Capitalism

With a New Postscript on the Financial Crisis and Its Aftermath

Geoffrey Ingham

• Publisher: Polity
• Year: 2013
• ISBN:
  9780745641232
• Edition: 1
• Topic: Scienze sociali
• Subtopic: Sociologia

Now with a substantial new postscript on the financial crisis

This book provides a basic introduction to the 'nuts and bolts' of capitalism. It starts by examining the classic accounts of capitalism found in the works of Adam Smith, Karl Marx, Max Weber, Joseph Schumpeter, and John Maynard Keynes. Each placed emphasis on different institutional elements of capitalism - Smith on the market's 'invisible hand'; Marx on capital's exploitation of labour; Weber on the foundations of economic rationality; and Schumpeter and Keynes on the instability that results from capitalism's essentially monetary and financial character.

Drawing on these classic accounts, Ingham then offers a succinct analysis of capitalism's basic institutions and their interconnections. Market exchange, the monetary system, the enterprise, capital and financial markets, and the role of the state are dealt with in separate chapters which make use of contemporary material on the recent history of the capitalist system - including the great inflation of the 1970s and the neo-liberal backlash; the 'dot.com' bubble of the late 1990s; and the collapse of Enron and other US corporations. This revised version includes a substantial new postscript on the financial crisis of 2007-8 and its aftermath. The result is a concise, masterly and up-to-date account of the world's most powerful economic system, written in a way that is accessible to students and general readers alike.

Part I: Classical theories of capitalism

1

Smith, Marx and Weber

Adam Smith (1723–1790): the market as a harmonizing ‘invisible hand’

Published in 1776, Adam Smith’s The Wealth of Nations was an attempt to explain western Europe’s unprecedented acceleration in economic growth. Before this time, the wealth of a nation was relatively easy to explain – it was largely the result of the ‘visible hand’ of military power. Countries might differ in their endowments – such as climate, the fertility of the land and natural resources – but these advantages could always be obtained by conquest. Economic power was evidently a consequence of military power. By and large, rulers subscribed to the mercantilist doctrine which held that power should be founded on amassing and hoarding wealth within a territorial state. For some, even the export trade was interpreted as a loss of resources that, furthermore, might even strengthen an enemy.¹

From the late seventeenth century onwards developments seemed to contradict this doctrine and to lend support to alternative explanations of the rise and fall of states. By the middle of the eighteenth century it was becoming apparent that the progression of society through a succession of increasingly wealthy stages of development could not be explained simply as the result of powerful rulers’ conscious intent. Arguably the most mercantilist of all European states, Spain, was eventually brought down by a small country with negligible natural material resources of its own – Holland (Smith 1986 [1776]: 473). Here, the relationship between military and economic power was seemingly reversed. Whilst Spain had sought power by the conquest and seizure of south American silver, the Dutch East India Company’s trading ventures produced the wealth that supported an expansion of military power. Successful wealthy European societies, Smith argued, were entering a new stage of economic development – based on ‘commerce’.² Here, the creation of wealth was the result of myriad individuals pursuing their own interests, not the strategies of powerful rulers. Consequently, the two fundamental economic questions – the growth of wealth and its distribution – now required a quite different explanation.

Smith’s answer to the questions is provided by his analysis of the interrelationship between three elements of ‘commercial’ society – factors of production, the market and the state. The Wealth of Nations was the first comprehensive examination of the emerging market capitalist system, and it remains enormously influential (Smith 1986 [1776]). It was written before the growth of industrial capitalism – that is to say, before factory production in large externally financed corporations. Rather, Smith was concerned with the first significant structural change in the evolution of the modern economy – the rapid development of market exchange. By the eighteenth century, the closed self-sufficient economic systems of the household and manor had given way to the market mechanism in which wages and prices were rapidly replacing traditional reciprocity and redistribution.³ Moreover, Smith saw that there was a direct link between this expansion of the market and the division of labour. Extensive specialization of task and economic function eliminates the self-sufficiency of household and manor, making market exchange necessary, which in turn permits further specialized, divided labour and, consequently, greater efficiency and economic growth.

