At the root this criticism is based, ironically enough, on the capitalist defence of private property as the product of labour. As noted in section B.4.2, Locke defended private property in terms of labour yet allowed that labour to be sold to others. This allowed the buyers of labour to appropriate the product of other people's labour and so, in the words of dissident economist David Ellerman, "capitalist production, i.e. production based on the employment contract denies workers the right to the (positive and negative) fruit of their labour. Yet people's right to the fruits of their labour has always been the natural basis for private property appropriation. Thus capitalist production, far from being founded on private property, in fact denies the natural basis for private property appropriation." [The Democratic worker-owned firm, p. 59] This was expressed by Proudhon in the following way:
"Whoever labours becomes a proprietor -- this is an inevitable deduction from the principles of political economy and jurisprudence. And when I say proprietor, I do not mean simply (as do our hypocritical economists) proprietor of his allowance, his salary, his wages, -- I mean proprietor of the value his creates, and by which the master alone profits . . . The labourer retains, even after he has received his wages, a natural right in the thing he was produced." [What is Property?, pp. 123-4]
In other words, taking the moral justification for capitalism, anarchists argue that it fails to meet its own criteria. Whether this principle should be applied in a free society is a moot point within anarchism. Individualist and mutualist anarchists argue it should be and, therefore, say that individual workers should receive the product of their toil (and so argue for distribution according to deed). Communist-anarchists argue that "social ownership and sharing according to need . . . would be the best and most just economic arrangement." This is for two reasons. Firstly, because "in modern industry" there is "no such thing" as an individual product as "all labour and the products of labour are social." [Berkman, What is Anarchism?, pp. 169-70] Secondly, in terms of simple justice need is not related to the ability to work and, of course, it would be wrong to penalise those who cannot work (i.e. the sick, the young and the old). Yet, while anarchists disagree over exactly how this should be most justly realised, they all agree that labour should control all that it produces (either individually or collectively) and, consequently, non-labour income is exploitation (it should be stressed that as both schemes are voluntary, there is no real contradiction between them). Anarchists tend to call non-labour income "surplus-value" or "usury" and these terms are used to group together profits, rent and interest (see section C.2.1 for details).
That this critique is a problem for capitalism can be seen from the many varied and wonderful defences created by economists to justify non-labour income. Economists, at least in the past, saw the problem clear enough. John Stuart Mill, the final great economist of the classical school, presented the typical moral justification of capitalism, along with the problems it causes. As he explains in his classic introduction to economics, the "institution of property, when limited to its essential elements, consists in the recognition, in each person, of a right to the exclusive disposal of what he or she have produced by their own exertions . . . The foundation of the whole is, the right of producers to what they themselves have produced." He then notes the obvious contradiction -- workers do not receive what they have produced. Thus it "may be objected" that capitalist society "recognises rights of property in individuals over which they have not produced," for example "the operatives in a manufactory create, by their labour and skill, the whole produce; yet, instead of it belonging to them, the law gives them only their stipulated hire [wages], and transfers the produce to someone who has merely supplied the funds, without perhaps contributing to the work itself." [Principles of Political Economy, p. 25] With the rise of neoclassical economics, the problem remained and so did need to justify capitalism continued to drive economics. J. B. Clark, for example, knew what was at stake and, like Mill, expressed it:
"When a workman leaves the mill, carrying his pay in his pocket, the civil law guarantees to him what he thus takes away; but before he leaves the mill he is the rightful owner of a part of the wealth that the day's industry has brought forth. Does the economic law which, in some way that he does not understand, determines what his pay shall be, make it to correspond with the amount of his portion of the day's product, or does it force him to leave some of his rightful share behind him? A plan of living that should force men to leave in their employer's hands anything that by right of creation is theirs, would be an institutional robbery -- a legally established violation of the principle on which property is supposed to rest." [The Distribution of Wealth, pp. 8-9]
Why should the owners of land, money and machinery get an income in the first place? Capitalist economics argues that everything involves a cost and, as such, people should be rewarded for the sacrifices they suffer when they contribute to production. Labour, in this schema, is considered a cost to those who labour and, consequently, they should be rewarded for it. Labour is thought of a disutility, i.e. something people do not want, rather than something with utility, i.e. something people do want. Under capitalism (like any class system), this perspective makes some sense as workers are bossed about and often subject to long and difficult labour. Most people will happily agree that labour is an obvious cost and should be rewarded.
Economists, unsurprisingly, have tended to justify surplus value by arguing that it involves as much cost and sacrifice as labour. For Mill, labour "cannot be carried on without materials and machinery . . . All these things are the fruits of previous production. If the labourers possessed of them, they would not need to divide the produce with any one; but while they have them not, an equivalent must be given to those who have." [Op. Cit., p. 25] This rationale for profits is called the "abstinence" or "waiting" theory. Clark, like Mill, expressed a defence of non-labour income in the face of socialist and anarchist criticism, namely the idea of marginal productivity to explain and justify non-labour income. Other theories have been developed as the weaknesses of previous ones have been exposed and we will discuss some of them in subsequent sections.
The ironic thing is that, well over 200 years after it came of age with Adam Smith's Wealth of Nations, economics has no agreed explanation for the source of surplus value. As dissident economists Michele I. Naples and Nahid Aslanbeigui show, introductory economics texts provide "no consistent, widely accepted theory" on the profit rate. Looking at the top three introductions to economics, they discovered that there was a "strange amalgam" of theories which is "often confusing, incomplete and inconsistent." Given that internal consistency is usually heralded as one of the hallmarks of neoclassical theory, "the theory must be questioned." This "failure . . . to provide a coherent theory of the rate of profit in the short run or long run" is damning, as the "absence of a coherent explanation for the profit rate represents a fundamental failure for the neoclassical model." ["What does determine the profit rate? The neoclassical theories present in introductory textbooks," pp. 53-71, Cambridge Journal of Economics, vol. 20, p. 53, p. 54, p. 69 and p. 70]
As will become clear, anarchists consider defences of "surplus value" to be essentially ideological and without an empirical base. As we will attempt to indicate, capitalists are not justified in appropriating surplus value from workers for no matter how this appropriation is explained by capitalist economics, we find that inequality in wealth and power are the real reasons for this appropriation rather than some actual productive act on the part of capitalists, investors or landlords. Mainstream economic theories generally seek to justify the distribution of income and wealth rather than to understand it. They are parables about what should be rather than what is. We argue that any scientific analysis of the source of "surplus value" cannot help conclude that it is due, primarily, to inequalities of wealth and, consequently, inequalities of power on the market. In other words, that Rousseau was right:
"The terms of social compact between these two estates of men may be summed up in a few words: 'You have need of me, because I am rich and you are poor. We will therefore come to an agreement. I will permit you to have the honour of serving me, on condition that you bestow on me that little you have left, in return for the pains I shall take to command you.'" [The Social Contract and Discourses, p. 162]
This is the analysis of exploitation we present in more detail in section C.2.2. To summarise it, labour faces social inequality when it passes from the market to production. In the workplace, capitalists exercise social power over how labour is used and this allows them to produce more value from the productive efforts of workers than they pay for in wages. This social power is rooted in social dependence, namely the fact that workers have little choice but to sell their liberty to those who own the means of life. To ensure the creation and appropriation of surplus-value, capitalists must not only own the production process and the product of the workers' labour, they must own the labour of the workers itself. In other words, they must control the workers. Hence capitalist production must be, to use Proudhon's term, "despotism." How much surplus-value can be produced depends on the relative economic power between bosses and workers as this determines the duration of work and the intensity of labour, however its roots are the same -- the hierarchical and class nature of capitalist society.
Surplus value is "the difference between the value produced by the workers and the wages they receive" and is "appropriated by the landlord and capitalist class . . . absorbed by the non-producing classes as profits, interest, rent, etc." [Charlotte Wilson, Anarchist Essays, pp. 46-7] It basically refers to any non-labour income (some anarchists, particularly individualist anarchists, have tended to call "surplus value" usury). As Proudhon noted, it "receives different names according to the thing by which it is yielded: if by land, ground-rent; if by houses and furniture, rent; if by life-investments, revenue; if by money, interest; if by exchange, advantage, gain, profit (three things which must not be confounded with the wages of legitimate price of labour)." [Op. Cit., p. 159]
For simplicity, we will consider "surplus value" to have three component parts: profits, interest and rent. All are based on payment for letting someone else use your property. Rent is what we pay to be allowed to exist on part of the earth (or some other piece of property). Interest is what we pay for the use of money. Profit is what we pay to be allowed to work a farm or use piece of machinery. Rent and interest are easy to define, they are obviously the payment for using someone else's property and have existed long before capitalism appeared. Profit is a somewhat more complex economic category although, ultimately, is still a payment for using someone else's property.
The term "profit" is often used simply, but incorrectly, to mean an excess over costs. However, this ignores the key issue, namely how a workplace is organised. In a co-operative, for example, while there is a surplus over costs, "there is no profit, only income to be divided among members. Without employees the labour-managed firm does not have a wage bill, and labour costs are not counted among the expenses to be extracted from profit, as they are in the capitalist firm." This means that the "economic category of profit does not exist in the labour-managed firm, as it does in the capitalist firm where wages are a cost to be subtracted from gross income before a residual profit is determined . . . Income shared among all producers is net income generated by the firm: the total of value added by human labour applied to the means of production, less payment of all costs of production and any reserves for depreciation of plant and equipment." [Christopher Eaton Gunn, Workers' Self-Management in the United States, p. 41 and p. 45] Gunn, it should be noted, follows both Proudhon and Marx in his analysis ("Let us suppose the workers are themselves in possession of their respective means of production and exchange their commodities with one another. These commodities would not be products of capital." [Marx, Capital, vol. 3, p. 276]).
In other words, by profits we mean income that flows to the owner of a workplace or land who hires others to do the work. As such returns to capital are as unique to capitalism as unemployment is. This means that a farmer who works their own land receives a labour income when they sell the crop while one who hires labourers to work the land will receives a non-labour income, profit. Hence the difference between possession and private property (or capital) and anarchist opposition to "capitalist property, that is, property which allows some to live by the work of others and which therefore presupposes a class of . . . people, obliged to sell their labour power to the property-owners for less than its value." [Malatesta, Errico Malatesta: His Life and Ideas, p. 102]
Another complication arises due to the fact that the owners of private property sometimes do work on them (i.e. be a boss) or hire others to do boss-like work on their behalf (i.e. executives and other managerial staff). It could be argued that bosses and executives are also "workers" and so contribute to the value of the commodities produced. However, this is not the case. Exploitation does not just happen, it needs to be organised and managed. In other words, exploitation requires labour ("There is work and there is work," as Bakunin noted, "There is productive labour and there is the labour of exploitation." [The Political Philosophy of Bakunin, p. 180]). The key is that while a workplace would grind to a halt without workers, the workers could happily do without a boss by organising themselves into an association to manage their own work. As such, while bosses may work, they are not taking part in productive activity but rather exploitative activity.
