Why capitalism works. From George Reisman at mises.org:
By the “benevolent nature of capitalism,” I mean the fact that it promotes human life and well-being and does so for everyone. There are many such insights, which have been developed over more than three centuries, by a series of great thinkers, ranging from John Locke to Ludwig von Mises and Ayn Rand. I present as many of them as I can in my book Capitalism.
I’m going to briefly discuss about a dozen or so of these insights that I consider to be the most important, and which I believe, taken all together, make the case for capitalism irresistible. Let me say that I apologize for the brevity of my discussions. Each one of the insights I go into would all by itself require a discussion longer than the entire time that has been allotted to me to speak today. Fortunately, I can fall back on the fact that, in my book at least, I think I have presented them in the detail they deserve.
And now, let me begin.
1) Individual freedom—an essential feature of capitalism—is the foundation of security, in the sense both of personal safety and of economic security. Freedom means the absence of the initiation of physical force. When one is free, one is safe—secure—from common crime, because what one is free of or free from is precisely acts such as assault and battery, robbery, rape, and murder, all of which represent the initiation of physical force. Even more important, of course, is that when one is free, one is free from the initiation of physical force on the part of the government, which is potentially far more deadly than that of any private criminal gang. (The Gestapo and the KGB, for example, with their enslavement and murder of millions made private criminals look almost kind by comparison.)
The fact that freedom is the absence of the initiation of physical force also means that peace is a corollary of freedom. Where there is freedom, there is peace, because there is no use of force: insofar as force is not initiated, the use of force in defense or retaliation is not required.
The economic security provided by freedom derives from the fact that under freedom, everyone can choose to do whatever he judges to be most in his own interest, without fear of being stopped by the physical force of anyone else, so long as he himself does not initiate the use of physical force. This means, for example, that he can take the highest paying job he can find and buy from the most competitive suppliers he can find; at the same time, he can keep all the income he earns and save as much of it as he likes, investing his savings in the most profitable ways he can. The only thing he cannot do is use force himself. With the use of force prohibited, the way an individual increases the money he earns is by using his reason to figure out how to offer other people more or better goods and services for the same money, since this is the means of inducing them voluntarily to spend more of their funds in buying from him rather than from competitors. Thus, freedom is the basis of everyone being as economically secure as the exercise of his own reason and the reason of his suppliers can make him.
2) A continuing increase in the supply of economically useable, accessible natural resources is possible as man converts a larger fraction of the virtual infinity that is nature into economic goods and wealth, on the foundation both of growing knowledge of nature and growing physical power over it. (For elaboration of this important point, see “Environmentalism in the Light of Menger and Mises” in the 2002 summer issue of The Quarterly Journal of Austrian Economics.)
3) Production and economic activity, by their very nature, serve to improve man’s environment. This is because from the point of view of physics and chemistry, all that production and economic activity consist of is the rearrangement of the same nature-given chemical elements in different combinations and their movement to different geographical locations. The guiding purpose of this rearrangement and movement is essentially nothing other than to make the chemical elements stand in an improved relationship to human life and well-being. It puts the chemical elements in combinations and locations where they provide greater utility, greater benefit to human beings.
The relationship of the chemical elements iron and copper, for example, to man’s life and well-being is greatly improved when they are extracted from beneath the earth and made to appear in such products as automobiles, refrigerators, and electric cable. The relationship of chemical elements such as carbon, hydrogen, oxygen, and nitrogen to man’s life and well-being is improved when they can be made to yield electric light and power. The relationship of a piece of land to man’s life and well-being is improved when instead of his having to sleep upon it in a sleeping bag and take precautions against snakes, scorpions, and other wildlife, he can sleep in a well-constructed modern home that is built upon it, with all the utilities and appliances we take for granted.
The totality of the chemical elements in their relationship to man, constitutes man’s external, material environment, and precisely this is what production and economic activity serve to improve, by their very nature.
4) The division of labor, a leading feature of capitalism, which can exist in highly developed form only under capitalism, provides among other major benefits, the enormous gains from the multiplication of the amount of knowledge that enters into the productive process and its continuing, progressive increase. Just consider: each distinct occupation, each suboccupation, has its own distinct body of knowledge. In a division-of-labor, capitalist society, there are as many distinct bodies of knowledge entering into the productive process as there are distinct jobs. The totality of this knowledge operates to the benefit of each individual, in his capacity as a consumer, when he buys the products produced by others — and much or most of it also in his capacity as a producer, insofar as his production is aided by the use of capital goods previously produced by others.
