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Friday, September 12, 2008

"The Economics of Kapital and the Capital of Economics"

Michael Perelman is giving a talk to give in China in a few months, and is hoping to get (helpful and constructive) feedback on this initial draft:

The Economics of Kapital and the Capital of Economics

Introduction I want to talk about two capitals ‑‑ capital as it appears in economic theory and Das Kapital of Karl Marx. A careful consideration of these two capitals serves as a warning of what might be in store for any country that allows itself to follow the logic of markets.

Each of these two capitals presents a different sort of difficulty. Economics, the basic theory of capitalism, paradoxically never bothered to develop a serious theory of capital. In contrast, Marx's idea of capital as a social relation is so rich that it defies being compressed into a simple theory.

For this reason, many parts of Marx have rarely been integrated into their modern analysis of his work; these parts stand as incredibly brilliant observations, each of which are like a kaleidoscope. Turn them a bit and they will generate many new observations, each of which could merit a book of its own.

The three observations selected here represent both a chronological sequence and a progression in the sophistication of the challenges that they present.

Observation 1: The Development of Capital

The first, and most simple, of these observations is Marx's recognition of the sequence of technological change, which begins in the final goods sector (usually the consumer goods sector) and then finally moves to the sector that produces the capital goods, which the consumer sector uses. When the Industrial Revolution was beginning in the textile industry, handicrafts workers still produced the machines. The same sequence occurred in the personal computer industry, where girls and young women had to laboriously put fragile chip connectors into the motherboards. This disconnect between what was considered a wonder of modern technology and the primitive process of production made for striking pictures of girls and young women work assembling computers, work that is now done with the assistance computers.

National economies seem to have followed a similar course, first producing consumer goods ‑‑ often textiles ‑‑ and then moving to the production of more sophisticated producer goods. The business press in the United States describes this transition as moving up the value chain.

At the time he was writing the first volume of Capital, Marx seemed to accept the popular idea of the time that that the economy would evolve through a series of natural stages. Capitalism may have been cruel prior to the time that modern manufacturing had not yet evolved in the capital goods sector, but it still seemed to be a necessary component of development.

Today, with a large pool of cheap labor in poorer countries around the world, this progression is mutating. Labor has become cheaper than capital, giving rise to the proliferation of sweat shops. Assuming a natural progression might not be appropriate.

observation 2: How Markets Destroy Capital


The second observation relates to the more advanced form of capitalism, where modern technology is already producing capital goods. In discussing this second observation, keep in mind that the strongest argument that proponents of markets offer is that capitalism is efficient because it ensures that investment goes to the most productive activities. Marx's second observation undermines that argument.

This observation is that a proper theory of value must reflect reproduction costs rather than production costs. This observation about reproduction costs has two divergent implications, both of which are important for understanding both capital and capitalism.

First, a little background may be useful. Many students of Marx regard value as a simple adding up of labor time required for the production of a commodity. Reproduction costs complicate the analysis because, at the time of an investment, nobody knows the future.

Obviously, business purchases capital goods today, not knowing either what the market will be like tomorrow. The framework of reproduction costs means that business will not know when a future technology will make a new capital good obsolete.

The declines in reproduction costs are especially severe during periods of rapid technological change. This phenomena was abundantly clear during the early decades of the personal computer, when each new generation of computers would start out with a price something like $10,000, decline relatively rapidly until it approached $1000, at which time a new generation would appear. While the price declines were relatively predictable, the timing was not.

Marx treated this observation most clearly in discussing Charles Babbage in the first volume of Capital. Babbage, who, like Isaac Newton, was Lucasian professor of mathematics at Cambridge, attempted to construct the first computer in the early nineteenth century, more than a century before the first working computer was produced. Of course, Babbage's computer was based on mechanical power rather than electronics, but it still required parts with very precise specifications. In carrying out this project, Babbage had to work with many workshops. In the process Babbage learnt a great deal about modern manufacturing.

Based on his experience, Babbage published an extraordinary book, The Economy of Machinery and Manufactures, which well beyond any contemporary work of political economy in creating a realistic analysis of modern production. The significance of rapid technical change struck Babbage, who claimed, "... the improvements succeeded each other so rapidly that machines which had never been finished were abandoned in the hands of their makers, because new improvements had superseded their utility" (Babbage 1835, p. 286). Babbage's rule of thumb was that the cost of an original machine was roughly five times the cost of a duplicate (Babbage 1835, p. 266). He used the example of frames for making patent net that initially sold for twelve hundred pounds. A few years, later they cost only sixty pounds (Marx 1977, p. 528; Babbage 1835, p. 286 and 214). According to Babbage's estimates, one hour of labor embodied in patent nets that were only a few years old would be equivalent to three minutes of direct labor embodied in the commodity.

