What is capitalism? The question may not be as trivial as it sounds. Up to this point, the present book has explained that capitalism is clearly not what it is normally taken to be. It is not a market economy, at least not in the sense that real competition and open markets represent the crucial control mechanisms in economic life. It is not a meritocratic society, since the highest incomes are the returns from capital ownership, which are not based on personal performance. It is also not an economic order in which effort and commitment determine career outcomes and success. Even in society’s middle, individual status is once again for the most part a matter of family background as well as chance and luck, while at the very top, family and inheritance have always been decisive. Also, capitalism is not an economy in which private actors make large profits for taking particularly high personal risks. Rather, in a market structure in which a few corporations are dominant, while few if any opportunities exist for newcomers, the highest profits are achieved where risk tends to be low. What is more, the state supports corporations in a variety of ways, shielding their owners from a large part of the risk.
But if capitalism is not what it is usually seen to be, what then is it? In short, capitalism is distinguished from other economic orders by the fact that capital is not merely used for production, but for the sake of capital, that is, that the essential goal of production is the return on invested capital. Products are not manufactured in response to existing needs or in order to create employment, but rather as a way of exploiting the invested capital by extracting the highest possible profit. Wages are a cost factor, customers a means to an end, profit is the goal, with the payout of this profit taking the form of capital income. And because only monetary return is at stake, the same capital owner may invest in firms in any sector of the economy, or move from one to the other.
Incomes unrelated to performance on the one hand, and open markets and free competition on the other, do not match. Mainstream economics, which assumes that we live in an economy with functioning markets, genuine competition, and open access to capital, has always had problems explaining the existence of stable profits and capital incomes.
In a functioning market, firms are able to make short-term profits by offering a new product or service that has not been offered by anyone else, or by entering a market in which demand outstrips supply. At that moment, they control a temporary monopoly which, however, competitors will soon crack. In the long run, tough competition in an open market means there is no reason why an entrepreneur should receive more than what his own entrepreneurial performance generates.
According to Marx, profits in capitalism are based on the worker creating more value with his work than the value his labour has on the capitalist market. The capitalist buys labour power and sells the product of work and, since the two differ, he is taking a cut without violating the laws of equal exchange. This theory accurately describes the foundation of profit, namely that those in dependent employment generate more than they are being paid for, i. e. that a part of the product of labour accrues to the firm’s owner. But this doesn’t answer the question why this should be the case.
If it was a natural law that the value of labour and thus wages were always lower than the value of the products made, the solution would be evident: Workers, become self-employed, hire your wife, son, and cousin while you’re at it, and cash in on the profits that the capitalist has always kept for himself. The problem with this model is that things don’t work this way.
Of course there are many former employees who have set up their own businesses or were pushed into self-employment. The more skilled and sophisticated the job they do, and the smaller the number of people who can do this job, and the greater their chance of earning a decent income as a self-employed person. The more basic the work and the larger the competition from others offering the same thing, the more precarious the situation tends to be. Even if the person setting up a small cafe or starting a creative online service has used all her savings, people will not be lining up to pay her a return. The young entrepreneur can usually be satisfied if she somehow manages to cover the interest for the bank loan. In highly competitive markets, earnings are rarely significantly higher than a normal wage for a comparable job, and often it is less. It’s not a way to get rich. What are people doing wrong?
In fact, we should pose the question the other way around. Why do regular profits and capital income without work exist in the first place? This is not a trivial question, since—at least in an efficient market—no one should be receiving anything without providing something in return.
Let’s start with profits, since in order to distribute capital income, a firm has to generate profits first, and not just sporadically but regularly. Profits—particularly in excess of immediate investment needs—obviously exist only in the absence of sufficient competition. There may be a variety of reasons for this. One way is to distinguish yourself from your competitors through higher quality and continuous product innovation, or by occupying a market niche with a high-tech product that cannot simply be copied. This route is followed by firms that are called “hidden champions”, which in terms of sales do not belong to the big players but usually realize large profits. Another way is to establish yourself in a saturated market that on account of high capital requirements or government-protected patents and copyrights is closed to new entrants. This is the route followed by the large industrial corporations.