Thus a given individual may work as a carpenter, say. His specialized body of knowledge is that of carpentering. But in his capacity as a consumer, he obtains the benefit of all the other distinct occupations throughout the economic system. The existence of such an extended body of knowledge is essential to the very existence of many products — all products that require in their production more knowledge than any one individual or small number of individuals can hold. Such products, of course, include machinery, which could simply not be produced in the absence of an extensive division of labor and the vast body of knowledge it represents.
Moreover, in a division-of-labor, capitalist society, a large proportion of the most intelligent and ambitious members of society, such as geniuses and other individuals of great ability, choose their concentrations precisely in areas that have the effect of progressively improving and increasing the volume of knowledge that is applied in production. This is the effect of such individuals concentrating on areas such as science, invention, and business.
5) At least since the time of Adam Smith and David Ricardo, it has been known that there is a tendency in a capitalist economy toward an equalization of the rate of profit, or rate of return, on capital across all branches of the economic system. Where rates of return are above average, they provide the incentive and also the means for stepped up investment and thus more production and supply, which then operates to reduce prices and the rate of return. Where rates of return are below average, the result is reduced investment and reduced production and supply, followed by a rise in profits and the rate of return. Thus high rates of profit come down and low rates come up.
The operation of this principle not only serves to keep the different branches of a capitalist economy in a proper balance with one another, but it also serves to give the consumers the power to determine the relative size of the various industries, simply on the basis of their pattern of buying and abstention from buying, to use the words of von Mises. Where the consumers spend more, profits rise, and where they spend less, profits fall. In response to the higher profits, investment and production are increased, and in response to the lower profits or losses, they are decreased. Thus the pattern of investment and production is made to follow the pattern of consumer spending.
Perhaps even more importantly, the operation of the tendency toward a uniform rate of return on capital invested serves to bring about a pattern of progressive improvement in products and methods of production. Any given business can earn an above-average rate of return by introducing a new or improved product that consumers want to buy, or a more efficient, lower-cost method of producing an existing product. But then the high profit it enjoys attracts competitors, and once the innovation becomes generally adopted, the high profit disappears, with the result that the consumers gain the full benefit of the innovation. They end up getting better products and paying lower prices.
If the firm that made the innovation wants to continue to earn an exceptional rate of profit, it must introduce further innovations, which end up with the same results. Earning a high rate of profit for a prolonged period of time requires the introduction of a continuing series of innovations, with the consumers obtaining the full benefit of all of the innovations up to the most recent ones.
6) As von Mises has shown, in a market economy, which, of course, is what capitalism is, private ownership of the means of production operates to the benefit of everyone, the nonowners, as well as owners. The nonowners obtain the benefit of the means of production owned by other people. They obtain this benefit as and when they buy the products of those means of production. To get the benefit of General Motors’ factories and their equipment, or the benefit of Exxon’s oil fields, pipelines, and refineries, I do not have to be a stockholder or a bondholder in those firms. I merely have to be in a position to buy an automobile, or gasoline, or whatever, that they produce.
Moreover, thanks to the dynamic, progressive aspect of the uniformity-of-rate-of-profit or rate-of-return principle that I explained a moment ago, the general benefit from privately owned means of production to the nonowners continually increases, as they are enabled to buy ever more and better products at progressively falling real prices. It cannot be stressed too strongly that these progressive gains, and the generally rising living standards that they translate into, vitally depend on the capitalist institutions of private ownership of the means of production, the profit motive, and economic competition, and would not be possible without them. It is these that underlie motivated, effective individual initiative in raising the standard of living.
7) A corollary of the general benefit from private ownership of the means of production is the general benefit from the institution of inheritance. Not only heirs but also nonheirs benefit from its existence. The nonheirs benefit because the institution of inheritance encourages saving and capital accumulation, to the extent that it leads people to accumulate and maintain capital for transmission to their heirs. The result of the existence of this extra accumulated capital is more means of production producing for the market, and thus more and better products for everyone to buy.