The factors of production

Commercial society comprises two sectors – agriculture and manufacture, in which capital (or stock), comprising mainly the instruments of production, employs labour (Smith 1986 [1776]: Book II). This gives commercial society its three factors of production – land, capital and labour. This fundamental division of function is the basis for ‘three great constituent orders’ of society – landlords, capitalists and labourers. Their mutual dependence can be traced through the exchange relations between rents, profits and wages in a ‘circular flow’ of production, income and expenditure. The capital stock provides the wages for the worker’s expenditure and consumption of the production, which, in turn, creates profit, more capital and so on.

The division of labour and market exchange

The basic mechanism of the commercial system is the division of labour, the mutual dependence of the separate parts and their consequent need to exchange their products. Unlike feudal obligation or the compulsion of slavery, interdependency – that is, the connection between the parts – in commercial society is based upon the market price of the respective factors that are freely established in what Smith referred to as the ‘perfect liberty’ of exchanges.

Within each of the three divisions of society – land, capital and labour – there is further specialization of function or task. Smith illustrated the advantages of specialization in raising the productivity of labour with the example of the eighteen distinct operations performed by different workers in the manufacture of nails (Smith 1986 [1776]: 112–13).

Coordination of the complex functionally differentiated system is accomplished spontaneously by the ‘invisible hand’ of the market – that is, the interaction of supply and demand that represents the decisions of myriad otherwise unconnected individuals. The rise and fall of prices signal the existence of either scarcity or abundance to producers and consumers, whose self-interest ensures that any imbalances are corrected. For example, capital is attracted to sectors with rising prices and profits, causing them to fall as a result of the increase in competition. If left to operate unhindered, the invisible hand ensures that the ‘circular flow’ of production, income and expenditure, and the supply and demand for goods, will move to an equilibrium at which incomes and revenues from production cover costs, and all resources are fully employed.

However, the market was not merely a self-regulating economic mechanism; it was also a means of social integration. Exchange cemented society in networks of mutually advantageous interdependence, and it could also be seen as resolving the eternal ethical question of the relationship between individual conduct and the general collective welfare. If self-interest led to the wealth of nations, then, as Mandeville had expressed it earlier in his Fable of the Bees (1714), ‘private vices’ were the source not only of ‘public benefits’ but also of ‘public virtue’.

This conclusion about the efficacy of the market depends on the important assumption that individuals do not wish to store wealth in the form of money. In his opposition to the mercantilist doctrine that the power of states is enhanced by the accumulation of precious metal money rather than the pursuit of commerce, Smith relegated money to a secondary, passive role in his analytical system. It was irrational, Smith contended, to hold money when it could either be used to obtain capital investment goods (fixed capital and stock) in order to make profits or spent to satisfy wants. Hoarded precious metal money was unproductive; for Smith, money should be nothing more than a medium to facilitate market exchange. This ‘great wheel of circulation’ was not to be confused with the real wealth of society that resided in the factors of production and goods that it circulated (Smith 1986 [1776]: 385).⁴

Commerce, politics and the state

In his polemic against the claims of absolutist monarchies and their false mercantilist policies, Smith relegated politics and the state to a minimal role in economic affairs. In the first place, the idea of the invisible hand’s harmonization of individual and societal welfare was incompatible with politics understood as conflict between inherently opposed interests. Second, his insistence that economic coordination and wealth creation were the spontaneous, unintended consequences of self-regarding individuals in the marketplace was aimed at demonstrating that the state’s direct involvement in economic activity was counterproductive. Governments must leave economic decision-making to individuals in the ‘perfect liberty’ of the competitive market.

This does not mean, as is all too commonly assumed, that the state is unimportant for Smith. On the contrary, he saw that it performed three indispensable roles in the commercial stage of society (Smith 1986 [1776]: Book V). First, the state should provide for the defence of the territory in which perfect liberty could be exercised. Second, and to the same end, the state must uphold the rule of law. Without secure property rights over the use and disposal of goods and capital the market cannot function. Third, the state should provide certain ‘public goods’ that it may never be profitable for individuals to produce ‘privately’ (see the discussion of ‘public goods’ in chapter 5). Smith’s short list of ‘public goods’ refers mainly to infrastructure, such as roads, bridges, harbours and canals, where the level of capital investment and the difficulty of setting prices and of collecting revenue deter private provision. But he remained convinced that wherever possible general public services were better performed when supplied in the pursuit of profit by private entrepreneurs.

