Economic Renaissance: The beginnings of Capitalism

Despite our images of cigar-smoking robber barons in dapper suits with monocles and shiny top-hats, capitalism actually started out innocuously enough from the poor classes. Prior to capitalism your social status was largely a product of your birth. If you were born poor you were poor the rest of your life. If you were born rich you inherited everything you had through the aristocracy of your family. You were pretty much stuck where you were. Manufacturing was purely a process held in cities by the wealthy and served only the wealthy.

Eventually, however, people in rural communities started having a surplus of people. More people were being born than there were things for them to do. These people had no work in the agricultural community and were denied access by kings and nobles to manufacturing and thus became outcasts in society. Eventually, however, these poor outcasts started banding together to make small shops that would produce something. They didn't produce expensive items that only the wealthy could enjoy but instead produced things that everyone could enjoy. And thus capitalism as we know it today was born.

As celebrated economist Ludwig Von Mises put it "It was mass production to satisfy the needs of the masses."

So capitalism didn't spring forth as the result of a wealthy aristocracy finding new ways to exploit the lower classes but it was a natural extension of the lower classes finding better ways to do things and make them available to everyone. And it was the first time the lower classes would have the opportunity to dig themselves out of the circle of poverty that had gripped the poor throughout history.

But not everyone is cut out for entrepreneurship. Some people don't want to shoulder the risk or don't feel they have the guile or ability to manage a business, others simply don't want to work that hard or take on that much stress. What did these people do? Well, they still sold someone a product but this time that product was their own skill and labor.

This is an important thing to realize because the collective gasp of outrage against capitalism is almost always centered on the idea that the laborer doesn't own the product of their labor, as if they were shackled to a machine and forced to toil for rich business owners. The laborer isn't trying to own the product of his labor, he is merely exchanging his labor for money.

Remember the Principle of Voluntary Exchange? Two parties freely exchange goods or services in such a way that both parties walk away from the arrangement better off. The same applies to labor. Let's consider that the laborer makes pins in a shop for a living. If the laborer toiled in the shop making pins for himself he is not only a pin-maker but a pin-salesmen too since he has to sell the pins to someone else since he can't eat them or build a house out of them. He now has to divide his time between two tasks, even if he's only really good at one.

So, instead the laborer takes his speciality, which is making pins, and sells that speciality to someone else who will be in charge of selling the pins. In fact, that someone else secures all the materials to make pins, furnishes the tools to make the pins, and sells and distributes the pins. All the pin-maker has to do is show up and make them in exchange for money which he can use to feed and shelter himself. The pin-maker walks away from the exchange better off because he got to get maximum profit from his speciality and the pin-merchant is better off because he found someone better than he at making pins and thus could concentrate his efforts on buying the materials and selling the final product (and doing all the accounting so he can pay his taxes to the government). Both parties are better off than when they started.

Let's break it down mathematically, just to clear it up some and really illuminate this wonderful system of exchange. We'll take our two-man pin-making company and use it further.

To keep it simple, let's assume a pound of pins costs $100 to make and a dedicated laborer can make a pound of pins a day. Since labor accounts for around 70% of the cost of a product that means that $70 was required in just what was paid to the employee to produce the product. The remaining $30 is the cost of the raw materials used to create the product.

Now, socially-minded folks think that charging $100 for the product would be fair because the laborer made $70 that day and then added $30 onto it for the cost of the materials to make the pins. In a Marxist viewpoint the laborer owns the product of his labor and an entrepreneur merely exploits the employee by robbing him of his work and then charging more for the product on the shelf.

By this reckoning it is entirely unfair for the entrepreneur to charge more than $100 for his product, even though the entrepreneur also labored for the creation of that product (the money he borrows to buy the capital in order to have a facility and tools in which his employee uses, the procurement of raw materials to be used in the product since raw materials don't buy themselves, and the sale and distribution of the final product since pins don't sell or deliver themselves), under a Marxist system it is proposed that the capitalist shouldn't make any money from this labor simply because he wasn't the one lifting the hammer to build it and thus he hasn't added any value to it.

