A Flaw in Capitalism

A description of a fundamental weakness in modern Capitalism and a prediction of where it is doomed to go.

©1995 Jeff Lewis

This essay came about because of two warring factions: my father and his friends, who were very much the ardent socialists. syndicalists and anarchists and my friends, many of whom were equally ardent capitalists (or capitalist wannabes). I sat between them and wondered how two groups of people could both be so certain that they were right in an absolute religious way.

This led me to stop and analyse both views and therein, I saw that in fact, both absolute models were flawed in some ways and that neither of them had found the perfect truth they seemed to believe they had found.

I will not be discussing the flaws in socialism in this essay - to sum that up briefly - people are inherently greedy - it's part of the nature of all animals to hoard against future loss. That tends to work against any system which requires people to take only what they need at the time. I do believe that with enough training and with a system which does ensure that there is always enough for anyone (and that's a pretty big if), people could be conditioned to take only what they need at the time and to shed a need to hoard personal items, but that's not likely to happen for some time.

The Basic Setup

To start off, let's imagine a hypothetical economic entity: a group of people who trade mostly within themselves at the normal day to day trading level. In our capitalist system, people work, get paid an amount of money for these services, exchange goods and get paid for that exchange. If a person gets more for a good or service than it cost in total for that good or service - then that person gets a profit. With services, that cost of goods can be very difficult to compute, and we'll discuss that in a later section, but for now the principle still holds.

Ok, let's take this fictional country and take a snapshot of its economic action for a period: say a year. During that year, goods will be manufactured, services will be sold, people and companies will receive earnings. Profits will be made. Let's add them up.

The total earnings made by all people and corporations in the year plus any savings held over from previous years represents the total available revenue to purchase any goods and services which are made available to purchase during that year. Similarily, the total retail price of all goods available and services sold during that year represents the total cost of all production in that same period.

Herein lies the problem. If the system requires that a profit is made, or at least breaking even if not a profit, the total earnings must be less than or at most equal to the total retail value of goods and services sold.This means that it is impossible, in a profit oriented system, to sell all the goods and services created, based on earnings alone. (It can be shown that because of entropy and inefficiencies in any production system, you can't even do this if you try to go for no profits...) This leads to overproduction no matter how efficient you make the system.

How We Used to Fix This

In the past, when there were only a couple of really effective (ie: technologically rich) capitalist countries in the world and the rest of the world was predominately resource rich with no way to exploit its wealth, the solution was easy: you dump your surplus onto these other countries in exchange for raw materials at way below cost. This, in effect, dumped a big negative earnings into the system which reset the surplus for a bit.

Problem is, even the natives get restless and soon the technology poor countries started to realise that if they wanted to make a profit, they'd have to learn how to do technology and get in the game. Soon, all sorts of unexpected players like Korea, India, Brazil and so on, started producing their own goods - shoddily at first, then progressively better and better until they too were effective competitors. But, since their labour had always been accustomed to low earnings, they could produce these goods at lower cost and be more effective at competition in a global market.

How We Try to Fix This (Badly)

In our system, we try to maximise profits. There are only a few ways to do that: reduce cost of materials, reduce cost of labour or increase productivity. The first is the most difficult to do. A car requires a certain amount of raw materials, and while technology can find cheaper materials, there will always be a basic cost of raw materials. The second is much easier to do. With larger and larger populations, the pool of people desperately looking for work is growing and faced with the choice of low wages or no wages, most people will take the low wages. There is a cost to this not often discussed, but I will discuss it shortly.

Finally, there is the last way - which is currently happening. Computer technology and new machining methods are radically improving efficiency and productivity. The very nature of our current recession and its jobless recovery shows this - we have a slowly growing economy, with few to no new jobs. Productivity is up, but we're not doing it by hiring more workers.

So does any of this actually help solve the underlying problem? Alas, no. You see, no matter what you do to maximise profits, the underlying problem is still there: you can't buy back what you make. Reducing cost of materials means that someone else isn't making as much earnings as they used to, thus they have less earnings to buy what you're making (although of the three, this is least harmful change one can make). If you reduce your workers salary, again, there's less earnings to buy the goods you make. And if you eliminate workers, or produce more by being efficient, there's more goods to buy for the same amount of available earnings, so you're still screwed.