Much the same can be said of executives and managers. Though they may not own the instruments of production, they are certainly buyers and controllers of labour power, and under their auspices production is still capitalist production. The creation of a "salary-slave" strata of managers does not alter the capitalist relations of production. In effect, the management strata are de facto capitalists and they are like "working capitalist" and, consequently, their "wages" come from the surplus value appropriated from workers and realised on the market. Thus the exploitative role of managers, even if they can be fired, is no different from capitalists. Moreover, "shareholders and managers/technocrats share common motives: to make profits and to reproduce hierarchy relations that exclude most of the employees from effective decision making" [Takis Fotopoulos, "The Economic Foundations of an Ecological Society", pp. 1-40, Society and Nature, No.3, p. 16] They are paid that well because they monopolise power in the company and can get away with it. In other words, the high pay of the higher levels of management is a share of profits not a labour income based on their contribution to production but rather due to their position in the economic hierarchy and the power that gives them.
This is not to say that 100 percent of what managers do is exploitative. The case is complicated by the fact that there is a legitimate need for co-ordination between various aspects of complex production processes -- a need that would remain under libertarian socialism and would be filled by elected and recallable (and in some cases rotating) managers (see section I.3). But under capitalism, managers become parasitic in proportion to their proximity to the top of the pyramid. In fact, the further the distance from the production process, the higher the salary; whereas the closer the distance, the more likely that a "manager" is a worker with a little more power than average. In capitalist organisations, the less you do, the more you get. In practice, executives typically call upon subordinates to perform managerial (i.e. co-ordinating) functions and restrict themselves to broader policy-making decisions. As their decision-making power comes from the hierarchical nature of the firm, they could be easily replaced if policy making was in the hands of those who are affected by it. As such, their role as managers do not require them to make vast sums. They are paid that well currently because they monopolise power in the company and can, consequently, get away with deciding that they, unsurprisingly, contribute most to the production of useful goods rather than those who do the actual work.
Nor are we talking, as such, of profits generated by buying cheap and selling dear. We are discussing the situation at the level of the economy as a whole, not individual transactions. The reason is obvious. If profits could just explained in terms of buying cheap in order to sell dear then, over all, such transactions would cancel each other out when we look at the market as a whole as any profit will cancel any loss. For example, if someone buys a product at, say,£20 and sells it at £25 then there would be no surplus overall as someone else will have to pay £20 for something which cost £25. In other words, what one person gains as a seller, someone else will lose as a buyer and no net surplus has been created. Capitalists, in other words, do not simply profit at each others' expense. There is a creation of surplus rather than mere redistribution of a given product. This means that we are explaining why production results in a aggregate surplus and why it gets distributed between social classes under capitalism.
This means that capitalism is based on the creation of surplus rather than mere redistribution of a given sum of products. If this were not the case then the amount of goods in the economy would not increase, growth would not exist and all that would happen is that the distribution of goods would change, depending on the transactions made. Such a world would be one without production and, consequently, not realistic. Unsurprisingly, as we noted in section C.1, this is the world of neoclassical economics. This shows the weakness of attempts to explain the source of profits in terms of the market rather than production. While the market can explain how, perhaps, a specific set of goods and surplus is distributed, it cannot explain how a surplus is generated in the first place. To understand how a surplus is created we need to look at the process of value creation. For this, it is necessary to look at production to see if there is something which produces more than it gets paid for. Anarchists, like other socialists, argue that this is labour and, consequently, that capitalism is an exploitative system. We discuss why in the next section.
Obviously, pro-capitalist economics argues against this theory of how a surplus arises and the conclusion that capitalism is exploitative. We will discuss the more common arguments below. However, one example will suffice here to see why labour is the source of a surplus, rather than (say) "waiting", risk or the productivity of capital (to list some of the more common explanations for capitalist appropriation of surplus value). This is a card game. A good poker-player uses equipment (capital), takes risks, delays gratification, engages in strategic behaviour, tries new tricks (innovates), not to mention cheats, and can make large winnings. However, no surplus product results from such behaviour; the gambler's winnings are simply redistributions from others with no new production occurring. For one to win, the rest must lose. Thus risk-taking, abstinence, entrepreneurship, and so on might be necessary for an individual to receive profits but they are far from sufficient for them not to be the result a pure redistribution from others.
In short, our discussion of exploitation under capitalism is first and foremost an economy-wide one. We are concentrating on how value (goods and services) and surplus value (profits, rent and interest) are produced rather than how they are distributed. The distribution of goods between people and the division of income into wages and surplus value between classes is a secondary concern as this can only occur under capitalism if workers produce goods and services to sell (this is the direct opposite of mainstream economics which assumes a static economy with almost no discussion of how scarce means are organised to yield outputs, the whole emphasis is on exchanges of ready made goods).
Nor is this distribution somehow fixed. As we discuss in section C.3, how the amount of value produced by workers is divided between wages and surplus value is source of much conflict and struggle, the outcome of which depends on the balance of power between and within classes. The same can be said of surplus value. This is divided between profits, interest and rent -- capitalists, financiers and landlords. This does not imply that these sections of the exploiting class see eye to eye or that there is not competition between them. Struggle goes on within classes and well as between classes and this applies at the top of the economic hierarchy as at the bottom. The different sections of the ruling elite fight over their share of surplus value. This can involve fighting over control of the state to ensure that their interests are favoured over others. For example, the Keynesian post-war period can be considered a period when industrial capitalists shaped state policy while the period after 1973 represents a shift in power towards finance capital.
We must stress, therefore, that the exploitation of workers is not defined as payment less than competitive ("free market") for their labour. Rather, exploitation occurs even if they are paid the market wage. This is because workers are paid for their ability to labour (their "labour-power," to use Marx's term) rather the labour itself. This means that for a given hour's work (labour), the capitalist expects the worker to produce more than their wage (labour power). How much more is dependent on the class struggle and the objective circumstances each side faces. Indeed, a rebellious workforce willing to take direct action in defence of their interests will not allow subjection or its resulting exploitation.
Similarly, it would be wrong to confuse exploitation with low wages. Yes, exploitation is often associated with paying low wages but it is more than possible for real wages to go up while the rate of exploitation falls or rises. While some anarchists in the nineteenth century did argue that capitalism was marked by falling real wages, this was more a product of the time they were living through rather than an universal law. Most anarchists today argue that whether wages rise or fall depends on the social and economic power of working people and the historic context of a given society. This means, in other words, that labour is exploited not because workers have a low standard of living (although it can) but because labour produces the whole of the value created in any process of production or creation of a service but gets only part of it back.
As such, it does not matter if real wages do go up or not. Due to the accumulation of capital, the social and economic power of the capitalists and their ability to extract surplus-value can go up at a higher rate than real wages. The key issue is one of freedom rather than the possibility of consuming more. Bosses are in a position, due to the hierarchical nature of the capitalist workplace, to make workers produce more than they pay them in wages. The absolute level of those wages is irrelevant to the creation and appropriation of value and surplus-value as this happens at all times within capitalism.
As an example, since the 1970s American workers have seen their wages stagnate and have placed themselves into more and more debt to maintain an expected standard of living. During this time, productivity has increased and so they have been increasingly exploited. However, between 1950s and 1970s wages did increase along with productivity. Strong unions and a willingness to strike mitigated exploitation and increased living standards but exploitation continued. As Doug Henwood notes, while "average incomes have risen considerably" since 1945, "the amount of work necessary to earn those incomes has risen with equal relentlessness . . . So, despite the fact that productivity overall is up more than threefold" over this time "the average worker would have to toil six months longer to make the average family income." [After the New Economy, pp. 39-40] In other words, rising exploitation can go hand in hand with rising wages.
Finally, we must stress that we are critiquing economics mostly in its own terms. On average workers sell their labour-power at a "fair" market price and still exploitation occurs. As sellers of a commodity (labour-power) they do not receive its full worth (i.e. what they actually produce). Even if they did, almost all anarchists would still be against the system as it is based on the worker becoming a wage-slave and subject to hierarchy. In other words, they are not free during production and, consequently, they would still being robbed, although this time it is as human beings rather than a factor of production (i.e. they are oppressed rather than exploited). Needless to say, the idea that we could be subject to oppression during working hours and not be exploited is one most anarchists would dismiss as a bad joke and, as a result, follow Proudhon and demand the abolition of wage labour (most take it further and advocate the abolition of the wages system as well, i.e. support libertarian communism).
"Values created by net product are classed as savings and capitalised in the most highly exchangeable form, the form which is freest and least susceptible of depreciation, -- in a word, the form of specie, the only constituted value. Now, if capital leaves this state of freedom and engages itself, -- that is, takes the form of machines, buildings, etc., -- it will still be susceptible of exchange, but much more exposed than before to the oscillations of supply and demand. Once engaged, it cannot be disengaged without difficulty; and the sole resource of its owner will be exploitation. Exploitation alone is capable of maintaining engaged capital at its nominal value." [System of Economical Contradictions, p. 291]
Under capitalism, workers not only create sufficient value (i.e. produced commodities) to maintain existing capital and their own existence, they also produce a surplus. This surplus expresses itself as a surplus of goods and services, i.e. an excess of commodities compared to the number a workers' wages could buy back. Thus Proudhon:
"The working man cannot . . . repurchase that which he has produced for his master. It is thus with all trades whatsoever. . . since, producing for a master who in one form or another makes a profit, they are obliged to pay more for their own labour than they get for it." [What is Property, p. 189]
In other words, the price of all produced goods is greater than the money value represented by the workers' wages (plus raw materials and overheads such as wear and tear on machinery) when those goods were produced. The labour contained in these "surplus-products" is the source of profit, which has to be realised on the market (in practice, of course, the value represented by these surplus-products is distributed throughout all the commodities produced in the form of profit -- the difference between the cost price and the market price). In summary, surplus value is unpaid labour and hence capitalism is based on exploitation. As Proudhon noted, "Products, say economists, are only bought by products. This maxim is property's condemnation. The proprietor producing neither by his own labour nor by his implement, and receiving products in exchange for nothing, is either a parasite or a thief." [Op. Cit., p. 170]
It is this appropriation of wealth from the worker by the owner which differentiates capitalism from the simple commodity production of artisan and peasant economies. All anarchists agree with Bakunin when he stated that:
"what is property, what is capital in their present form? For the capitalist and the property owner they mean the power and the right, guaranteed by the State, to live without working . . . [and so] the power and right to live by exploiting the work of someone else . . . those . . . [who are] forced to sell their productive power to the lucky owners of both." [The Political Philosophy of Bakunin, p. 180]
It is the nature of capitalism for the monopolisation of the worker's product by others to exist. This is because of private property in the means of production and so in "consequence of [which] . . . [the] worker, when he is able to work, finds no acre to till, no machine to set in motion, unless he agrees to sell his labour for a sum inferior to its real value." [Peter Kropotkin, Anarchism, p. 55]
Therefore workers have to sell their labour on the market. However, as this "commodity" "cannot be separated from the person of the worker like pieces of property. The worker's capacities are developed over time and they form an integral part of his self and self-identity; capacities are internally not externally related to the person. Moreover, capacities or labour power cannot be used without the worker using his will, his understanding and experience, to put them into effect. The use of labour power requires the presence of its 'owner'. . . To contract for the use of labour power is a waste of resources unless it can be used in the way in which the new owner requires . . . The employment contract must, therefore, create a relationship of command and obedience between employer and worker." So, "the contract in which the worker allegedly sells his labour power is a contract in which, since he cannot be separated from his capacities, he sells command over the use of his body and himself. . . The characteristics of this condition are captured in the term wage slave." [Carole Pateman, The Sexual Contract, pp. 150-1]
Or, to use Bakunin's words, "the worker sells his person and his liberty for a given time" and so "concluded for a term only and reserving to the worker the right to quit his employer, this contract constitutes a sort of voluntary and transitory serfdom." [The Political Philosophy of Bakunin, p. 187] This domination is the source of the surplus, for "wage slavery is not a consequence of exploitation -- exploitation is a consequence of the fact that the sale of labour power entails the worker's subordination. The employment contract creates the capitalist as master; he has the political right to determine how the labour of the worker will be used, and -- consequently -- can engage in exploitation." [Pateman, Op. Cit., p. 149]
So profits exist because the worker sells themselves to the capitalist, who then owns their activity and, therefore, controls them (or, more accurately, tries to control them) like a machine. Benjamin Tucker's comments with regard to the claim that capital is entitled to a reward are of use here. He notes that some "combat. . . the doctrine that surplus value -- oftener called profits -- belong to the labourer because he creates it, by arguing that the horse. . . is rightly entitled to the surplus value which he creates for his owner. So he will be when he has the sense to claim and the power to take it. . . Th[is] argument . . is based upon the assumption that certain men are born owned by other men, just as horses are. Thus its reductio ad absurdum turns upon itself." [Instead of a Book, pp. 495-6] In other words, to argue that capital should be rewarded is to implicitly assume that workers are just like machinery, another "factor of production" rather than human beings and the creator of things of value. So profits exists because during the working day the capitalist controls the activity and output of the worker (i.e. owns them during working hours as activity cannot be separated from the body and "[t]here is an integral relationship between the body and self. The body and self are not identical, but selves are inseparable from bodies." [Carole Pateman, Op. Cit., p. 206]).