The effect of additional capital, of course, is also an additional demand for labor, and thus higher wage rates. The demand for labor, it should be realized, is a major means by which all privately owned means of production operate to the benefit of nonowners. Capital underlies the demand for labor as well as the supply of products.
8) Under capitalism, not only is one man’s gain not another man’s loss, insofar as it comes out of an increase in overall, total production, but also—in the most important cases, namely, those of the building of great industrial fortunes — one man’s gain is positively other men’s gain. This follows from the fact that the sheer arithmetical requirements of building a great fortune are a combination of the earning of a high rate of profit on capital for a prolonged period of time, and the saving and reinvestment of the far greater part of the profits earned, year after year.
As we have seen, the earning of a high rate of profit for a prolonged period of time, in the face of competition, requires the introduction of a series of significant innovations. These innovations represent better and less expensive products for the consumers. The saving and reinvestment of the profits earned on the innovations constitute the accumulation of means of production, which also serves the consumers. Thus both in their origin, in high profits, and in their disposition, in the accumulation of capital, great industrial fortunes represent corresponding gains to the general consuming public. For example, old Henry Ford’s starting with a capital of $25,000 in 1903 and ending with a capital of $1 billion in 1946 was the other side of the coin of the average person becoming enabled to buy a greatly improved, far more efficiently produced automobile—produced largely in factories representing Ford’s billion.
9) As von Mises has shown, the economic competition that takes place under capitalism is radically different than the biological competition that prevails in the animal kingdom. In fact, its character is diametrically opposite. The animal species are confronted with scarce, nature-given means of subsistence, whose supply they are unable to increase. Man, by virtue of his possession of reason, can increase the supply of everything on which his survival and well-being depend. Thus, instead of the biological competition of animals striving to grab off limited supplies of nature-given necessities, with the strong succeeding and the weak perishing, economic competition under capitalism is a competition in who can increase the supply of things the most, with the outcome being practically everyone surviving longer and better.
Totally unlike lions in the jungle, who must compete for a limited supply of animals such as zebras and gazelles, by means of the power of their senses and limbs, producers under capitalism are in competition for a limited supply of dollars in the hands of consumers, which they compete for by means of offering the best and most economical products their minds can devise. Since such competition is a competition in the positive creation of new and additional wealth, there are no genuine long-run losers as the result of it. There are only winners.
The competition of farmers and farm-equipment manufacturers enables the hungry and weak to eat and grow strong; that of pharmaceutical manufacturers enables the sick to recover their health; that of eye-glass and hearing-aid manufacturers enables many who otherwise could not see or hear, to do so. So far from being a competition whose outcome is “the survival of the fittest,” the competition of capitalism is more accurately described as a competition whose outcome is the survival of all, or at least of more and more, for longer and longer and ever better. The only sense in which only the “fittest” survive is that it is the fittest products and fittest methods of production that survive, until replaced by still fitter products and methods of production, with the effects on human survival just described.
As von Mises has also shown, with his development of Ricardo’s law of comparative advantage into the law of association, there is room for all in the competition of capitalism. Even those who are less capable than others in every respect have a place. In fact, in large measure, competition under capitalism, so far from being a matter of conflict among human beings, is a process of organizing that one great system of social cooperation known as the division of labor. It decides at what point in this all-embracing system of social cooperation each individual will make his specific contribution—who, for example, and for how long, will be a captain of industry, and who will be a janitor, and who will fill all the positions in between.
In this competition, each individual, however limited his abilities, is enabled to outcompete all others, however superior to him in their abilities they may be, for his special place. Quite literally, and as an everyday occurrence, those with abilities no greater than required to be a janitor are able to outcompete, hands down, without question, the world’s greatest productive geniuses — for the job of janitor. For example, Bill Gates might be so superior an individual that in addition to being able to revolutionize the software industry, he might be able to clean five times as many square feet of office space in the same time as any janitor now living, and do it better. But if Gates can earn a million dollars an hour running Microsoft, and janitors can be found willing to work for, say, $10 an hour, their readiness to perform the job at one one-hundred thousandth of the hourly rate Gates would require, so far dwarfs their lesser abilities that it is they who are “hors de concours” in this case.