Well, maybe that's a fair enough assessment. Maybe instead the pin-maker should secure the materials, secure the capital, build the product, sell the product, and deliver the product himself, instead of just giving it over to the capitalist. Now all this work makes the worker not only the producer of pins but also the purchaser, the accountant, the salesman, and the delivery truck driver.

All of this work would require not only a great deal of skill in multiple areas but it would also require him to split his workday to accommodate all these tasks. And for his workday to be equal to his workday from when he was only a laborer working for the capitalist, he is going to have less time allotted to produce the actual product. In this sense, do you feel he should still only charge $100 for his product? He'll quickly fall behind the normal standard of living he might have enjoyed if he settled for $70 and was just a laborer because he is only getting paid for the time spent producing, not the time spent purchasing the materials, selling the product, distributing the product, and finally accounting for all the sales for taxes.

If all those tasks take an equal amount of time, then he's only making $14 for a day's work of working for himself instead of the $70 a day he made simply working for someone else. So the worker has one of three options. He can work much longer hours to produce more, he can raise his prices substantially to make up for his income gap, or he can simply settle for a paltry wage that he probably wouldn't be able to live on because if the entire economy operates that way then the prices remain high while income remains low. This is tantamount to self-imposed serfdom.

So, this is a pretty simple yet effective example about how capitalism works. The idea is that everyone walks away from the exchange better off. In the next installment I'll discuss our plucky pin-maker further and explain how the division of labor makes everyone in a society richer.

"So what exactly is this economy business anyhow?" Pt. III (home stretch!)

In my last installment of on the rudiments of economics, I'll discuss the five Key Principles of Economics, those things that are self-evident truths that we understand and accept in the economic world like we do gravity or fire being hot.  I'll touch on them here but will reference them more and more as time goes on because economic analysis keeps coming back to them.  Think of them as the foundation on which economies are built.

-The Principle of Opportunity Cost is based on the principle that economics is all about analyzing trade-offs.  The opportunity cost of something is what you have to sacrifice to get it.  If you pay $100 for tickets to the next sweet U2 show, then that is $100 you aren't spending on something else, like CD's from a bunch of other bands that are infinitely better, or donations to Sally Struthers, or approximately 20 Shamwows.  Additionally, we can apply it to time as well since time is a limited resource too.  For every U2 concert you go to, that's less time you have to look at porn on the internet, or punch yourself fervently and repeatedly in the crotch (though efficient people will realize that the latter activity is very similar to going to the concert in the first place).  

-The Marginal Principle is simply thinking in marginal terms and the results of small incremental changes in activity.  "Marginal Benefit" is the additional result of an increase in an activity and "Marginal Cost" is the additional cost of said increase in activity.  If U2 could raise the price of tickets and sell them all by playing an extra hour, their marginal benefit (more ticket revenue) exceeds their marginal cost (less time lamenting the social injustice in the world) and it would make sense for them to pursue this.  The level of the increase in an activity should always continue until the marginal cost equals the marginal benefit.  Thinking at the margin is basically "fine-tuning" the decision-making process to the point where we maximize the benefit from our choices.  

-The Principle of Diminishing Returns is the principle that states the number of inputs will eventually cause a reduction in outputs that decrease at an increasing rate.  At some point U2 playing long concerts will actually cause the increase of ticket sales to slow down as they extend their sets because at some point, the allure of listening to 12-hours of Bono keening into a microphone stops being worth the additional cost of the ticket.  So for every additional hour they spend playing (the input), actually causes ticket sales to slow down (the output).  They still might sell more tickets for each additional hour they play, but not at the rate they were selling them when they decided to only play for two hours.  And, at some point, it will start costing them more to play than they will generate in revenue.