Considered purely in terms of output, this results in, as Proudhon noted, workers working "for an entrepreneur who pays them and keeps their products." [quoted by Martin Buber, Paths in Utopia, p. 29] The ability of capitalists to maintain this kind of monopolisation of another's time and output is enshrined in "property rights" enforced by either public or private states. In short, therefore, property "is the right to enjoy and dispose at will of another's goods - the fruit of an other's industry and labour." [P-J Proudhon, What is Property, p. 171] And because of this "right," a worker's wage will always be less than the wealth that he or she produces.
The surplus value produced by labour is divided between profits, interest and rent (or, more correctly, between the owners of the various factors of production other than labour). In practice, this surplus is used by the owners of capital for: (a) investment (b) to pay themselves dividends on their stock, if any; (c) to pay for rent and interest payments; and (d) to pay their executives and managers (who are sometimes identical with the owners themselves) much higher salaries than workers. As the surplus is being divided between different groups of capitalists, this means that there can be clashes of interest between (say) industrial capitalists and finance capitalists. For example, a rise in interest rates can squeeze industrial capitalists by directing more of the surplus from them into the hands of rentiers. Such a rise could cause business failures and so a slump (indeed, rising interest rates is a key way of regulating working class power by generating unemployment to discipline workers by fear of the sack). The surplus, like the labour used to reproduce existing capital, is embodied in the finished commodity and is realised once it is sold. This means that workers do not receive the full value of their labour, since the surplus appropriated by owners for investment, etc. represents value added to commodities by workers -- value for which they are not paid nor control.
The size of this surplus, the amount of unpaid labour, can be changed by changing the duration and intensity of work (i.e. by making workers labour longer and harder). If the duration of work is increased, the amount of surplus value is increased absolutely. If the intensity is increased, e.g. by innovation in the production process, then the amount of surplus value increases relatively (i.e. workers produce the equivalent of their wage sooner during their working day resulting in more unpaid labour for their boss). Introducing new machinery, for example, increases surplus-value by reducing the amount of work required per unit of output. In the words of economist William Lazonick:
"As a general rule, all market prices, including wages, are given to the particular capitalist. Moreover, in a competitive world a particular capitalist cannot retain privileged access to process or product innovations for any appreciable period of time. But the capitalist does have privileged access to, and control over, the workers that he employs. Precisely because the work is not perfectly mobile but is dependent on the capitalist to gain a living, the capitalist is not subject to the dictates of market forces in dealing with the worker in the production process. The more dependent the worker is on his or her particular employer, the more power the capitalist has to demand longer and harder work in return for a day's pay. The resultant unremunerated increase in the productivity of the worker per unit of time is the source of surplus-value."The measure of surplus-value is the difference between the value-added by and the value paid to the worker. As owner of the means of production, the industrial capitalist has a legal right to keep the surplus-value for himself." [Competitive Advantage on the Shop Floor, p. 54]
Such surplus indicates that labour, like any other commodity, has a use value and an exchange value. Labour's exchange value is a worker's wages, its use value their ability to work, to do what the capitalist who buys it wants. Thus the existence of "surplus products" indicates that there is a difference between the exchange value of labour and its use value, that labour can potentially create more value than it receives back in wages. We stress potentially, because the extraction of use value from labour is not a simple operation like the extraction of so many joules of energy from a ton of coal. Labour power cannot be used without subjecting the labourer to the will of the capitalist - unlike other commodities, labour power remains inseparably embodied in human beings. Both the extraction of use value and the determination of exchange value for labour depends upon - and are profoundly modified by - the actions of workers. Neither the effort provided during an hours work, nor the time spent in work, nor the wage received in exchange for it, can be determined without taking into account the worker's resistance to being turned into a commodity, into an order taker. In other words, the amount of "surplus products" extracted from a worker is dependent upon the resistance to dehumanisation within the workplace, to the attempts by workers to resist the destruction of liberty during work hours.
Thus unpaid labour, the consequence of the authority relations explicit in private property, is the source of profits. Part of this surplus is used to enrich capitalists and another to increase capital, which in turn is used to increase profits, in an endless cycle (a cycle, however, which is not a steady increase but is subject to periodic disruption by recessions or depressions - "The business cycle." The basic causes for such crises will be discussed later, in sections C.7 and C.8).
It should be noted that few economists deny that the "value added" by workers in production must exceed the wages paid. It has to, if a profit is to be made. As Adam Smith put it:
"As soon as stock has accumulated in the hands of particular persons, some of them will naturally employ it in setting to work industrious people, whom they will supply with materials and subsistence, in order to make a profit by the sale of their work, or by what their labour adds to the value of the materials . . . The value which the workmen add to the materials, therefore, resolves itself in this case into two parts, of which one pays their wages, the other the profits of their employer upon the whole stock of materials and wages which he advanced. He could have no interest to employ them, unless he expected from the sale of their work something more than what was sufficient to replace his stock to him." [The Wealth of Nations, p. 42]
That surplus value consists of unpaid labour is a simple fact. The difference is that non-socialist economists refuse to explain this in terms of exploitation. Like Smith, David Ricardo argued in a similar manner and justified surplus value appropriation in spite of this analysis. Faced with the obvious interpretation of non-labour income as exploitation which could easily be derived from classical economics, subsequent economists have sought to obscure this fact and have produced a series of rationales to justify the appropriation of workers labour by capitalists. In other words, to explain and justify the fact that capitalism is not based on its own principle that labour creates and justifies property. These rationales have developed over time, usually in response to socialist and anarchist criticism of capitalism and its economics (starting in response to the so-called Ricardian Socialists who predated Proudhon and Marx and who first made such an analysis commonplace). These have been based on many factors, such as the abstinence or waiting by the capitalist, the productivity of capital, "time-preference," entrepreneurialism and so forth. We discuss most rationales and indicate their weaknesses in subsequent sections.
"If each productive function is paid for according to the amount of its product, then each man get what he himself produces. If he works, he gets what he creates by working; if he provides capital, he gets what his capital produces; and if, further, he renders service by co-ordinating labour and capital, he gets the product that can be separately traced to that function. Only in one of these ways can a man produce anything. If he receives all that he brings into existence through any one of these three functions, he receives all that he creates at all." [John Bates Clark, The Distribution of Wealth, p.7]
Needless to say, this analysis was based on the need to justify the existing system, for it was "the purpose of this work to show that the distribution of income to society is controlled by a natural law, and that this law, if it worked without friction, would give to every agent of production the amount of wealth which that agent creates." In other words, "what a social class gets is, under natural law, what it contributes to the general output of industry." [Clark, Op. Cit., p. v and p. 313] And only mad people can reject a "natural law" like gravity -- or capitalism!
Most schools of capitalist economics, when they bother to try and justify non-labour income, hold to this theory of productivity. Unsurprisingly, as it proves what right-wing economist Milton Friedman called the "capitalist ethic": "To each according to what he and the instruments he owns produces." [Capitalism and Freedom, pp. 161-162] As such, this is one of the key defences of capitalism, based as it is on the productive contribution of each factor (labour, land and capital). Anarchists as unconvinced.
Unsurprisingly, this theory took some time to develop given the theoretical difficulties involved. After all, you need all three factors to produce a commodity, say a bushel of wheat. How can we determine that percentage of the price is due to the land, what percentage to labour and what percentage to capital? You cannot simply say that the "contribution" of each factor just happens to be identical to its cost (i.e. the contribution of land is what the market rent is) as this is circular reasoning. So how is it possible to specify contribution of each factor of production independently of the market mechanism in such a way as to show, firstly, that the contributions add up to 100 percent and, secondly, that the free market will in fact return to each factor its respective contribution?
This is where marginal productivity theory comes in. In neo-classical theory, the contribution of a specific factor is defined as the marginal product of that factor when the other factors are left constant. Take, as an example, a hundred bushels of wheat produced by X acres of land being worked by Y workers using £Z worth of capital. The contribution of land can then be defined as the increase in wheat that an extra acre of land would produce (X+1) if the same number of workers employed the same capital worked it. Similarly, the contribution of a worker would be the increase that would result if an addition worker was hired (Y + 1) to work the same land (X) with the same capital (£Z). The contribution of capital, obviously, would be the increase in wheat produced by the same number of workers (X) working the same amount of land (Y) using one more unit of capital (£Z+1). Then mathematics kicks in. If enough assumptions are made in terms of the substitutability of factors, diminishing returns, and so forth, then a mathematical theorem (Euler's Theorem) can be used to show that the sum of these marginal contributions would be a hundred bushels. Applying yet more assumptions to ensure "perfect competition" it can be mathematically proven that the rent per acre set by this perfect market will be precisely the contribution of the land, that the market wage will be the contribution of the worker, and the market interest rate will be the contribution of capital. In addition, it can be shown that any monopoly power will enable a factor owner to receive more than it contributes, so exploiting the others.