At the same time, because productive geniuses are free to succeed in revolutionizing products and methods of production, those with abilities no greater than required to be janitors are able to enjoy not only food, clothing, and shelter, but even such products as automobiles, television sets, and personal computers, products whose very existence they could probably never have even dreamed of on their own.
The losses associated with competition are at most short-run losses only. For example, once the blacksmiths and horse breeders put out of business by the automobile found other lines of work on a comparable level, the only lasting effect of the automobile on them was that they too, in their capacity as consumers, came to enjoy the advantages of the automobile over the horse. Similarly, farmers using mules, who were driven out of business by the competition of farmers using tractors, did not die of starvation, but simply had to change their line of work, and when they did so, they along with everyone else enjoyed both a more abundant supply of food and of other products as well, which other products could be produced precisely on the foundation of labor released from agriculture.
Even in those cases in which an isolated competition results in an individual having to spend the remainder of his life at a lower station than he enjoyed before, for example, the owner of a buggy-whip factory having to live for the rest of his life as an ordinary wage earner after being put out of business by the automobile—even he cannot reasonably claim that competition has harmed him. The most he can reasonably claim is merely that from this point on, the immense gains he derives from competition are less than the still more immense gains he derived from it previously. For competition is what underlies the production and supply of everything he continues to be able to buy and is what is responsible for the purchasing power of every dollar of his and everyone else’s income. And, of course, it proceeds to raise his real income from the level to which it was set back. Indeed, under capitalism, competition proceeds to raise the standard of living of the average wage earner above that of even the very wealthiest people in the world a few generations earlier. (Today, for example, the average wage earner in a capitalist country has a standard of living higher than that even of Queen Victoria, in probably every respect except the ability to employ servants.)
10) And now, once more with credit to Mises, so far from being the planless chaos and “anarchy of production” that is alleged by Marxists, capitalism is in actuality as thoroughly and rationally planned an economic system as it is possible to have. The planning that goes on under capitalism, without hardly ever being recognized as such, is the planning of each individual participant in the economic system. Every individual who thinks about a course of economic activity that would be of benefit to him and how to carry it out is engaged in economic planning. Individuals plan to buy homes, automobiles, appliances, and, indeed, even groceries. They plan what jobs to train for and where to offer and apply the abilities they possess. Business firms plan to introduce new products or discontinue existing products; they plan to change their methods of production or continue to use the methods they presently use; they plan to open branches or close branches; they plan to hire new workers or layoff workers they presently employ; they plan to add to their inventories or reduce their inventories.
Still more examples of routine, everyday economic planning by private individuals and businesses could be found. Private economic planning is everywhere around us and everyone engages in it. But, to everyone except students of Mises, it is invisible. To those who are ignorant of Mises, economic planning is the province of government.
Immense, all-pervasive private economic planning not only exists, but it is also all coordinated, integrated, harmonized to produce a cohesively planned economic system. The means by which this is accomplished is the price system. All of the economic planning of private individuals and business firms takes place on the basis of a consideration of prices—prices constituting costs and prices constituting revenue or income. Individuals planning to buy goods or services of any kind always consider the prices of those goods and services and are prepared to change their plans in the face of price changes. Individuals planning to sell goods or services always consider the prices they can expect for their goods or services and are also prepared to change their plans in the face of price changes. Business firms, of course, base their plans on a consideration both of sales revenues and of costs and thus of the respective prices constituting both, and are prepared to change their plans in response to changes in profitability.
Thus, for example, when my wife and I first moved to California, our housing plan was to purchase a house high on a hill overlooking the Pacific Ocean. But after learning the price of such houses, we quickly decided that we needed to revise our housing plan and look for a house several miles inland instead. In this way, we were led to change our housing plan in a way that made it harmonize with the plans of other people, who also planned to buy the kind of house we were originally planning to buy but, in addition, were willing and able to commit to their plan more money than we were willing and able to commit. The higher bids of others and our consideration of those bids brought about a harmonization of our housing plan with theirs.