-The Principle of Voluntary Exchange is the big one that the socialist thinkers overlook a lot.  This is when two individuals make an exchange that makes both individuals better off.  Everything from wages people are paid to the price of goods falls under this and you'll hear me talk about it a lot.  If U2 is charging $100 a ticket for their two-hour show of rockin' tunes, they are better off for having sold you the ticket and the concert-goer is better off for having an enjoyable experience of delay-drenched guitar rock and an increased awareness of social injustices going on throughout our world.  Or, to put it into more tangible terms, when you buy a pound of hamburger at Wal-mart, Wal-mart is better off with the money you give them than they were with the pound of meat slowly decaying in their meatcase and you are better off with a pound of cow meat than you were with the money because you can't actually eat money.  The cow, incidentally, has benefitted nothing from this exchange.  

-The Real-Nominal Principle is the principle that states what matters to people is the real value of money or income and not its "face" value.  The "1" on the dollar bill means nothing to you other than what it will actually buy you.   In 1913 that dollar in your pocket bought you a dollar's worth of goods.  Today it will buy you $0.04 worth of goods.  (or a 100-dollar bill bought you a U2 ticket but back then it would have bought you 25 U2 tickets--fun for the whole family!).  Obviously we are more concerned with what our money will actually buy us as opposed to what the number on the currency says.  This is important to remember too because if the price of your goods goes up by 4% in a year, and you get a 3% raise that year, you're actually worse off this year than last year.  This is part of the "money illusion" and I'll be bringing that concept up later on down the road.

So that concludes the fundamentals.  Now you're ready to strap on your thinking helmets and follow me down through the maelstrom of free market economics and why freer markets mean freer people overall and how these uncontrolled forces actually work better and more naturally on their own than when we try to tinker with them ourselves.  See you soon!  

"So what exactly is this economy business anyhow?" Pt. II

So now that we're up to snuff on the The Holy Trinity of Economics Questions, let's see how we can go about answering them.  

First off, people are largely the ones who take resources and turn them into goods (though bees might produce honey, they still don't package it and deliver it to us.  Yet.)  or produce services. We call these resources the factors of production which I will outline below:

-Natural resources are provided by, you guessed it, nature.  This can be anything from iron ore, to fertile land, oil and gas (the stuff underground, not the stuff that Uncle Herb produces), water, and Bono's fertile imagination.  

-Labor is the physical or mental effort that people exercise to produce a good or service.  At your favorite fast food joint the cook heats a hamburger patty (the raw material) and throws it into a bun and wraps it with paper (the product) and the squeaky-voiced kid with the headset takes your money and hands you your greasy prize (the service).  Note that this doesn't apply to sandwich artists.  Those people create mayonnaise-drenched works of art, apparently.  

-Physical capital is all the equipment machinery, buildings, tools, infrastructure and other physical objects that are used to produce goods and services.  The fast food cook can't cook your freedom fries without a deep-fryer and the cashier can't keep your food warm for hours before you buy it without those orange lamps.  Even sandwich artists need a palette and canvas (i.e. rows of colorful tubs filled with ingredients and some waxy paper).

-Human capital is the knowledge and skills required to do the job which are acquired through experience or education.  This is why fast food places have an orientation so they can train their teenaged worker-bees on the many arcane aspects of grilling "meat" and how to push buttons on a cash register.  Getting them to get your order right, on the other hand, is a much more advanced discipline.  Sandwich artists, conversely, are born with their talent.  That's why they are artistes!  

-Entrepreneurship (stop with the ugly words!) is the effort exerted to coordinate the other aforementioned factors of production to produce and sell products.  The entrepreneur is the one who comes with the idea ("what if we could produce full-cooked 'food' nearly instantaneously for people in a hurry?"), decides how to produce it ("We'll use teenagers who need to learn the value of working and have them operate utterly simple machines!"), and raises the cash to bring the idea to the marketplace ("I get a loan from the bank, I build a building with some machines in it, and I buy cheap killing-room floor scraps from the meat-packing plant to create my product!").  Well, we can only assume that was Ray Kroc's vision, anyway.