While this is impressive, the problems are obvious. As we discuss in section C.2.5, this model does not (indeed, cannot) describe any actual real economy. However, there is a more fundamental issue than mere practicality or realism, namely that it confuses a moral principle (that factors should receive in accordance with their productive contributions) with an ownership issue. This is because even if we want to say that land and capital "contribute" to the final product, we cannot say the same for the landowner or the capitalist. Using our example above, it should be noted that neither the capitalist nor the landowner actually engages in anything that might be called a productive activity. Their roles are purely passive, they simply allow what they own to be used by the people who do the actual work, the labourers.
Marginal productivity theory shows that with declining marginal productivity, the contribution of labour is less than the total product. The difference is claimed to be precisely the contribution of capital and land. But what is this "contribution" of capital and land? Without any labourers there would be no output. In addition, in physical terms, the marginal product of, say, capital is simply the amount by which production would decline is one piece of capital were taken out of production. It does not reflect any productive activity whatsoever on the part of the owner of said capital. It does not, therefore, measure his or her productive contribution. In other words, capitalist economics tries to confuse the owners of capital with the machinery they own. Unlike labour, whose "ownership" cannot be separated from the productive activities being done, capital and land can be rewarded without their owners actually doing anything productive at all.
For all its amazing mathematics, the neo-classical solution fails simply because it is not only irrelevant to reality, it is not relevant ethically.
To see why, let us consider the case of land and labour (capital is more complex and will be discussed in the next two sections). Marginal productivity theory can show, given enough assumptions, that five acres of land can produce 100 bushels of wheat with the labour of ten men and that the contribution of land and labour are, respectively, 40 and 60 bushels each. In other words, that each worker receives a wage representing 6 bushels of wheat while the landlord receives an income of 40 bushels. As socialist David Schweickart notes, "we have derived both the contribution of labour and the contribution of land from purely technical considerations. We have made no assumptions about ownership, competition, or any other social or political relationship. No covert assumptions about capitalism have been smuggled into the analysis." [After Capitalism, p. 29]
Surely this means that economics has produced a defence of non-labour income? Not so, as it ignores the key issue of what represents a valid contribution. The conclusion that the landlord (or capitalist) is entitled to their income "in no way follows from the technical premises of the argument. Suppose our ten workers had cultivated the five acres as a worker collective. In this, they would receive the entire product, all one hundred bushels, instead of sixty. Is this unfair? To whom should the other forty bushels go? To the land, for its 'contribution'? Should the collective perhaps burn forty bushels as an offering to the Land-God? (Is the Land-Lord the representative on Earth of this Land-God?)." [Op. Cit., p. 30] It should be noted that Schweickart is echoing the words of Proudhon:
"How much does the proprietor increase the utility of his tenant's products? Has he ploughed, sowed, reaped, mowed, winnowed, weeded? . . . I admit that the land is an implement; but who made it? Did the proprietor? Did he -- by the efficacious virtue of the right of property, by this moral quality infused into the soil -- endow it with vigour and fertility? Exactly there lies the monopoly of the proprietor, though he did not make the implement, he asks pay for its use. When the Creator shall present himself and claim farm-rent, we will consider the matter with him; or even when the proprietor -- his pretended representative -- shall exhibit his power of attorney." [What is Property?, pp. 166-7]
In other words, granting permission cannot be considered as a "contribution" or a "productive" act:
"We can see that a moral sleight-of-hand has been performed. A technical demonstration has passed itself off as a moral argument by its choice of terminology, namely, by calling a marginal product a 'contribution.' The 'contribution = ethical entitlement' of the landowner has been identified with the 'contribution = marginal product' of the land . . . What is the nature of the landowner's 'contribution' here? We can say that the landlord contributed the land to the workers, but notice the qualitative difference between his 'contribution' and the contribution of his workforce. He 'contributes' his land -- but the land remains intact and remains his at the end of the harvest, whereas the labour contributed by each labourer is gone. If the labourers do not expend more labour next harvest, they will get nothing more, whereas the landowner can continue to 'contribute' year after year (lifting not a finger), and be rewarded year after year for doing so." [Schweickart, Op. Cit., p. 30]
As the examples of the capitalist and co-operative farms shows, the "contribution" of land and capital can be rewarded without their owners doing anything at all. So what does it mean, "capital's share"? After all, no one has ever given money to a machine or land. That money goes to the owner, not the technology or resource used. When "land" gets its "reward" it involves money going to the landowner not fertiliser being spread on the land. Equally, if the land and the capital were owned by the labourers then "capital" and "land" would receive nothing despite both being used in the productive process and, consequently, having "aided" production. Which shows the fallacy of the idea that profits, interest and rent represent a form of "contribution" to the productive process by land and capital which needs rewarded. They only get a "reward" when they hire labour to work them, i.e. they give permission for others to use the property in question in return for telling them what to do and keeping the product of their labour.
As Proudhon put it, "[w]ho is entitled to the rent of the land? The producer of the land, without doubt. Who made the land? God. Then, proprietor, retire!" [Op. Cit., p. 104] Much the same can be said of "capital" (workplaces, machinery, etc.) as well. The capitalist, argued Berkman, "gives you a job; that is permission to work in the factory or mill which was not built by him but by other workers like yourself. And for that permission you help to support him for the rest of your life or as long as you work for him." [What is Anarchism?, p. 14]
So non-labour income exists not because of the owners of capital and land "contribute" to production but because they, as a class, own the means of life and workers have to sell their labour and liberty to them to gain access:
"We cry shame on the feudal baron who forbade the peasant to turn a clod of earth unless he surrendered to his lord a fourth of his crop. We called those the barbarous times, But if the forms have changed, the relations have remained the same, and the worker is forced, under the name of free contract, to accept feudal obligations." [Kropotkin, The Conquest of Bread, pp. 31-2]
It is capitalist property relations that allow this monopolisation of wealth by those who own (or boss) but do not produce. The workers do not get the full value of what they produce, nor do they have a say in how the surplus value produced by their labour gets used (e.g. investment decisions). Others have monopolised both the wealth produced by workers and the decision-making power within the company. This is a private form of taxation without representation, just as the company is a private form of statism.
Therefore, providing capital is not a productive act, and keeping the profits that are produced by those who actually do use capital is an act of theft. This does not mean, of course, that creating capital goods is not creative nor that it does not aid production. Far from it! But owning the outcome of such activity and renting it does not justify capitalism or profits. In other words, while we need machinery, workplaces, houses and raw materials to produce goods we do not need landlords and capitalists.
The problem with the capitalists' "contribution to production" argument is that one must either assume (a) a strict definition of who is the producer of something, in which case one must credit only the worker(s), or (b) a looser definition based on which individuals have contributed to the circumstances that made the productive work possible. Since the worker's productivity was made possible in part by the use of property supplied by the capitalist, one can thus credit the capitalist with "contributing to production" and so claim that he or she is entitled to a reward, i.e. profit.
However, if one assumes (b), one must then explain why the chain of credit should stop with the capitalist. Since all human activity takes place within a complex social network, many factors might be cited as contributing to the circumstances that allowed workers to produce -- e.g. their upbringing and education, the contribution of other workers in providing essential products, services and infrastructure that permits their place of employment to operate, and so on (even the government, which funds infrastructure and education). Certainly the property of the capitalist contributed in this sense. But his contribution was less important than the work of, say, the worker's mother. Yet no capitalist, so far as we know, has proposed compensating workers' mothers with any share of the firm's revenues, and particularly not with a greater share than that received by capitalists! Plainly, however, if they followed their own logic consistently, capitalists would have to agree that such compensation would be fair.
In summary, while some may consider that profit is the capitalist's "contribution" to the value of a commodity, the reality is that it is nothing more than the reward for owning capital and giving permission for others to produce using it. As David Schweickart puts it, "'providing capital' means nothing more than 'allowing it to be used.' But an act of granting permission, in and of itself, is not a productive activity. If labourers cease to labour, production ceases in any society. But if owners cease to grant permission, production is affected only if their authority over the means of production is respected." [Against Capitalism, p. 11]
This authority, as discussed earlier, derives from the coercive mechanisms of the state, whose primary purpose is to ensure that capitalists have this ability to grant or deny workers access to the means of production. Therefore, not only is "providing capital" not a productive activity, it depends on a system of organised coercion which requires the appropriation of a considerable portion of the value produced by labour, through taxes, and hence is actually parasitic. Needless to say, rent can also be considered as "profit", being based purely on "granting permission" and so not a productive activity. The same can be said of interest, although the arguments are somewhat different (see section C.2.6).
So, even if we assume that capital and land are productive, it does not follow that owning those resources entitles the owner to an income. However, this analysis is giving too much credit to capitalist ideology. The simple fact is that capital is not productive at all. Rather, "capital" only contributes to production when used by labour (land does produce use values, of course, but these only become available once labour is used to pick the fruit, reap the corn or dig the coal). As such, profit is not the reward for the productivity of capital. Rather labour produces the marginal productivity of capital. This is discussed in the next section.
Needless to say, capitalist economists disagree. "Here again the philosophy of the economists is wanting. To defend usury they have pretended that capital was productive, and they have changed a metaphor into a reality," argued Proudhon. The socialists had "no difficulty in overturning their sophistry; and through this controversy the theory of capital has fallen into such disfavour that today, in the minds of the people, capitalist and idler are synonymous terms." [System of Economical Contradictions, p. 290]
Sadly, since Proudhon's time, the metaphor has become regained its hold, thanks in part to neo-classical economics and the "marginal productivity" theory. We explained this theory in the last section as part of our discussion on why, even if we assume that land and capital are productive this does not, in itself, justify capitalist profit. Rather, profits accrue to the capitalist simply because he or she gave their permission for others to use their property. However, the notion that profits represent that "productivity" of capital is deeply flawed for other reasons. The key one is that, by themselves, capital and land produce nothing. As Bakunun put it, "neither property nor capital produces anything when not fertilised by labour." [The Political Philosophy of Bakunin, p. 183]
In other words, capital is "productive" simply because people use it. This is hardly a surprising conclusion. Mainstream economics recognises it in its own way (the standard economic terminology for this is that "factors usually do not work alone"). Needless to say, the conclusions anarchists and defenders of capitalism draw from this obvious fact are radically different.
The standard defence of class inequalities under capitalism is that people get rich by producing what other people want. That, however, is hardly ever true. Under capitalism, people get rich by hiring other people to produce what other people want or by providing land, money or machinery to those who do the hiring. The number of people who have became rich purely by their own labour, without employing others, is tiny. When pressed, defenders of capitalism will admit the basic point and argue that, in a free market, everyone gets in income what their contribution in producing these goods indicates. Each factor of production (land, capital and labour) is treated in the same way and their marginal productivity indicates what their contribution to a finished product is and so their income. Thus wages represent the marginal productivity of labour, profit the marginal productivity of capital and rent the marginal productivity of land. As we have used land and labour in the previous section, we will concentrate on land and "capital" here. We must note, however, that marginal productivity theory has immense difficulties with capital and has been proven to be internally incoherent on this matter (see next section). However, as mainstream economics ignores this, so will we for the time being.
