squeegeed the windshields, and then demanded payment from angry drivers. The squeegee men certainly got George’s argument – the drivers got added value in having clean windshields, so now the laborers should be paid, right?

Capital accumulation, also called capital formation, is an increase in a stock of capital. Capital is accumulated whenever a capital asset is created or acquired. Capital assets are expected to yield an income which adds directly to wealth. Part or all of the new wealth can become capital if reinvested in new capital assets, thereby adding to capital formation. Accumulated capital is what distinguishes the rich from the poor. If capital accumulates, (not a sure thing), then wealth can grow because capital can compound on itself and grow ever-faster. Huts can become houses. Cow paths can become paved streets. Over the generations slow investment gets big results. A newsboy who steadily invests $10 a week during his working life may leave $100,000 to his children. Change accelerates as the capital stock grows. Entrepreneurs who start successful businesses can become rich and help others to do the same. Andrew Carnegie and John D. Rockefeller made millions in steel and oil. Sometimes capital is accumulated very rapidly. President Jefferson’s Louisiana Purchase doubled the size of the United States. Capitalism has reduced poverty because it strongly encourages the accumulation of capital.

Productivity is the measure of labor’s output in a given time; the efficiency or effectiveness of labor in production. If more widgets are produced per man-hour, labor costs are lower. Profits can be higher, prices can fall or better widgets can be made. Society gets richer if overall productivity rises steadily, as it has. When capital is applied to technical innovations, productivity goes up by leaps and bounds. Shovels are much better than sharpened sticks; backhoes outperform hundreds of shovels. Economists differ on exactly how increasing capital adds to productivity. Neoclassical theory holds that the vital ingredient is technology. Discoveries such as steam power and electricity are presumed to be unpredictable events, coming out of the blue. If they don’t occur capital won’t grow and the economy will drift into a stationary state. If society is friendly toward entrepreneurs, that is, if they can make money, capital will be directed to innovation and the lightning can strike again and again. Education and organization boost productivity. A worker who can read produces more than an illiterate one. This is why education, organization, and machinery are all considered to be capital – they improve productivity when applied to labor.