Thus there are a variety of ways in which competition can be eliminated or at least restricted. Some of these—such as specializing in a particularly sophisticated product—may well be in the public interest. Others—such as the takeover of competing firms or the exploitation of patents as an instrument to block competition—are not. However, regardless of the means employed, the important point is that in capitalist production, competition occurs only in a limited fashion. If, on the other hand, the economy is working along the lines described in standard economics textbooks—many suppliers competing with a standard product having little influence on the market price, while new firms are established all the time, putting pressure on existing enterprises—this is not a suitable environment for capitalism to thrive in. In sectors with conditions like these, there may well be successful individual entrepreneurs who achieve a decent income for their performance. But such businesses rarely produce regular profits and capital incomes without work.
We have described the situation in the chapter on “robber barons”—the merchant of the early period who invested his capital in long-distance trade and enjoyed high returns, benefiting above all from limited competition. Long-distance trade was open only to those who were able to raise the large sums of capital needed for long trade routes. The merchant’s own capital was extended through loans and bank bills, but they were available only those who already had wealth. Thus only very few individuals had the wherewithal to engage in these projects, and this small group monopolized the connection between producer and buyer. It was a profitable business.
Large-scale manufacturing is an ideal environment for capitalism. Its typical market form since the late nineteenth century is the oligopoly: a market dominated by a small number of large producers with relatively stable market shares in which new entrants are rarely able to upset the business of the established actors. This is a rich soil for consistently high profits, which can then be distributed in the form of incomes without work.
In the service sector, capitalism has taken root where similar conditions exist: a small number of large companies, limited competition, closed markets. The digital economy is a particularly favourable environment in this respect since it has a tendency not only towards developing stable oligopolies but monopolies of exclusive producers. As we have seen, it is not just the extreme advantages of size—once an application has been programmed, copies are virtually free—but also the network effect. Once established as an industry standard, it becomes virtually impossible to dislodge.
If you want to maintain stable profits, you should ensure that your firm has as few competitors as possible. Whether the competition is kept at bay through superior quality and innovation power or through patent rights and other state privileges, through simple economies of scale and high capital requirements or through digital network effects is of considerable importance for society. For the enterprise itself it is secondary, but the more convenient and popular of these methods for keeping competitors at a safe distance are economically the most damaging.
In any event, the previously quoted founder of PayPal and Silicon Valley billionaire, Peter Thiel, is correct when he writes: “Actually, capitalism and competition are opposites. Capitalism is premised on the accumulation of capital, but under perfect competition all profits get competed away.”66 It follows in short that “competition and capitalism are a contradiction in terms.”67 This is true. However, in contrast to what Thiel has in mind this is not an argument against competition, but an argument against capitalism.
This explains how stable profits are generated. But why are there capital incomes without something in return? Conceivably profits could remain in the enterprise and be reinvested. As we have seen, capital incomes do not represent any remuneration for delayed consumption since capital is not generated by delayed consumption and saving. Nor do capital incomes represent remuneration for any kind of work, since while capital is generated by labour, it is not the labour of those who own the capital. Invoking the risk taken by the capital owner is not a valid argument either, since risk is undoubtedly higher for young start-ups than for the shareholders of an established corporation.
The most frequent justification is that only thanks to capital providers is it possible for entrepreneurs to set up firms and for workers to work—at least in all those sectors in which capital requirements are far above the life savings of an average earner. This argument does indeed go to the heart of the matter. Capital incomes, which today account for almost a third of our economic output, emerge only because the large majority of people in our current economic order do not, and never will, have any direct access to capital.
In the second part of the book, we will show that this does not necessarily have to be the case and that an economy in which access to capital is democratized would be significantly more innovative and dynamic than the present economy. Under current conditions, however, unearned capital incomes are simply the monopoly price we have to pay, since the existing ownership system is concentrating capital in the hands of a small minority of society.