As we shall see, this partial qualification of the invisible hand’s efficacy opens up the possibility that the state may be required under certain circumstances to play a more extensive economic role, or even replace the market mechanism. Smith was writing at a time when most goods and services could be more easily provided privately, as they required relatively less capital investment and coordination than today. Despite the recent privatization of public services in advanced capitalist economies, the modern state’s role in financing public works, as we shall see, is far greater than it was in Smith’s day. Rail transport, for example, is widely accepted in many, if not quite all, developed economies as being most effectively and efficiently run by the state. Furthermore, the deleterious environmental consequences of industrialism, financial crises and protracted economic depressions were less apparent in the middle of the eighteenth century.

Eventually, states were called upon to try to deal with what modern economists refer to as ‘negative externalities’ and ‘market failure’ (see the discussions in chapters 5 and 8). (But, eighty years or so after the publication of The Wealth of Nations, Karl Marx, as we shall see, had formed a clear view of the negative consequences of the ‘perfect’ economic liberty of commercial society.)

Value and distribution

The question of the source of value and its distribution remains the subject of an intense debate in economic theory that cannot be discussed here in any detail. Rather, the present aim is to focus on how Smith’s answers disclose his conception of the structure of the emerging capitalist society – that is, his attempt to make the operation of the guiding ‘hand’ more visible to us.

Just as the power of states and their sovereigns no longer provided wholly satisfactory explanations of the growth of the wealth of nations, it could no longer account for its distribution among the three great constituent orders of society and labour’s different occupations (Smith 1986 [1776]: 134). Commerce and industry had at least partially overturned traditional hierarchies based on religious sanction and political power. For example, the mediaeval scholastics’ attempt prescriptively to regulate economic life with ‘just prices’ and the prohibition of unethical practices such as usury had long since been abandoned. But the question remained: why and how did the apparently free and equal exchange in the ‘perfect liberty’ of the market result in inequality? It remains, as we shall see, a central issue in the politics of modern capitalist democracies.

In a similar manner to the explanation of wealth creation as a spontaneous outcome of the market, Smith and the classical economists sought to locate the mechanism for the distribution of income among the factors of production (land, labour and capital) and the specialized occupations in the actual structure of the division of labour itself. Inequality was produced by the impersonal, and implicitly neutral, mechanism of the ‘invisible hand’, not by directly coercive exploitation as it had been in feudal society. The relative shares of rents, wages and profits were determined by their exchange value – that is, the price that had to be freely paid for the use of land, labour and capital for production.

Smith distinguished between the natural price – that is, that which exactly covers costs of production – and the market price, which is determined by scarcity and the balance of supply and demand at any point in time. The two prices frequently diverge in the short term, but in the long run the competitive market ensured their convergence. For example, if the market price were too low to cover costs, then the enterprise or sector would fail. On the other hand, if the market price met these with ease, then, as we have noted, more enterprise would be attracted to the sector in pursuit of easy profits, increasing both competition and supply and, consequently, reducing prices. In modern economic terminology, the economy would move towards equilibrium (Smith 1986 [1776]: chapter VII). At this point, the relative share of the distribution of income between the three factors and their respective occupations is that which brings about the full employment of society’s resources. In this situation, produced by free exchange, the factors of production would receive precisely the return which rewarded their contribution to this perfect balance. Any other distribution would perturb the equilibrium. In the long run, rent, wages and profits were equivalent to the value of their contribution to the aggregate wealth. Not only was the ‘invisible hand’ efficient, it was also just and fair.⁵