Similarly, a naive college freshman might have a career plan that calls for him to major in Medieval French literature or Renaissance poetry. But sometime before the start of his junior year, he comes to realize that if he persists in such a career plan, he can expect to live his life starving in a garret. On the other hand, if he changes his career plan and majors in a field such as accounting or engineering, he can expect to live very comfortably. And so he changes his career plan and major. In changing his career plan on the basis of a consideration of prospective income, the student is making a change that better accords with the plans of others in the economic system. For execution of the plans of others requires the services of far more accountants and engineers than it does the services of literary experts.
A last example: consumers change their dietary plan, and thus plan, say, to eat more fish and chicken and less red meat. This results in a corresponding change in their pattern of buying and abstention from buying. Now, in order to maintain their profitability, supermarkets and restaurants must plan to change their offerings, namely, to increase the respective quantities of fish and chicken and fish and chicken entrees or sandwiches they supply, and decrease the quantities of red meat and red-meat entrees or sandwiches they supply. These plan changes, and corresponding purchase changes, on the part of supermarkets and restaurants result in further plan changes and purchase changes, on the part of their suppliers and on the part of their suppliers’ suppliers, and so on, until the entire economic system has been sufficiently replanned to accord with the change in the plans and purchases of the consumers.
The price system and the consideration of cost and revenue that it entails on the part of all individuals leads to the economic system continually being replanned in response to changes in demand or supply in a way that maximizes gains and minimizes losses and ensures that each individual process of production is carried on in a way that is maximally conducive to production in the rest of the economic system.
For example, as the result of a decrease in the supply of crude oil, there will be a rise in the price of crude oil and of oil products. All individual buyers will consider the higher prices in relation to their own specific circumstances—in the case of consumers, their own needs and desires; in the case of business firms, their ability to pass along the increase to customers. And all of them will consider the alternatives to the use of oil or oil products available to them specifically. Thus, on the basis of his individual thinking and planning, each of the participants will reduce his demand for the items in a way that least impairs his well-being. And in this way, the thinking and planning of all participants in the economic system who use oil or oil products will enter into the determination of where and by how much the quantity of oil and oil products demanded decreases in response to a rise in their price. This is clearly an instance of responding to a loss of supply in a way that minimizes the loss. The reduction in supply will be accompanied by an equivalent reduction in its use in the least important of the employments for the which the previously larger supply had been sufficient.
Similarly, the price system and the individual thinking and planning of all participants leads to the maximization of the gains from an increase in the supply of any scarce factor of production. The additional supply is absorbed in those uses in which it is most highly valued, that is, in which it can be absorbed with the least fall in price.
Ironically, while capitalism is an economic system that is thoroughly and rationally planned, and continuously replanned in response to changes in economic conditions, socialism, as Mises has shown, is incapable of rational economic planning. In destroying the price system and its foundations, namely, private ownership of the means of production, the profit motive, and competition, socialism destroys the intellectual division of labor that is essential to rational economic planning. It makes the impossible demand that the planning of the economic system be carried out as an indivisible whole in a single mind that only an omniscient deity could possess.
What socialism represents is so far from rational economic planning that it is actually the prohibition of rational economic planning. In the first instance, by its very nature, it is a prohibition of economic planning by everyone except the dictator and the other members of the central planning board. They are to enjoy a monopoly privilege on planning, in the absurd, virtually insane belief that their brains can achieve the all-seeing, all-knowing capabilities of omniscient deities. They cannot. Thus, what socialism actually represents is the attempt to substitute the thinking and planning of one man, or at most of a mere handful of men, for the thinking and planning of tens and hundreds of millions, indeed, of billions of men. By its nature, this attempt to make the brains of so few meet the needs of so many has no more prospect of success than would an attempt to make the legs of so few the vehicle for carrying the weight of so many.
To have rational economic planning, the independent thinking and planning of all are required, operating in an environment of private ownership of the means of production and the price system, i.e., capitalism.
11) I turn now to the subject of monopoly. Socialism is the system of monopoly. Capitalism is the system of freedom and free competition.
As Mises has pointed out, the essential nature-given requirements of human life, such as drinking water, arable land, and the accessible supplies of practically all minerals are typically available in quantities so great that not all available sources can be exploited. The labor that would be required is not available. It is employed on pieces of land and mineral deposits that are more productive or in the numerous operations of manufacturing and commerce, where its employment is demonstrated by market prices to be more important than the production of an additional supply of agricultural commodities or minerals.