So what of the argument that profits represent the contribution of capital? The reason why anarchists are not impressed becomes clear when we consider ten men digging a hole with spades. Holding labour constant means that we add spades to the mix. Each new spade increases productivity by the same amount (because we assume that labour is homogenous) until we reach the eleventh spade. At that point, the extra spade lies unused and so the marginal contribution of the spade ("capital") is zero. This suggests that the socialists are correct, capital is unproductive and, consequently, does not deserve any reward for its use.
Of course, it will be pointed out that the eleventh spade cost money and, as a result, the capitalist would have stopped at ten spades and the marginal contribution of capital equals the amount the tenth spade added. Yet the only reason that spade added anything to production was because there was a worker to use it. In other words, as economist David Ellerman stresses, the "point is that capital itself does not 'produce' at all; capital is used by Labour to produce the outputs . . . Labour produces the marginal product of capital." [Property and Contract in Economics, p. 204] As such, to talk of the "marginal product" of capital is meaningless as holding labour constant is meaningless:
"Consider, for example, the 'marginal product of a shovel' in a simple production process wherein three workers use two shovels and a wheelbarrow to dig out a cellar. Two of the workers use two shovels to fill the wheelbarrow which the third worker pushes a certain distance to dump the dirt. The marginal productivity of a shovel is defined as the extra product produced when an extra shovel is added and the other factors, such as labour, are held constant. The labour is the human activity of carrying out this production process. If labour was held 'constant' is the sense of carrying out the same human activity, then any third shovel would just lie unused and the extra product would be identically zero."'Holding labour constant' really means reorganising the human activity in a more capital intensive way so that the extra shovel will be optimally utilised. For instance, all three workers could use the three shovels to fill the wheelbarrow and then they could take turns emptying the wheelbarrow. In this manner, the workers would use the extra shovel and by so doing they would produce some extra product (additional earth moved during the same time period). This extra product would be called the 'marginal product of the shovel, but in fact it is produced by the workers who are also using the additional shovel . . . [Capital] does not 'produce' its marginal product. Capital does not 'produce' at all. Capital is used by Labour to produce the output. When capital is increased, Labour produces extra output by using up the extra capital . . . In short, Labour produced the marginal product of capital (and used up the extra capital services)." [Op. Cit., pp. 207-9]
Therefore, the idea that profits equals the marginal productivity of capital is hard to believe. Capital, in this perspective, is not only a tree which bears fruit even if its owner leaves it uncultivated, it is a tree which also picks its own fruit, prepares it and serves it for dinner! Little wonder the classical economists (Smith, Ricardo, John Stuart Mill) considered capital to be unproductive and explained profits and interest in other, less obviously false, means.
Perhaps the "marginal productivity" of capital is simply what is left over once workers have been paid their "share" of production, i.e. once the marginal productivity of labour has been rewarded. Obviously the marginal product of labour and capital are related. In a production process, the contribution of capital will (by definition) be equal to total price minus the contribution of labour. You define the marginal product of labour, it is necessary to keep something else constant. This means either the physical inputs other than labour are kept constant, or the rate of profit on capital is kept constant. As economist Joan Robinson noted:
"I found this satisfactory, for it destroys the doctrine that wages are regulated by marginal productivity. In a short-period case, where equipment is given, at full-capacity operation the marginal physical product of labour is indeterminate. When nine men with nine spades are digging a hole, to add a tenth man could increase output only to the extent that nine dig better if they have a rest from time to time. On the other hand, to subtract the ninth man would reduce output by more or less the average amount. The wage must lie somewhere between the average value of output per head and zero, so that marginal product is greater or much less than the wage according as equipment is being worked below or above its designed capacity." [Contributions to Modern Economics, p. 104]
If wages are not regulated by marginal productivity theory, then neither is capital (or land). Subtracting labour while keeping capital constant simply results in unused equipment and unused equipment, by definition, produces nothing. What the "contribution" of capital is dependent, therefore, on the economic power the owning class has in a given market situation (as we discuss in section C.3). As David Lazonick notes, the neo-classical theory of marginal productivity has two key problems which flow from its flawed metaphor that capital is "productive":
"The first flaw is the assumption that, at any point in time, the productivity of a technology is given to the firm, irrespective of the social context in which the firm attempts to utilise the technology . . . this assumption, typically implicit in mainstream economic analysis and [is] derived from an ignorance of the nature of the production process as much as everything else . . .""The second flaw in the neo-classical theoretical structure is the assumption that factor prices are independent of factor productivities. On the basis of this assumption, factor productivities arising from different combinations of capital and labour can be taken as given to the firm; hence the choice of technique depends only on variations in relative factor prices. It is, however, increasingly recognised by economists who speak of 'efficiency wages' that factor prices and factor productivities may be linked, particularly for labour inputs . . . the productivity of a technology depends on the amount of effort that workers choose to supply." [William Lazonick, Competitive Advantage on the Shop Floor, p. 130 and pp. 133-4]
In other words, neo-classical economics forgets that technology has to be used by workers and so its "productivity" depends on how it is applied. If profit did flow as a result of some property of machinery then bosses could do without autocratic workplace management to ensure profits. They would have no need to supervise workers to ensure that adequate amounts of work are done in excess of what they pay in wages. This means the idea (so beloved by pro-capitalist economics) that a worker's wage is the equivalent of what she produces is one violated everyday within reality:
"Managers of a capitalist enterprise are not content simply to respond to the dictates of the market by equating the wage to the value of the marginal product of labour. Once the worker has entered the production process, the forces of the market have, for a time at least, been superseded. The effort-pay relation will depend not only on market relations of exchange but also. . . on the hierarchical relations of production -- on the relative power of managers and workers within the enterprise." [William Lazonick, Business Organisation and the Myth of the Market Economy, pp. 184-5]
But, then again, capitalist economics is more concerned with justifying the status quo than being in touch with the real world. To claim that a workers wage represents her contribution and profit capital's is simply false. Capital cannot produce anything (never mind a surplus) unless used by labour and so profits do not represent the productivity of capital. In and of themselves, fixed costs do not create value. Whether value is created depends on how investments are developed and used once in place. Which brings us back to labour (and the social relationships which exist within an economy) as the fundamental source of surplus value.
Then there is the concept of profit sharing, whereby workers are get a share of the profits made by the company. Yet profits are the return to capital. This shatters the notion that profits represent the contribution of capital. If profits were the contribution of the productivity of equipment, then sharing profits would mean that capital was not receiving its full "contribution" to production (and so was being exploited by labour!). It is unlikely that bosses would implement such a scheme unless they knew they would get more profits out of it. As such, profit sharing is usually used as a technique to increase productivity and profits. Yet in neo-classical economics, it seems strange that such a technique would be required if profits, in fact, did represent capital's "contribution." After all, the machinery which the workers are using is the same as before profit sharing was introduced -- how could this unchanged capital stock produce an increased "contribution"? It could only do so if, in fact, capital was unproductive and it was the unpaid efforts, skills and energy of workers' that actually was the source of profits. Thus the claim that profit equals capital's "contribution" has little basis in fact.
As capital is not autonomously productive and goods are the product of human (mental and physical) labour, Proudhon was right to argue that "Capital, tools, and machinery are likewise unproductive . . . The proprietor who asks to be rewarded for the use of a tool or for the productive power of his land, takes for granted, then, that which is radically false; namely, that capital produces by its own effort - and, in taking pay for this imaginary product, he literally receives something for nothing." [What is Property?, p. 169]
It will be objected that while capital is not productive in itself, its use does make labour more productive. As such, surely its owner is entitled to some share of the larger output produced by its aid. Surely this means that the owners of capital deserve a reward? Is this difference not the "contribution" of capital? Anarchists are not convinced. Ultimately, this argument boils down to the notion that giving permission to use something is a productive act, a perspective we rejected in the last section. In addition, providing capital is unlike normal commodity production. This is because capitalists, unlike workers, get paid multiple times for one piece of work (which, in all likelihood, they paid others to do) and keep the result of that labour. As Proudhon argued:
"He [the worker] who manufactures or repairs the farmer's tools receives the price once, either at the time of delivery, or in several payments; and when this price is once paid to the manufacturer, the tools which he has delivered belong to him no more. Never can he claim double payment for the same tool, or the same job of repairs. If he annually shares in the products of the farmer, it is owing to the fact that he annually does something for the farmer."The proprietor, on the contrary, does not yield his implement; eternally he is paid for it, eternally he keeps it." [Op. Cit., pp. 169-170]
While the capitalist, in general, gets their investment back plus something extra, the workers can never get their time back. That time has gone, forever, in return for a wage which allows them to survive in order to sell their time and labour (i.e. liberty) again. Meanwhile, the masters have accumulated more capital and their the social and economic power and, consequently, their ability to extract surplus value goes up at a higher rate than the wages they have to pay (as we discuss in section C.7, this process is not without problems and regularly causes economic crisis to break out).
Without labour nothing would have been produced and so, in terms of justice, at best it could be claimed that the owners of capital deserve to be paid only for what has been used of their capital (i.e. wear and tear and damages). While it is true that the value invested in fixed capital is in the course of time transferred to the commodities produced by it and through their sale transformed into money, this does not represent any actual labour by the owners of capital. Anarchists reject the ideological sleight-of-hand that suggests otherwise and recognise that (mental and physical) labour is the only form of contribution that can be made by humans to a productive process. Without labour, nothing can be produced nor the value contained in fixed capital transferred to goods. As Charles A. Dana pointed out in his popular introduction to Proudhon's ideas, "[t]he labourer without capital would soon supply his wants by its production . . . but capital with no labourers to consume it can only lie useless and rot." [Proudhon and his "Bank of the People", p. 31] If workers do not control the full value of their contributions to the output they produce then they are exploited and so, as indicated, capitalism is based upon exploitation.
Of course, as long as "capital" is owned by a different class than as those who use it, this is extremely unlikely that the owners of capital will simply accept a "reward" of damages. This is due to the hierarchical organisation of production of capitalism. In the words of the early English socialist Thomas Hodgskin "capital does not derive its utility from previous, but present labour; and does not bring its owner a profit because it has been stored up, but because it is a means of obtaining a command over labour." [Labour Defended against the Claims of Capital] It is more than a strange coincidence that the people with power in a company, when working out who contributes most to a product, decide it is themselves!