During the later part nineteenth century, such rapid devaluation of capital was sweeping across the U.S. economy. For example, not long after Marx wrote, the American steel magnate, Andrew Carnegie, upon hearing about a superior design for a rolling mill ordered his young assistant, Charles Schwab, to raze and reconstruct an existing three‑month‑old mill (Livesay 2000, p. 130).

The point here is that capitalism can create new value in the form of a capital good, but it destroys existing values as well. Unlike the 20th century Austrian economist, Joseph Schumpeter, who wrote about creative destruction (Schumpeter 1950), Babbage emphasized what might be called destructive creativity.

In a laissez‑faire economy, profits become impossible when the sequence of technical change becomes too rapid As the Carnegie example shows, when the pace of technological change reaches a threshold, capitalists may not be able to operate their stock long enough to recoup their initial outlays. For example, capital destruction became so intense in economy of the late 19th century United States that industry experienced a prolonged crisis, even though the economy was growing at the time.

Rapid technological change creates another problem for capital. Investors do not relish the prospect of having their capital goods become obsolete; nor do they want to be left behind when new technological opportunities present themselves. During times of rapid technological change, the lure of great profits makes investors more likely to rush into projects that will go sour.

For example, in the late 1990s, extravagant predictions about the Internet led business to overinvest in fiber-optic cable. In two years, business companies spent an estimated $35 billion to lay an estimated 100 million miles of optical fiber -- more than enough to reach the sun. After this flurry of investment, the industry found that only about 2.6 percent of the capacity was actually being used (Romero 2001; Blumentstein 2001). By the time the demand increases enough to require this much optical cable, the technology embodied in this investment may well be obsolete.


The second implication of reproduction costs is environmental. Unlike declining reproduction costs for industrial goods, reproduction costs for resources tend to increase. Ironically, Marx's value theory is often wrongly dismissed for having neglected natural resources. For example, in a widely circulated article, Paul Samuelson charged Marx with ignoring "the patent fact that natural resources, too, are productive" (Samuelson 1957, p. 894). However, with his concept of reproduction costs, Marx offered a framework well in advance of contemporary economics. The wanton depletion and degradation of resources should be taken into account in evaluating economic activities, even though the price system pays no attention to such matters.

Consequently, while new technology for extracting resources may create the illusion of diminishing scarcity, rapidly rising, but unpriced, future reproduction costs go unnoticed. Looking at the exploitation of resources only in terms of how much it costs to capture them is ridiculous.

Reproduction costs require a different perspective. Imagine a person walking into automobiles dealership, offering to pay the cost of extracting the automobile from the premises ‑‑ maybe $.10 worth of gasoline plus a nickel, representing a fifty percent markup. Nobody would take such an offer seriously, yet the market prices resource extraction in a similar fashion.

Markets, of course, are supposed to signal when resources are becoming scarce, so that people take measures to economize. In the United States, there was a bird known as the passenger pigeon, which was so numerous that flocks of birds would actually block out the sun. Hunters would fill large wagons with the birds that they killed. They had a ready market for their produce because the bird tasted like chicken, making pigeon prices similar to those of chickens. Because of this relatively tight relationship, the price of these birds stayed relatively constant right up to the time that they became extinct (Perelman 2003, pp. 67‑77).

In the case of the passenger pigeons, the warning from the price system was nonexistent. Of course, the world has survived without passenger pigeons, but fossil fuels and water, which are central to our lives, must be treated with considerably more care. As a result, reproduction costs and market prices diverge, blinding society to future dangers.

Wrapping up

Babbage's examples stand as a stark reminder that the economic dogma that markets are efficient is highly questionable. Why, then, should anyone believe that markets could provide an efficient method of organizing investment?

In fact, as mentioned before, economics has never bothered to produce a serious theory of capital. Instead, the discipline takes care not to develop a serious theory of capital by making unrealistic assumptions that presume that business has knowledge of the future or that investment lasts only one period or, in the case of resources, that some new backstop technology will provide an adequeate substitute.

Without such assumptions, capitalist investment could not be portrayed as the engine of a process of efficient utilization of resources, but rather would be exposed as a relatively uninformed bet on the future.

A coordinated economy in which producers and technologists communicated among each other directly, rather than indirectly through prices, could avoid some of these inefficiencies. Unlike business, economics can avoid such problems by assuming them away.

Observation 3: Why Capital Requires New Social Relations

The final, and most interesting observation suggests the importance of going beyond the call for more direct communication between producers and technologists. This observation is also the most challenging. It may also be less familiar because it occurs in Marx's notebooks, known as the Grundrisse. This observation occurs in a relatively long paragraph, which is rich enough to merit an entire book.