In these conditions, and in the absence of government interference, what is required to enable any producer (or combination of producers) to become the sole supplier of anything is that the price he charges is too low to make it worthwhile for other potential suppliers to enter the field. The position of sole supplier is secured by lowness of price, and is not the basis for imposing a high price.
The same essential point applies to cases in which the necessity of investing large sums of capital sharply limits the number of suppliers. Here a large capital is required in order to achieve low unit costs of production, which are necessary in order to be profitable at low selling prices.
Monopoly is actually the result of government intervention. Specifically it is the reservation of a market or part of a market to one or more suppliers by means of the initiation of physical force. Exclusive government franchises, protective tariffs, and licensing laws are examples.
12) Capitalism is a system of progressively rising real wages, the shortening of hours, and the improvement of working conditions. Contrary to Adam Smith and Karl Marx, businessmen and capitalists do not deduct profits from what allegedly was originally all wages or what allegedly is naturally and rightfully all wages. The original and primary form of income is profit, not wages. Manual workers producing and selling products either in Adam Smith’s “early and rude state of society” or in Karl Marx’s “simple circulation” did not earn wages, but sales revenues. When one sells a loaf of bread or a pair of shoes, or any other product, one is not paid a wage but a sales revenue. And precisely because those manual workers did not behave as capitalists, i.e., did not buy for the sake of selling but made expenditures merely as consumers, they made no expenditures for means of producing whatever goods they may have sold, and thus they incurred no money costs to be deducted from their sales revenues; i.e., the full magnitude of their sales revenues was profit, not wages. Profit, it turns out, is the original and primary form of labor income.
Contrary to Adam Smith and Karl Marx, it is only with the coming of capitalists and the accumulation of capital that the phenomenon of wages comes into existence, along with the demand for capital goods. Both wages and the expenditure for capital goods show up as money costs of production which must be deducted from sales revenues. The more economically capitalistic the economic system, in the sense of the greater is the buying for the purpose of earning sales revenues, relative to sales revenues, the higher are wages and other costs relative to sales revenues, and thus the lower are profits relative both to sales revenues and to wages. In other words, what capitalists are responsible for is not the creation of the phenomenon of profit and its deduction from wages, but the creation of the phenomena of wages and money costs and their deduction from sales revenues, which were originally all profit. Capitalists are responsible for the creation of wages and the reduction of the proportion of sales revenues that represents profit. The more numerous and the wealthier are capitalists, the higher are wages relative to profits.
The fact that wage earners may be willing to work for minimum subsistence, in the absence of any better alternative, and that businessmen and capitalists, like any other buyer, prefer to pay less rather than more, are propositions that are true but utterly irrelevant to the determination of the wages that the wage earners must actually accept. Those wages are determined by the competition of employers for labor, which is both the most fundamentally useful element in the economic system and is intrinsically scarce.
In that competition, it is against the self-interest of any employer to allow wage rates to go below the point corresponding to the full employment of the kind of labor in question, in the location in question. Such low wage rates mean that the quantity of labor demanded exceeds the supply available, i.e., that there is a shortage of the labor concerned. A shortage of labor is comparable to an auction in which there are still two or more bidders for one and the same item. The only way that the bidder who wants the item the most can secure it, is by outbidding his rivals and making the item too expensive for them, so that they must step aside and make it possible for him to secure the item.
In the labor market there may be tens or even hundreds of millions of workers. But the scarcity of labor means that there are potential jobs for far more than that number. The fact that each of us would like the benefit of the labor of at least ten others can be taken as an indication of the extent of the scarcity of labor.
When a wage rate goes below the point corresponding to the full employment of the kind of labor concerned, it becomes possible for employers not able or willing to pay that higher rate to obtain labor at the expense of other employers who are able and willing to pay that higher rate. The situation is exactly the same as the stronger bidder at an auction who is faced with the loss of the item he wants to another, weaker bidder. The way to secure the labor he needs is to raise the bidding and knock out the competition of the weaker employers.
In the face of labor shortages, which appear when ceiling prices are imposed on labor, employers actually conspire with their employees to evade the spirit of the wage controls, by giving out phony promotions. This enables them to claim that they are not violating the controls when in fact they are.