Ok, So Why Are We Still Here?

Good question. The answer is simple. Capitialism, as we practice it today, hasn't been around that long. We just like to think it has. In fact, capitalism, like most social systems, undergoes constant change and revision.

Prior to the 1700's, most markets were small and geared mostly to subsistance production. There was no standard of exchange to meter the relative earnings and costs of goods from place to place, so there was no way to tell if you'd really made a profit. Many people supplimented their earnings, if they had any at all, with food grown by themselves on their own lands (or lands they were permitted to live on in exchange for services). People themselves were the technology which ran the world and everyone was, for all intents and purposes, in a third world country.

As well, the world population was relatively low. There just weren't that many people around to compete for jobs and resources. You see, there's a basic formula which has to be considered here: take all of the world's useful (to us) resources and divide that by the total population. That's a real upper limit measure to the wealth of the planet as a whole. The world doesn't change much over time. Our population does. It doesn't take a genius to realise that a smaller population means more wealth per person.

In the 1700's, serious technology started to move from theoretical musings to real world applications. In a real sense, engineering was created in the 1700's. Adam Smith wrote his famous 'The Wealth of Nations' which clearly defined capitalism (although he didn't call it that) and also defined the concept of division of labour. We started specialising and improving our means of production. We also started standardising things. The metric system was created in this period as was standard money (although that one took time to get a foothold). Now, when two people talked about the cost of a certain amount of something, they knew they were both talking about the same thing.

For the first time, there was an objective way to measure profit.

The 1800's, contrary to the views of people like WIlliam F. Buckley Jr., were not a great time for workers. Capitalism in its most unbridled sense was king of the U.S. and in a less unbridled form in other countries. Adam Smith himself, a century earlier had noted that a free market system without compassion is worse than any tyranny and there were many free market tyrants around who ruled with an iron fist and more than a little lunacy.

Finally, the late 1800's and early 1900's brought the first major backlashes against this sort of capitalism and introduced the labour union which fundamentally changed the way capitalism worked. The depression of the 1930's and the World War II paved the way for John Maynard Keynes and his brilliant observation about the stability of capitalist systems: which is to say, they aren't.

Until the stock market crash of 1929, everyone firmly believed that a free market system would always selfcorrect. Problem is that no one seemed to be aware of the concepts of positive feedback and hysteresis. Market hysteresis meant that markets could not shift quickly to sudden rapid changes and positive feedback meant that when the system started to shift, that shift itself could cause the shift to grow bigger as the market reacted to its own shifting.

That brought us the Keynsian model of economics which added the government as a 'flywheel' if you will. Its job was to deaden the economy when it started to race too quickly, and to pump in capital when it was slowing too much. It was to be an economic 'governor' in the same way a flywheel was the governor of a car or bus. It provided negative feedback in the system.

This worked surprisingly well until the 1980's when suddenly we had very conservative, anti-government governments in many countries at one time: and in most of the G7 major economic powers including Reagan/Bush in the States, Mulroney in Canada and Thatcher in the UK. All of these governments collectively decided that Keynsian economics was wrong and that an uncontrolled free market system should be reinstituted immediately. Thus Reaganomics was invented again.

That finally brings us to where we are now. In Keynsian economics, the government taxes during boom times to slow growth, then pumps money back in during slow times to restart the economy: but during the 1980's, none of the major economies did that. They basically let their economies run at full steam collecting less taxes than ever. Then, as you probably guessed, the bust side of the economy happened - and there was no money around to jump start anything. Thus, we languish in an eerie half-recession. Our technology allows production to continue with fewer workers, but fewer workers means fewer people to buy those goods - and with so many layoffs and earnings reductions in order to preserve profits, workers are frightened to spend.

Normally, the government would create work projects and pump money into the public's hands to buy goods and get the economy running again, but they don't have the money. In fact, they themselves are reducing staff - which is adding to the stalling of recovery.

Another relatively new change in Capitalism is the widespread use of credit. We've always had credit in some form or another, but it's only been this century (and the latter half of it for the most part) where the organised widespread use of credit has become required.