Savings are no longer scarce, on the contrary—in Western economies they exist in abundance, while banks pay basically no interest to savers. However, capital is scarce, and those who control it make fundamental decisions on investments and jobs. This is why capital continues to earn substantial returns.
In our economy, of course there are not only profit hunters who see firms simply as lucrative investment objects—there are also many genuine entrepreneurs. They are those who work together with their employees for a dynamic economy, innovation, and quality products. However, the assumption that entrepreneurs need capitalism is a major error. Precisely because access to capital is difficult, it holds firms back and makes life difficult for them.
Schumpeter already noticed that in many firms, there was a conflict of interest between entrepreneurs and capital investors. Obviously the individual establishing a firm needs purchasing power, i. e. capital, in order to be able to invest. Unless he hails from a wealthy family, the entrepreneur will not himself have the requisite financial means, which is why “for him … private ownership of the means of production [becomes] an obstacle”68, as Schumpeter emphasized. For a new entrepreneur from a less wealthy background has to secure the capital he needs from others. Even if he succeeds, which quite often is not the case, he ends up in a position of dependence, since the capital investors as rightful owners are entitled to exert direct influence over the firm.
“… and I’m supposed to give up my autonomy and stand by while others take charge”69, complained the engineer Gottlieb Daimler, who together with Wilhelm Maybach had built the first high-speed gasoline engine and the first four-wheeled vehicle with an internal combustion engine, when he had to accept the industrialists Duttenhofer and Lorenz as co-owners of the Daimler Motor Company. The history of many firms is a history of highly talented technicians and courageous founders who, upon bringing in external investors, lost their autonomy, subsequently wasting their energy on problems and conflicts with co-owners. In quite a few cases such conflicts ended with the actual technological head and founder leaving the firm in frustration.
The Person behind the Product is the title of a book portraying 40 successful engineers and firm founders who created the foundation for Germany’s top listed corporations. The upshot of these portraits is summarized as follows: “With their inventions inventors frequently lost their independence. They often had to rely on what today is called risk capital. This was no different for the pioneers of motorization such as Nikolaus Otto, Gottlieb Daimler, or Karl Benz. They were forced to go through serious conflicts with the beneficiaries of their patents, i. e. the investors.”70
While these were portraits of entrepreneurs from the late nineteenth and early twentieth centuries, the U.S. economist and head of the Foundation on Economic Trends, Jeremy Rifkin, describes the same situation for the present. “[M]any entrepreneurs I’ve met over the years are far more driven by the creative act than the almighty dollar. The pecuniary fetish generally comes later when entrepreneurial enterprises mature, become publicly traded in the market, and take on shareholders whose interest is in the return on their investment. There are countless tales of entrepreneurs driven out of their own companies by professional management brought in to transform the enterprise from a creative performance to a sober, ”financially responsible“ business, a euphemism that means focusing more attention on the bottom line.”71 We could also say: those welcomed aboard to transform a creative enterprise into a capitalist one.
For good reasons, most economists interested in competition, economic dynamism, the meritocratic principle, and prosperity have not had a favourable view of capitalism. The classical liberal economist Alexander Rüstow lamented “the quasi-theological absolutized laissez-faire degenerate subsidized-monopolistic-protectionist-pluralist economy of the nineteenth and twentieth centuries we call ‘capitalist’ and ‘capitalism’”, which was entirely different from “the free market economy of perfect competition, the normal subject of liberal economic theory.”72
“With the intention of doing God’s will, the devil was given free rein, the devil of seeking enrichment at the expense of others, lust for power, and the will to dominate.”73
Ludwig Erhard wrote about his teacher, the economist Franz Oppenheimer: “He recognized capitalism as the institution that results in inequality, indeed enshrines inequality, even though he was certainly not interested in simple-minded egalitarianism. On the other hand, he despised communism since it necessarily destroyed freedom. He called for a new way—a third way—a happy synthesis that would provide a solution.”74
Genuine entrepreneurs have no need for capitalism. With the disappearance of capitalism, the exclusivity of access to capital could be eliminated, and with it the opportunity to turn other people’s labour into one’s own income without work.