This means that the notion that labour gets its "share" of the products created is radically false for, as "a description of property rights, the distributive shares picture is quite misleading and false. The simple fact is that one legal party owns all the product. For example, General Motors doesn't just own 'Capital's share' of the GM cars produced; it owns all of them." [Ellerman, Op. Cit., p. 27] Or as Proudhon put it, "Property is the right to enjoy and dispose of another's goods, -- the fruit of another's industry and labour." The only way to finally abolish exploitation is for workers to manage their own work and the machinery and tools they use. This is implied, of course, in the argument that labour is the source of property for "if labour is the sole basis of property, I cease to be a proprietor of my field as soon as I receive rent for it from another . . . It is the same with all capital." Thus, "all production being necessarily collective" and "all accumulated capital being social property, no one can be its exclusive proprietor." [What is Property?, p. 171, p. 133 and p. 130]
The reason why capital gets a "reward" is simply due to the current system which gives capitalist class an advantage which allows them to refuse access to their property except under the condition that they command the workers to make more than they have to pay in wages and keep their capital at the end of the production process to be used afresh the next. So while capital is not productive and owning capital is not a productive act, under capitalism it is an enriching one and will continue to be so until such time as that system is abolished. In other words, profits, interest and rent are not founded upon any permanent principle of economic or social life but arise from a specific social system which produce specific social relationships. Abolish wage labour by co-operatives, for example, and the issue of the "productivity" of "capital" disappears as "capital" no longer exists (a machine is a machine, it only becomes capital when it is used by wage labour).
So rather that the demand for labour being determined by the technical considerations of production, it is determined by the need of the capitalist to make a profit. This is something the neo-classical theory implicitly admits, as the marginal productivity of labour is just a roundabout way of saying that labour-power will be bought as long as the wage is not higher than the profits that the workers produce. In other words, wages do not rise above the level at which the capitalist will be able to produce and realise surplus-value. To state that workers will be hired as long as the marginal productivity of their labour exceeds the wage is another way of saying that workers are exploited by their boss. So even if we do ignore reality for the moment, this defence of profits does not prove what it seeks to -- it shows that labour is exploited under capitalism.
However, as we discuss in the next section, this whole discussion is somewhat beside the point. This is because marginal productivity theory has been conclusively proven to be flawed by dissident economics and has been acknowledged as such by leading neo-classical economists.
We will discuss each issue in turn.
The theory is based on a high level of abstraction and the assumptions used to allow the mathematics to work are so extreme that no real world example could possibly meet them. The first problem is determining the level at which the theory should be applied. Does it apply to individuals, groups, industries or the whole economy? For depending on the level at which it is applied, there are different problems associated with it and different conclusions to be drawn from it. Similarly, the time period over which it is to be applied has an impact. As such, the theory is so vague that it would be impossible to test as its supporters would simply deny the results as being inapplicable to their particular version of the model.
Then there are problems with the model itself. While it has to assume that factors are identical in order to invoke the necessary mathematical theory, none of the factors used are homogenous in the real world. Similarly, for Euler's theory to be applied, there must be constant returns to scale and this does not apply either (it would be fair to say that the assumption of constant returns to scale was postulated to allow the theorem to be invoked in the first place rather than as a result of a scientific analysis of real industrial conditions). Also, the model assumes an ideal market which cannot be realised and any real world imperfections make it redundant. In the model, such features of the real world as oligopolistic markets (i.e. markets dominated by a few firms), disequilibrium states, market power, informational imperfections of markets, and so forth do not exist. Including any of these real features invalidates the model and no "factor" gets its just rewards.
Moreover, like neo-classical economics in general, this theory just assumes the original distribution of ownership. As such, it is a boon for those who have benefited from previous acts of coercion -- their ill-gotten gains can now be used to generate income for them!
Finally, "marginal productivity" theory ignores the fact that most production is collective in nature and, as a consequence, the idea of subtracting a single worker makes little or no sense. As soon as there is "a division of labour and an interdependence of different jobs, as is the case generally in modern industry," its "absurdity can immediately be shown." For example, "[i]f, in a coal-fired locomotive, the train's engineer is eliminated, one does not 'reduce a little' of the product (transportation), one eliminates it completely; and the same is true if one eliminates the fireman. The 'product' of this indivisible team of engineer and fireman obeys a law of all or nothing, and there is no 'marginal product' of the one that can be separated from the other. The same thing goes on the shop floor, and ultimately for the modern factory as a whole, where jobs are closely interdependent." [Cornelius Castoriadis, Political and Social Writings, vol. 3, p. 213] Kropotkin made the same point, arguing it "is utterly impossible to draw a distinction between the work" of the individuals collectively producing a product as all "contribute . . . in proportion to their strength, their energy, their knowledge, their intelligence, and their skill." [The Conquest of Bread, p. 170 and p. 169]
This suggests another explanation for the existence of profits than the "marginal productivity" of capital. Let us assume, as argued in marginal productivity theory, that a worker receives exactly what she has produced because if she ceases to work, the total product will decline by precisely the value of her wage. However, this argument has a flaw in it. This is because the total product will decline by more than that value if two or more workers leave. This is because the wage each worker receives under conditions of perfect competition is assumed to be the product of the last labourer in neo-classical theory. The neo-classical argument presumes a "declining marginal productivity," i.e. the marginal product of the last worker is assumed to be less than the second last and so on. In other words, in neo-classical economics, all workers bar the mythical "last worker" do not receive the full product of their labour. They only receive what the last worker is claimed to produce and so everyone bar the last worker does not receive exactly what he or she produces. In other words, all the workers are exploited bar the last one.
However, this argument forgets that co-operation leads to increased productivity which the capitalists appropriate for themselves. This is because, as Proudhon argued, "the capitalist has paid as many times one day's wages" rather than the workers collectively and, as such, "he has paid nothing for that immense power which results from the union and harmony of labourers, and the convergence and simultaneousness of their efforts. Two hundred grenadiers stood the obelisk of Luxor upon its base in a few hours; do you suppose that one man could have accomplished the same task in two hundred days? Nevertheless, on the books of the capitalist, the amount of wages would have been the same." Therefore, the capitalist has "paid all the individual forces" but "the collective force still remains to be paid. Consequently, there remains a right of collective property" which the capitalist "enjoy[s] unjustly." [What is Property?, p. 127 and p. 130]
As usual, therefore, we must distinguish between the ideology and reality of capitalism. As we indicated in section C.1, the model of perfect competition has no relationship with the real world. Unsurprisingly, marginal productivity theory is likewise unrelated to reality. This means that the assumptions required to make "marginal productivity" theory work are so unreal that these, in themselves, should have made any genuine scientist reject the idea out of hand. Note, we are not opposing abstract theory, every theory abstracts from reality is some way. We are arguing that, to be valid, a theory has to reflect the real situation it is seeking to explain in some meaningful way. Any abstractions or assumptions used must be relatively trivial and, when relaxed, not result in the theory collapsing. This is not the case with marginal productivity theory. It is important to recognise that there are degrees of abstraction. There are "negligibility assumptions" which state that some aspect of reality has little or no effect on what is being analysed. Sadly for marginal productivity theory, its assumptions are not of this kind. Rather, they are "domain assumptions" which specify "the conditions under which a particular theory will apply. If those conditions do not apply, then neither does the theory." [Steve Keen, Debunking Economics, p. 151] This is the case here.
However, most economists will happily ignore this critique for, as noted repeatedly, basing economic theory on reality or realistic models is not considered a major concern by neoclassical economists. However, "marginal productivity" theory applied to capital is riddled with logical inconsistencies which show that it is simply wrong. In the words of the noted left-wing economist Joan Robinson:
"The neo-classicals evidently had not been told that the neo-classical theory did not contain a solution of the problems of profits or of the value of capital. They have erected a towering structure of mathematical theorems on a foundation that does not exist. Recently [in the 1960s, leading neo-classical economist] Paul Samuelson was sufficiently candid to admit that the basis of his system does not hold, but the theorems go on pouring out just the same." [Contributions to Modern Economics, p. 186]
If profits are the result of private property and the inequality it produces, then it is unsurprising that neoclassical theory would be as foundationless as Robinson argues. After all, this is a political question and neo-classical economics was developed to ignore such questions. Marginal productivity theory has been subject to intense controversy, precisely because it claims to show that labour is not exploited under capitalism (i.e. that each factor gets what it contributes to production). We will now summarise this successful criticism.
The first major theoretical problem is obvious, how do you measure capital? In neoclassical economics, capital is referred to as machinery of all sorts as well as the workplaces that house them. Each of these items are, in turn, made up of a multitude of other commodities and many of these are assemblies of other commodities. So what does it mean to say, as in marginal productivity theory, that "capital" is varied by one unit? The only thing these products have in common is a price and that is precisely what economists do use to aggregate capital. Sadly, though, shows "that there is no meaning to be given to a 'quantity of capital' apart from the rate of profit, so that the contention that the 'marginal product of capital' determines the rate of profit is meaningless." [Robinson, Op. Cit., p. 103] This is because argument is based on circular reasoning:
"For long-period problems we have to consider the meaning of the rate of profit on capital . . . the value of capital equipment, reckoned as its future earnings discounted at a rate of interest equal to the rate of profit, is equal to its initial cost, which involves prices including profit at the same rate on the value of the capital involved in producing it, allowing for depreciation at the appropriate rate over its life up to date."The value of a stock of capital equipment, therefore, involves the rate of profit. There is no meaning in a 'quantity of capital' apart from the rate of profit." [Collected Economic Papers, vol. 4, p. 125]
In other words, according to neoclassical theory, the rate of profit and interest depends on the amount of capital, and the amount of capital depends on the rate of profit and interest. One has to assume a rate of profit in order to demonstrate the equilibrium rate of return is determined. This issue is avoided in neo-classical economics simply by ignoring it (it must be noted that the same can be said of the "Austrian" concept of "roundaboutness" as "it is impossible to define one way of producing a commodity as 'more roundabout' than another independently of the rate of profit . . . Therefore the Austrian notion of roundaboutness is as internally inconsistent as the neoclassical concept of the marginal productivity of capital." [Steve Keen, Debunking Economics, p. 302]).