The background to this observation is the idea that the core of capitalist production was cost minimization, which was accomplished by cutting back on labor costs, either through holding wages down or driving workers harder. Although profit maximization is not exactly equivalent to the minimization of labor time, Marx's point becomes even stronger once we recognize that, even today, business tends to put excessive influence on investments that cause labor costs, even as labor inputs, to shrink. For example, based on a survey of 60 New England factories, Michael Piore found that employers instructed engineers to pursue single-mindedly the goal of developing methods to reduce labor inputs, without regard for the more rational criterion of overall cost minimization. He went on to say:

Virtually without exception, the engineers distrusted hourly labor and admitted a tendency to substitute capital whenever they had the discretion to do so. As one engineer explained, "if the cost comparison favored labor but we were close, I would mechanize anyway." [Piore 1968, p. 610]

Even forty years later, except for a few high tech corporations, evidence of a change in the mentality that Piore described is lacking. In other words, the capitalist system has not been able to wean itself from its primitive roots, which developed a time where profit depended on the capacity to drive workers longer and harder.

In addition, in the United States, business and government have done everything possible to hold wages in check. According to government statistics, hourly wages corrected for inflation peaked in 1972 at $8.99 measured in 1982 dollars. By 2007, hourly wages had fallen to $8.24 (President of the United States 2008, Table B‑47, p. 282).

Although wages rose modestly during that period using a different measure of inflation, the government does not even bother to calculate many of the costs that poorer families face, such as higher interest rates and higher fees (see Perelman 2007, chapter 1). As a result, the deterioration of wages is probably even more severe than the official data indicate.

Shrinking wages cause the typical family to have to devote more hours to the labor market, preventing people from developing their capacities in the way that Marx described in this observation. For example, between 1970 and 2002, annual hours worked per capita rose 20 percent in the United States, while falling in most other advanced economies, where a stronger labor movement has been able to slightly moderate market forces (Organisation for Economic Co‑operation and Development 2004c, p. 6).

This third observation was to call attention to the glaring contradiction between emphasis on the minimization of labor costs and the nature of modern technology, which was to minimize the role of direct labor in production. In Marx's words:

... to the degree that large industry develops, the creation of real wealth comes to depend less on labour time and on the amount of labour employed than on the power of the agencies set in motion during labour time, whose 'powerful effectiveness' is itself in turn out of all proportion to the direct labour time spent on their production, but depends rather on the general state of science and on the progress of technology, or the application of this science to production." [Marx 1973, pp. 704‑5]

Not only does the typical production process require less labor, but the kind of labor needed changes. In Marx's words, in a rational economy the modern worker:

... steps to the side of the production process instead of being its chief actor. In this transformation, it is neither the direct human labour he himself performs, nor the time during which he works, but rather the appropriation of his own general productive power, his understanding of nature and his mastery over it by virtue of his presence as a social body ‑‑ it is, in a word, the development of the social individual which appears as the great foundation‑stone of production and of wealth. The theft of alien labour time, on which the present wealth is based, appears a miserable foundation in face of this new one, created by large‑scale industry itself. As soon as labour in the direct form has ceased to be the great well‑spring of wealth, labour time ceases and must cease to be its measure, and hence exchange value [must cease to be the measure] of use value. [Marx 1973, p. 705]

Marx's point was that the requirements of modern technology demand measures to expand people's potential rather than treating them as implements that must be driven as hard as possible.

The language of economics reinforces this attitude toward labor, referring to workers' acquisition of knowledge and experience as human capital. I have just finished writing a book, entitled The Invisible Handcuffs of Capitalism: How Market Tyranny Stifles the Economy by Stunting Workers.

This book explores the way that capitalist performance will continue to fall behind the technical capacity of society because of the inability to human potential and the way economics has made great efforts to make this problem invisible by emphasizing transactions, while putting aside all matters of work, workers, and working conditions.

Summing Up

Marx's first observation warns us about the importance of keeping in mind the structure of economic development. The second observation warns us about the dangers surrounding economic development, including both in terms of devalorization and the depletion and destruction of resources. Marx's third observation is the most challenging.

This observation suggests that the most important dimension of economic development is the nurturing of labor. This priority is not merely a call for social justice, but for economic rationality. In each case, conventional economics fall short of understanding the challenges of creating a modern economy.


Babbage, Charles. 1835. The Economy of Machinery and Manufactures, 4th ed. (London: Charles Knight).

Blumenstein, Rebecca. 2001. "The Path to the U.S. Fiber Cable Glut." Wall Street Journal (18 June).

Perelman, Michael. 2003. The Perverse Economy: The Impact of Markets on People and Nature (New York: Palgrave).

Perelman, Michael. forthcoming. The Invisible Handcuffs of Capitalism: How Market Tyranny Stifles the Economy by Stunting Workers.

Romero, Simon. 2001. "Once‑Bright Future of Optical Fiber Dims." New York Times (18 June).

Samuelson, Paul A. 1957. "Wages and Interest ‑‑ A Modern Dissection of Marxian Economic Models." American Economic Review, Vol. 67, No. 6 (December): pp. 884‑912.

Schumpeter, Joseph A. 1950. Capitalism, Socialism and Democracy, 3rd. edn. (New York: Harper & Row).

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