In a free market, the entrepreneur is half of the equation on who gets to answer the three economic questions.  The other half of the equation is consumers: the people who ultimately buy (or don't buy) the product.  In a free market the questions are answered through the millions of transactions that take place everyday; when someone has a good idea and can produce it as cheaply as possible, more people will buy this product.  When someone has a bad idea (like Crystal Pepsi), then people don't put forth the cash to buy it, thus telling the entrepreneur in no uncertain terms, that their idea for transparent cola is a stupid one. 

And good ideas become better ideas when someone takes an idea and improves on it to make it easier to produce and more accessible to more people.  Consider that automobiles were originally a luxury only the wealthiest people could afford but as society got richer overall (because we got more productive and innovative) and innovation led to cheaper and easier forms of production, prices of automobiles dropped as real wages and the standard of living went up.  Now people in all social classes have access to automobiles to some degree or another.  Jetson-styled flying cars, on the other hand, we're still waiting for.  

"So what exactly is this economy business anyhow?" Pt. I

So we've been hearing an awful lot about the economy in the last year or so. Like a child at a family reunion it goes largely unnoticed until it starts doing bad things. We hear about it everyday now, usually accompanied by tales of gloom and woe. It's our modern Ragnarok, the giants of poverty will rise up and strike the good people of the world down. But despite hearing about the economy, there's still a lot of head-scratching by the general public as to what all the noise is about. So before I go on long-winded diatribes about the fun stuff, let's get the basics down first so we're clear from the get-go.

Economics is the study of choices in the environment of scarcity. Notice there is absolutely nothing about money in that definition. Economics isn't the study of money, so get that out of your mind right here and now. No, seriously, just shoo it right out of the cerebral door along with last week's grocery list and what you heard Rush Limbaugh wheezing about yesterday.

Yes, money is involved in the economy and in the study of economics but that's only one facet of the greater whole; economies existed long before money ever existed. Ever since Ub-Ub the Caveman figured out how to turn a pile of dry tinder into something more useful, we've had economies.

But the key words are "choices" and "scarcity" in what we're talking about. Let's start with the last one first. Scarcity is the idea that resources--those things we use to produce goods and services--are limited, while human wants are unlimited. Yes, even you, who lives in a spartan apartment decrying the evils of materialism and consumerism has unlimited wants, even if your want is to simply distribute all the resources of the world evenly to mankind.

The second key word in the definition is "choices". The economy exists because of scarcity; when we want lots of things (like food, shelter, or patchouli oil) but don't have enough things to go around. Economics is the study of the choices we make in this scenario of trade-offs.

So let's consider a few examples:

--You have a limited amount of time. If you work a job at the salt mines, for every hour you are toiling away to make salt barons rich, that's an hour you lose that you could be spending playing euchre or reading a Noam Chomsky book.

--There is a limited amount of land. For every acre of land you make into a nature reserve, that's one acre of land we can't build a widget factory on. And take it from me, people like widgets.

--You have a limited amount of income. Conversely, every hour you spend reading World Orders Old and New is an hour you aren't in the salt mine generating income for yourself. And if you spend $20 this year buying that sweet new Coldplay album, that's $20 less you have to spend on sushi or put into a savings account.

So with limited resources we have to decide how we're going to use them. This brings us to the Holy Trinity of Economics Questions: What, How and Who?

-What products do we produce? Here are the trade-offs: if Bono is in the studio making the next brilliant life-altering sonic masterpiece that will change the world, that's less time he's spending helping to put together the next Live Aid or raising money for Amnesty International.

-How do we produce the products? There is often more than one way to skin a cat (I won't go into the gruesome details) but to use another example, we can create energy from coal, natural gas, wind, smashing atoms or a million hamster wheels. How do we decide which way to produce the goods?

-Who gets to consume the product? Now we have to decide how those goods are distributed. If someone makes more money than someone else, should that person be allowed to consume more? Or should the government take that money from him and give it someone else? Or (even more likely) should the government take the goods from everyone and keep most of them for themselves (governing is hard work, folks!) and give the leftovers back to who hasn't starved yet?

These three questions will essentially be the large bulk of what I'll address throughout this blog, but consider those questions for yourselves. They're important!