The next problem with the theory is that "capital" is treated as something utterly unreal. Take, for example, leading neoclassical Dennis Robertson's 1931 attempt to explain the marginal productivity of labour when holding "capital" constant:
"If ten men are to be set out to dig a hole instead of nine, they will be furnished with ten cheaper spades instead of nine more expensive ones; or perhaps if there is no room for him to dig comfortably, the tenth man will be furnished with a bucket and sent to fetch beer for the other nine." ["Wage-grumbles", Economic Fragments, p. 226]
So to work out the marginal productivity of the factors involved, "ten cheaper spades" somehow equals nine more expensive spades? How is this keeping capital constant? And how does this reflect reality? Surely, any real world example would involve sending the tenth digger to get another spade? And how do nine expensive spades become nine cheaper ones? In the real world, this is impossible but in neoclassical economics this is not only possible but required for the theory to work. As Robinson argued, in neo-classical theory the "concept of capital all the man-made factors are boiled into one, which we may call leets . . . [which], though all made up of one physical substance, is endowed with the capacity to embody various techniques of production . . . and a change of technique can be made simply by squeezing up or spreading out leets, instantaneously and without cost." [Contributions to Modern Economics, p. 106]
This allows economics to avoid the obvious aggregation problems with "capital", make sense of the concept of adding an extra unit of capital to discover its "marginal productivity" and allows capital to be held "constant" so that the "marginal productivity" of labour can be found. For when "the stock of means of production in existence can be represented as a quantity of ectoplasm, we can say, appealing to Euler's theorem, that the rent per unit of ectoplasm is equal to the marginal product of the given quantity of ectoplasm when it is fully utilised. This does seem to add anything of interest to the argument." [Op. Cit., p. 99] This ensures reality has to be ignored and so economic theory need not discuss any practical questions:
"When equipment is made of leets, there is no distinction between long and short-period problems . . . Nine spades are lumps of leets; when the tenth man turns up it is squeezed out to provide him with a share of equipment nine-tenths of what each man had before . . . There is no room for imperfect competition. There is no possibility of disappointed expectations . . . There is no problem of unemployment . . . Unemployed workers would bid down wages and the pre-existing quantity of leets would be spread out to accommodate them." [Op. Cit., p. 107]
The concept that capital goods are made of ectoplasm and can be remoulded into the profit maximising form from day to day was invented in order to prove that labour and capital both receive their contribution to society, to show that labour is not exploited. It is not meant to be taken literally, it is only a parable, but without it the whole argument (and defence of capitalism) collapses. Once capital equipment is admitted to being actual, specific objects that cannot be squeezed, without cost, into new objects to accommodate more or less workers, such comforting notions that profits equal the (marginal) contribution of "capital" or that unemployment is caused by wages being too high have to be discarded for the wishful thinking they most surely are.
The last problem arises when ignore these issues and assume that marginal productivity theory is correct. Consider the notion of the short run, where at least one factor of production cannot be varied. To determine its marginal productivity then capital has to be the factor which is varied. However, common sense suggests that capital is the least flexible factor and if that can be varied then every other one can be as well? As dissident economist Piero Sraffa argued, when a market is defined broadly enough, then the key neoclassical assumption that the demand and supply of a commodity are independent breaks down. This was applied by another economist, Amit Bhaduri, to the "capital market" (which is, by nature, a broadly defined industry). Steve Keen usually summarises these arguments, noting that "at the aggregate level [of the economy as a whole], the desired relationship -- the rate of profit equals the marginal productivity of capital -- will not hold true" as it only applies "when the capital to labour ratio is the same in all industries -- which is effectively the same as saying there is only one industry." This "proves Sraffa's assertion that, when a broadly defined industry is considered, changes in its conditions of supply and demand will affect the distribution of income." This means that a "change in the capital input will change output, but it also changes the wage, and the rate of profit . . . As a result, the distribution of income is neither meritocratic nor determined by the market. The distribution of income is to some significant degree determined independently of marginal productivity and the impartial blades of supply and demand . . . To be able to work out prices, it is first necessary to know the distribution of income . . . There is therefore nothing sacrosanct about the prices that apply in the economy, and equally nothing sacrosanct about the distribution of income. It reflects the relative power of different groups in society." [Op. Cit., p. 135]
It should be noted that this critique bases itself on the neoclassical assumption that it is possible to define a factor of production called capital. In other words, even if we assume that neo-classical economics theory of capital is not circular reasoning, it's theory of distribution is still logically wrong.
So mainstream economics is based on a theory of distribution which is utterly irrelevant to the real world and is incoherent when applied to capital. This would not be important except that it is used to justify the distribution of income in the real world. For example, the widening gap between rich and poor (it is argued) simply reflects a market efficiently rewarding more productive people. Thus the compensation for corporate chief executives climbs so sharply because it reflects their marginal productivity. Except, of course, the theory supports no such thing -- except in a make believe world which cannot exist (lassiez fairy land, anyone?).
It must be noted that this successful critique of neoclassical economics by dissident economists was first raised by Joan Robinson in the 1950s (it usually called the Cambridge Capital Controversy). It is rarely mentioned these days. While most economic textbooks simply repeat the standard theory, the fact is that this theory has been successfully debunked by dissident economists over four decades go. As Steve Keen notes, while leading neoclassical economists admitted that the critique was correct in the 1960s, today "economic theory continues to use exactly the same concepts which Sraffa's critique showed to be completely invalid" in spite the "definitive capitulation by as significant an economist as Paul Samuelson." As he concludes: "There is no better sign of the intellectual bankruptcy of economics than this." [Op. Cit., p. 146, p. 129 and p. 147]
Why? Simply because the Cambridge Capital Controversy would expose the student of economics to some serious problems with neo-classical economics and they may start questioning the internal consistency of its claims. They would also be exposed to alternative economic theories and start to question whether profits are the result of exploitation. As this would put into jeopardy the role of economists as, to quote Marx, the "hired prize-fighters" for capital who replace "genuine scientific research" with "the bad conscience and evil intent of apologetics." Unsurprisingly, he characterised this as "vulgar economics." [Capital, vol. 1, p. 97]
Based on this argument, many supporters of capitalism claim that it is legitimate for the person who provided the capital to get back more than they put in, because of the "time value of money." This is because investment requires savings and the person who provides those had to postpone a certain amount of current consumption and only agree to do this only if they get an increased amount later (i.e. a portion, over time, of the increased output that their saving makes possible). This plays a key role in the economy as it provide the funds from which investment can take place and the economy grow.
In this theory, interest rates are based upon this "time value" of money and the argument is rooted in the idea that individuals have different "time preferences." Some economic schools, like the Austrian school, argue that the actions by banks and states to artificially lower interest rates (by, for example, creating credit or printing money) create the business cycle as this distorts the information about people's willingness to consume now rather than later leading to over investment and so to a slump.
That the idea of doing nothing (i.e. not consuming) can be considered as productive says a lot about capitalist theory. However, this is beside the point as the argument is riddled with assumptions and, moreover, ignores key problems with the notion that savings always lead to investment.
The fundamental weakness of the theory of time preference must be that it is simply an unrealistic theory and does not reflect where the supply of capital does come from. It may be appropriate to the decisions of households between saving and consumption, but the main source of new capital is previous profit under capitalism. The motivation of making profits is not the provision of future means of consumption, it is profits for their own sake. The nature of capitalism requires profits to be accumulated into capital for if capitalists did only consume the system would break down. While from the point of view of the mainstream economics such profit-making for its own sake is irrational in reality it is imposed on the capitalist by capitalist competition. It is only by constantly investing, by introducing new technology, work practices and products, can the capitalists keep their capital (and income) intact. Thus the motivation of capitalists to invest is imposed on them by the capitalist system, not by subjective evaluations between consuming more later rather than now.
Ignoring this issue and looking at the household savings, the theory still raises questions. The most obvious problem is that an individual's psychology is conditioned by the social situation they find themselves in. Ones "time preference" is determined by ones social position. If one has more than enough money for current needs, one can more easily "discount" the future (for example, workers will value the future product of their labour less than their current wages simply because without those wages there will be no future). We will discuss this issue in more detail later and will not do so here (see section C.2.7).
The second thing to ask is why should the supply price of waiting be assumed to be positive? If the interest rate simply reflects the subjective evaluations of individuals then, surely, it could be negative or zero. Deferred gratification is as plausible a psychological phenomenon as the overvaluation of present satisfactions, while uncertainty is as likely to produce immediate consumption as it is to produce provision for the future (saving). Thus Joan Robinson:
"The rate of interest (excess of repayment over original loan) would settle at the level which equated supply and demand for loans. Whether it was positive or negative would depend upon whether spendthrifts or prudent family men happened to predominate in the community. There is no a priori presumption in favour of a positive rate. Thus, the rate of interest cannot be account for as the 'cost of waiting.'"The reason why there is always a demand for loans at a positive rate of interest, in an economy where there is property in the means of production and means of production are scarce, is that finance expended now can be used to employ labour in productive processes which will yield a surplus in the future over costs of production. Interest is positive because profits are positive (though at the same time the cost and difficulty of obtaining finance play a part in keeping productive equipment scarce, and so contribute to maintaining the level of profits)." [Contributions to Modern Economics, p. 83]
It is only because money provides the authority to allocate resources and exploit wage labour that money now is more valuable ("we know that mere saving itself brings in nothing, so long as the pence saved are not used to exploit." [Kropotkin, The Conquest of Bread, p. 59]). The capitalist does not supply "time" (as the "time value" theory argues), the loan provides authority/power and so the interest rate does not reflect "time preference" but rather the utility of the loan to capitalists, i.e. whether it can be used to successfully exploit labour. If the expectations of profits by capitalists are low (as in, say, during a depression), loans would not be desired no matter how low the interest rate became. As such, the interest rate is shaped by the general profit level and so be independent of the "time preference" of individuals.
Then there is the problem of circularity. In any real economy, interest rates obviously shape people's saving decisions. This means that an individual's "time preference" is shaped by the thing it is meant to explain:
"But there may be some savers who have the psychology required by the text books and weigh a preference for present spending against an increment of income (interest, dividends and capital gains) to be had from an increment of wealth. But what then? Each individual goes on saving or dis-saving till the point where his individual subjective rate of discount is equal to the market rate of interest. There has to be a market rate of interest for him to compare his rate of discount to." [Joan Robinson, Op. Cit., pp. 11-12]
Looking at the individuals whose subjective evaluations allegedly determine the interest rate, there is the critical question of motivation. Looking at lenders, do they really charge interest because they would rather spend more money later than now? Hardly, their motivation is far more complicated than that. It is doubtful that many people actually sit down and work out how much their money is going to be "worth" to them a year or more from now. Even if they did, the fact is that they really have no idea how much it will be worth. The future is unknown and uncertain and, consequently, it is implausible that "time preference" plays the determining role in the decision making process.
In most economies, particularly capitalism, the saver and lender are rarely the same person. People save and the banks use it to loan it to others. The banks do not do this because they have a low "time preference" but because they want to make profits. They are a business and make their money by charging more interest on loans than they give on savings. Time preference does not enter into it, particularly as, to maximise profits, banks loan out more (on credit) than they have in savings and, consequently, make the actual interest rate totally independent of the rate "time preference" would (in theory) produce.
Given that it would be extremely difficult, indeed impossible, to stop banks acting in this way, we can conclude that even if "time preference" were true, it would be of little use in the real world. This, ironically, is recognised by the same free market capitalist economists who advocate a "time preference" perspective on interest. Usually associated with the "Austrian" school, they argue that banks should have 100% reserves (i.e. they loan out only what they have in savings, backed by gold). This implicitly admits that the interest rate does not reflect "time preference" but rather the activities (such as credit creation) of banks (not to mention other companies who extend business credit to consumers). As we discuss in section C.8, this is not due to state meddling with the money supply or the rate of interest but rather the way capitalism works.
Moreover, as the banking industry is marked, like any industry, by oligopolistic competition, the big banks will be able to add a mark up on services, so distorting any interest rates set even further from any abstract "time preference" that exists. Therefore, the structure of that market will have a significant effect on the interest rate. Someone in the same circumstances with the same "time preference" will get radically different interest rates depending on the "degree of monopoly" of the banking sector (see section C.5 for "degree of monopoly"). An economy with a multitude of small banks, implying low barriers of entry, will have different interest rates than one with a few big firms implying high barriers (if banks are forced to have 100% gold reserves, as desired by many "free market" capitalists, then these barriers may be even higher). As such, it is highly unlikely that "time preference" rather than market power is a more significant factor in determining interest rates in any real economy. Unless, of course, the rather implausible claim is made that the interest rate would be the same no matter how competitive the banking market was -- which, of course, is what the "time preference" argument does imply.