Smith’s legacy

In the third century after its publication The Wealth of Nations holds its place as the most cited work in economics. As we shall see, the economic and political crises of the early twentieth century led to a loss of faith in the effectiveness of the free market. John Maynard Keynes and others argued that the economy required greater levels of state involvement (see chapter 2), and for a short time communist economic systems appeared to be viable alternatives. However, as we shall see, the economic crises and inflation in the West during the 1970s and the disintegration of communism in the late 1980s led to the discrediting of Keynesian macro-economic management and the utter abandonment of socialist state planning. In the strong revival of the belief in the superiority of the free market as the means of organizing economic activity, Smith’s analysis of the efficacy of the market experienced a strong revival. Together with the work of later theorists such as Friedrich Hayek (1899–1992) and Milton Friedman (1912–2006),⁶ The Wealth of Nations forms the basis for the hegemony of today’s economic ‘neo-liberalism’, which favours market deregulation, privatization and the reduction of the state’s role in economic affairs.

Pro-globalization arguments for the extension of market capitalism are fundamentally Smithian in their advocacy of a world-wide division of labour and free trade, with states largely restricted to the provision of public goods and the facilitation of the market mechanism (Wolf 2005). Even his greatest critic, Karl Marx, agreed that the division of labour, competition and trade were responsible for the hitherto unprecedented expansion of human welfare; but he believed that Smith had misunderstood the nature of the ‘invisible hand’ and its eventual consequences. For Marx, the capitalist system was to be explained not simply by the technologically determined division of labour and market exchange, but, rather, by the inherent inequality of power of capitalist property relations. Furthermore, the market’s efficiency was ultimately negated by contradictory and eventually destructive tendencies.

Karl Marx (1818–1883): exploitation and the fatal contradictions of the capitalist mode of production

As Lenin observed, Marx combined three strands of thought – German philosophy, French socialism and Scottish and English political economy (Kolakowski 1978). Our main focus will be on Marx’s critical dissection of the last-mentioned, for which he used two related analytical tools taken from German philosophy: the distinction between appearance and essence, and the Hegelian idea of historical progress through the dialectical interaction of contradictory elements. First, Marx sought the ‘laws of motion of modern society’ at a deeper level than the superficial appearance of, on the one hand, equal exchange between freely contracting individuals and, on the other, the functional integration of the factors of production in the ‘circular flow’. He also challenged the idea that capitalist society harmonized individual interests and collective social welfare in the way that Adam Smith had contended.

For Marx, capitalist production did not have the primary aim of creating ‘use-values’ for the satisfaction of genuine human needs; rather it was an economic system exclusively oriented to the realization of monetary profit by the production of commodities with an ‘exchange value’. In Smith’s scheme these two goals are reconciled by the invisible hand; but, for Marx, the capitalist mode of production places them in opposition. Use-values are subordinated to the pursuit of exchange-value and profits. Moreover, the seemingly free market of exchange between legal equals masks an underlying reality of increasing inequality and exploitation. Workers, unlike slaves, were free to choose which master to work for, but, without alternative means of subsistence, they were compelled to sell their labour to the bourgeois class. The fundamental market exchange in capitalism – that is, the buying and selling of labour power – was inherently unequal. Marx sought to tear away what he considered to be the ‘masks’ and ‘veils’ that bourgeois political economy had placed over the real ‘laws of motion’ – that is, to uncover the essence that lay beneath the superficial appearance described in what he referred to as Smith’s ‘bourgeois political economy’.

Second, the idea of a harmonious integration of the factors of production – land, capital and labour – was unable to explain obvious features of capitalist society. If capital, production, income and consumption were functionally linked in a ‘circular flow’ of equal exchange, in which the revenues from each were used by the others to the point where costs were covered, how were profits and economic crises to be explained? A ‘circular flow’ guided by an ‘invisible hand’ seriously misrepresented a type of society that was subject to ever more frequent economic booms and slumps and growing inequality. Marx contended that the pursuit of individual interest in the market not only failed to maximize collective welfare but also resulted in the anarchy of uncoordinated economic decision-making that brought about unintended and uncontrolled fluctuations between over- and under-production.

In general, Marx argued that crises were expressions of the inherent contradictions between t...