Now, given the height of money wage rates, which we have seen is determined by the competition of employers for scarce labor, what determines real wages, i.e., the goods and services that the wage earners can buy with the money they earn, is prices. Real wages are determined fully as much by prices as they are by wages. Real wages rise only when prices fall relative to wages.
What makes prices fall relative to wages is a rise in the productivity of labor, i.e., the output per unit of labor. A rise in the productivity of labor means a larger supply of consumers goods relative to the supply of labor, and thus lower prices of consumers’ goods relative to wage rates. If we could somehow measure the supply of consumers’ goods, a doubling of the productivity of labor would operate to double the supply of consumers’ goods relative to the supply of labor and, in the face of the same overall respective expenditures to buy consumers’ goods and labor, result in a halving of the prices of consumers’ goods in the face of the same overall average wage rates. In other words, it would double real wage rates.
The rise in the productivity of labor is always the essential element in the rise in real wages. It is what enables increases in the quantity of money and volume of spending, which are responsible for higher average money wages, being accompanied by prices that do not rise or do not rise to the same extent as wages.
And what is responsible for the rise in the productivity of labor is the activities of businessmen and capitalists. Their progressive innovations and capital accumulation underlie the rise in the productivity of labor and thus in real wages.
13) Finally, my last point: a one-hundred- percent-reserve, precious-metals monetary system would make a capitalist society both inflation-proof and deflation/depression-proof. The modest increase in the supply of precious metals, and thus the modest rate of increase in the volume of spending that proceeds from it, would not be able to raise prices in the face of the substantial rate at which the production and supply of practically all goods other than the precious metals increases under capitalism. Prices would most likely tend to fall, as they did over the course of the Nineteenth Century.
Falling prices due to increased production, however, do not constitute deflation. They do not signify any reduction in the average rate of profit, that is, the average rate of return on capital invested. Nor do they signify any greater difficulty of repaying debts. Yet a plunge in profits and a sudden increase in the difficulty of repaying debt are essential symptoms of deflation/depression.
Indeed, the modest increase in the quantity of money and volume of spending that goes on under a one-hundred- percent-reserve, precious-metals monetary system serves to add a positive component to the rate of return and to make debt repayment somewhat easier, not more difficult. The falling prices caused by increased production do not interfere with this. When prices fall because of increased production in the face of an increase in the quantity of money and volume of spending, the average seller is in the position of having a supply of goods to sell that is larger in greater proportion than prices are lower and thus to be able to earn more money, not less.
Genuine deflation, the accompaniment of depression, is financial contraction—that is, a decrease in the quantity of money and/or volume of spending. This is what wipes out profitability and makes debt repayment more difficult. But such contraction is precisely what a one-hundred- percent-reserve, precious-metals monetary system prevents. It prevents it because once precious-metal money comes into existence, it does not suddenly go out of existence, as occurs with fiduciary media when the banks that issue them fail. And because its rate of increase is modest, it does not lead to any substantial, artificial reduction in the demand for money for holding, which then must be followed by a reversal when the increase in the quantity of money stops or slows.
Nor do the continuous saving and capital accumulation that go on under capitalism operate to reduce the rate of return on capital. The nominal saving that takes place out of money income, takes place largely out of a rate of return that is elevated by the increase in the quantity of money and volume of spending, and, so long as the quantity of money and volume of spending go on modestly increasing, that saving does not reduce the rate of return.
If there were no increase in the quantity of money and volume of spending, the rate of return would be lower, but stable at the lower level. Capital accumulation would proceed simply on the basis of falling replacement prices, with unchanged expenditures buying progressively larger quantities of capital goods.
In such a context, the role of saving exists entirely at the gross level, where it determines such vital matters as the degree to which the economic system concentrates on the production of capital goods relative to the production of consumers’ goods and the length of the period of production. The essential elements in capital accumulation then stand revealed as a sufficiently high relative production of capital goods, and sufficiently long period of production, together with technological progress and anything else that serves to increase production, above all, economic freedom.
Here, for lack of time. I must close. I’d like to do so by saying that if you’ve found my talk today to be of interest, I hope you will explore the matters I’ve discussed, at greater length and in detail in my book. Its entire sum and substance can be understood as a systematic exposition of the benevolent nature of capitalism.