Nor is "time preference" that useful when we look at the saver. People save money for a variety of motives, few (if any) of which have anything to do with "time preference." A common motive is, unsurprisingly, uncertainty about the future. Thus people put money into savings accounts to cover possible mishaps and unexpected developments (as in "saving for a rainy day"). Indeed, in an uncertain world future money may be its own reward for immediate consumption is often a risky thing to do as it reduces the ability to consumer in the future (for example, workers facing unemployment in the future could value the same amount of money more then than now). Given that the future is uncertain, many save precisely for precautionary reasons and increasing current consumption is viewed as a disutility as it is risky behaviour. Another common reason would be to save because they do not have enough money to buy what they want now. This is particularly the case with working class families who face stagnating or falling income or face financial difficulties.[Henwood, Wall Street, p. 65] Again, "time preference" does not come into it as economic necessity forces the borrowers to consume more now in order to be around in the future.
Therefore, money lending is, for the poor person, not a choice between more consumption now/less later and less consumption now/more later. If there is no consumption now, there will not be any later. So not everybody saves money because they want to be able to spend more at a future date. As for borrowing, the real reason for it is necessity produced by the circumstances people find themselves in. As for the lender, their role is based on generating a current and future income stream, like any business. So if "time preference" seems unlikely for the lender, it seems even more unlikely for the borrower or saver. Thus, while there is an element of time involved in decisions to save, lend and borrow, it would be wrong to see interest as the consequence of "time preference." Most people do not think in terms of it and, therefore, predicting their behaviour using it would be silly.
At the root of the matter is that for the vast majority of cases in a capitalist economy, an individual's "time preference" is determined by their social circumstances, the institutions which exist, uncertainty and a host of other factors. As inequality drives "time preference," there is no reason to explain interest rates by the latter rather than the former. Unless, of course, you are seeking to rationalise and justify the rich getting richer. Ultimately, interest is an expression of inequality, not exchange:
"If there is chicanery afoot in calling 'money now' a different good than 'money later,' it is by no means harmless, for the intended effect is to subsume money lending under the normative rubric of exchange . . . [but] there are obvious differences . . . [for in normal commodity exchange] both parties have something [while in loaning] he has something you don't . . . [so] inequality dominates the relationship. He has more than you have now, and he will get back more than he gives." [Schweickart, Against Capitalism, p. 23]
While the theory is less than ideal, the practice is little better. Interest rates have numerous perverse influences in any real economy. In neo-classical and related economics, saving does not have a negative impact on the economy as it is argued that non-consumed income must be invested. While this could be the case when capitalism was young, when the owners of firms ploughed their profits back into them, as financial institutions grew this became less so. Saving and investment became different activities, governed by the rate of interest. If the supply of savings increased, the interest rate would drop and capitalists would invest more. If the demand for loans increased, then the interest rate would rise, causing more savings to occur.
While the model is simple and elegant, it does have its flaws. These are first analysed by Keynes during the Great Depression of the 1930s, a depression which the neo-classical model said was impossible.
For example, rather than bring investment into line with savings, a higher interest can cause savings to fall as "[h]ousehold saving, of course, is mainly saving up to spend later, and . . . it is likely to respond the wrong way. A higher rate of return means that 'less' saving is necessary to get a given pension or whatever." [Robinson, Op. Cit., p. 11] Similarly, higher interest rates need not lead to higher investment as higher interest payments can dampen profits as both consumers and industrial capitalists have to divert more of their finances away from real spending and towards debt services. The former causes a drop in demand for products while the latter leaves less for investing.
As argued by Keynes, the impact of saving is not as positive as some like to claim. Any economy is a network, where decisions affect everyone. In a nutshell, the standard model fails to take into account changes of income that result from decisions to invest and save (see Michael Stewart's Keynes and After for a good, if basic, introduction). This meant that if some people do not consume now, demand falls for certain goods, production is turned away from consumption goods, and this has an effect on all. Some firms will find their sales failing and may go under, causing rising unemployment. Or, to put it slightly differently, aggregate demand -- and so aggregate supply -- is changed when some people postpone consumption, and this affects others. The decrease in the demand for consumer goods affects the producers of these goods. With less income, the producers would reduce their expenditure and this would have repercussions on other people's incomes. In such circumstances, it is unlikely that capitalists would be seeking to invest and so rising savings would result in falling investment in spite of falling interest rates. In an uncertain world, investment will only be done if capitalists think that they will end up with more money than they started with and this is unlikely to happen when faced with falling demand.
Whether rising interest rates do cause a crisis is dependent on the the strength of the economy. During a strong expansion, a modest rise in interest rates may be outweighed by rising wages and profits. During a crisis, falling rates will not counteract the general economic despair. Keynes aimed to save capitalism from itself and urged state intervention to counteract the problems associated with free market capitalism. As we discuss in section C.8.1, this ultimately failed partly due to the mainstream economics gutting Keynes' work of key concepts which were incompatible with it, partly due to Keynes' own incomplete escape from neoclassical economics, partly due the unwillingness of rentiers to agree to their own euthanasia but mostly because capitalism is inherently unstable due to the hierarchical (and so oppressive and exploitative) organisation of production.
Which raises the question of whether someone who saves deserve a reward for so doing? Simply put, no. Why? Because the act of saving is no more an act of production than is purchasing a commodity (most investment comes from retained profits and so the analogy is valid). Clearly the reward for purchasing a commodity is that commodity. By analogy, the reward for saving should be not interest but one's savings -- the ability to consume at a later stage. Particularly as the effects of interest rates and savings can have such negative impacts on the rest of the economy. It seems strange, to say the least, to reward people for helping do so. Why should someone be rewarded for a decision which may cause companies to go bust, so reducing the available means of production as reduced demand results in job loses and idle factories? Moreover, this problem "becomes ever more acute the richer or more inegalitarian the society becomes, since wealthy people tend to save more than poor people." [Schweickart, After Capitalism, p. 43]
Supporters of capitalists assume that people will not save unless promised the ability to consume more at a later stage, yet close examination of this argument reveals its absurdity. People in many different economic systems save in order to consume later, but only in capitalism is it assumed that they need a reward for it beyond the reward of having those savings available for consumption later. The peasant farmer "defers consumption" in order to have grain to plant next year, even the squirrel "defers consumption" of nuts in order to have a stock through winter. Neither expects to see their stores increase in size over time. Therefore, saving is rewarded by saving, as consuming is rewarded by consuming. In fact, the capitalist "explanation" for interest has all the hallmarks of apologetics. It is merely an attempt to justify an activity without careful analysing it.
To be sure, there is an economic truth underlying this argument for justifying interest, but the formulation by supporters of capitalism is inaccurate and unfortunate. There is a sense in which 'waiting' is a condition for capital increase, though not for capital per se. Any society which wishes to increase its stock of capital goods may have to postpone some gratification. Workplaces and resources turned over to producing capital goods cannot be used to produce consumer items, after all. How that is organised differs from society to society. So, like most capitalist economics there is a grain of truth in it but this grain of truth is used to grow a forest of half-truths and confusion.
As such, this notion of "waiting" only makes sense in a 'Robinson Crusoe" style situation, not in any form of real economy. In a real economy, we do not need to "wait" for our consumption goods until investment is complete since the division of labour/work has replaced the succession in time by a succession in place. We are dealing with an already well developed system of social production and an economy based on a social distribution of labour in which there are available all the various stages of the production process. As such, the notion that "waiting" is required makes little sense. This can be seen from the fact that it is not the capitalist who grants an advance to the worker. In almost all cases the worker is paid by their boss after they have completed their work. That is, it is the worker who makes an advance of their labour power to the capitalist. This waiting is only possible because "no species of labourer depends on any previously prepared stock, for in fact no such stock exists; but every species of labourer does constantly, and at all times, depend for his supplies on the co-existing labour of some other labourers." [Thomas Hodgskin, Labour Defended Against the Claims of Capital] This means that the workers, as a class, creates the fund of goods out of which the capitalists pay them.
Ultimately, selling the use of money (paid for by interest) is not the same as selling a commodity. The seller of the commodity does not receive the commodity back as well as its price, unlike the typical lender of money. In effect, as with rent and profits, interest is payment for permission to use something and, therefore, not a productive act which should be rewarded. It is not the same as other forms of exchange. Proudhon pointed out the difference:
"Comparing a loan to a sale, you say: Your argument is as valid against the latter as against the former, for the hatter who sells hats does not deprive himself."No, for he receives for his hats -- at least he is reputed to receive for them -- their exact value immediately, neither more nor less. But the capitalist lender not only is not deprived, since he recovers his capital intact, but he receives more than his capital, more than he contributes to the exchange; he receives in addition to his capital an interest which represents no positive product on his part. Now, a service which costs no labour to him who renders it is a service which may become gratuitous." [Interest and Principal: The Circulation of Capital, Not Capital Itself, Gives Birth to Progress]
The reason why interest rates do not fall to zero is due to the class nature of capitalism, not "time preference." That it is ultimately rooted in social institutions can be seen from Böhm-Bawerk's acknowledgement that monopoly can result in exploitation by increasing the rate of interest above the rate specified by "time preference" (i.e. the market):
"Now, of course, the circumstances unfavourable to buyers may be corrected by active competition among sellers . . . But, every now and then, something will suspend the capitalists' competition, and then those unfortunates, whom fate has thrown on a local market ruled by monopoly, are delivered over to the discretion of the adversary. Hence direct usury, of which the poor borrower is only too often the victim; and hence the low wages forcibly exploited from the workers. . ."It is not my business to put excesses like these, where there actually is exploitation, under the aegis of that favourable opinion I pronounced above as to the essence of interest. But, on the other hand, I must say with all emphasis, that what we might stigmatise as 'usury' does not consist in the obtaining of a gain out of a loan, or out of the buying of labour, but in the immoderate extent of that gain . . . Some gain or profit on capital there would be if there were no compulsion on the poor, and no monopolising of property; and some gain there must be. It is only the height of this gain where, in particular cases, it reaches an excess, that is open to criticism, and, of course, the very unequal conditions of wealth in our modern communities bring us unpleasantly near the danger of exploitation and of usurious rates of interest." [The Positive Theory of Capital, p. 361]
Little wonder, then, that Proudhon continually stressed the need for working people to organise themselves and credit (which, of course, they would have done naturally, if it were not for the state intervening to protect the interests, income and power of the ruling class, i.e. of itself and the economically dominant class). If, as Böhm-Bawerk admitted, interest rates could be high due to institutional factors then, surely, they do not reflect the "time preferences" of individuals. This means that they could be lower (effectively zero