Credit, in effect, 'creates' money. You're making a promise that sometime in the future, you'll return earnings in exchange for that future earning's purchasing power and this allows you to buy more goods than you actually should be able to - in the short term. However, since that loan comes with profits attached, you have to pay interest, it actually has a double hit on the problem: it makes it worse because now your future earnings can't buy anything when they are earned and now there's more money tied up in profits.

Now, Let's Go Global

Ok, remember a while back I noted that the way countries have dealt with their surplus goods by dumping them onto unsuspecting non-tech countries in exchange for raw materials at cut-rate prices? That worked well while most of the world was non-tech and generally not capitalist. However, we've been going out there and preaching to the world about the wonders of high-tech and capitalism.

And we've been good at it.

While the exact nature of each country's interpretation of capitalism varies, more and more of the world now creates goods and services for profit. Moreover, they're not accepting the 'here's some neat beads, can we have all your fresh water' sales tactic which has worked so well up to now.

Japan learned that if you make it smaller, better and cheaper, you can fight dirty and still be rich. Most of the Asian Rim countries are learning this lesson too: we taught them it.

Problem is, where do you sell your surplus when everyone has a surplus?

Well, the answer is, you don't. That's where we're having problems. That's why we're stuck in this stalled recession-limbo. We have goods and services, we're not poor - but we can't seem to sell enough to make a profit, and more and more people are losing work and not having enough to survive. As a society, we're dying rich.

Unfortunately, trade deals which try to make the world a 'level playing field' are really being used mostly to allow the lowest cost labour to be accessed with the result that the available earnings will continue to go down - which makes it less and less possible to buy all the goods produced.

The Unemployment Myth

One final note. We have a wonderful way of playing with numbers and definitions to 'prove' to ourselves that something is right. Unemployment is one of those areas which takes the greatest number of reality hits.

For example: what does that unemployment rate number really mean? Most people think it means the percentage of the population who could work but aren't employed. It doesn't. In most countries it represents the percentage of people who are elegible for social support while looking for work who aren't employed. A much smaller number.

In fact, prior to the 1800's, generally speaking everyone in a family, husband, wife, children, would work. Usually on the family land to grow and harvest goods but also for other people doing chores and the like to get a little extra. In the 1800's, child labour was very common and was an essential way to get enough money to survive.

The concept of a family where only the father worked is a very recent one. So, if we're going to talk about earnings and employment, let's keep the model constant. In the 1800's, employment was close to 90% of the population - everyone worked in some capacity to earn either goods or earnings to buy goods. By the 1900's, children didn't work - which dropped the employment rate to around 50%. By the 1950's, women no longer considered appropriate to work in an earnings capacity (and to all the women reading this - do not get me wrong, I'm not saying women stopped working: I'm saying they stopped earning revenue) which dropped the percentage of the population employed in revenue earning capabilities to less than 30%.

This means that relative to the 1800's, our real unemployment rate: that is, the percentage of the population who could be working for earnings but are not, is close to 70%, not the 8-10% you normally hear about.

This means that on average, every person who earns revenue is supporting three other people who are not. This gives you an indication of just how efficient our means of production has become. Relative to the 1800's, each person who works in a production job is creating three times his own needs.

The Curse of Societal Short-term Memory

There's one other force which has to be noted: societies as a whole have a two generation memory. Anything which happened more than 40 years in the past becomes irrelevent to the current generation.

Examples: Trade unions were created as a response to extremely poor treatment of workers in the late 1800's. Today, people see unions as unimportant and more a problem than a solution. Many honestly believe that whatever reasons existed for the creation of unions no longer exist. Oddly though, what's happening to workers today is almost exactly what happened to workers 100 years ago.

World War II is just outside of the 40 year period and we're starting to see a resurgence of neo-Nazi and fascist groups and governments which rule using fascist methods. By this, I'm not saying that they're behaving like Hitler, but rather are returning to the sorts of tactics used by the goverments like his.

Unfortunately, this means that we're doomed to repeat the same mistakes over and over in a roughly 40 year cycle. The actual cycle goes: 20 years later is nostalgia and 40 years later is forgotten. This is why the Brady Bunch and disco is coming back into vogue again. First we idealise the past, then we forget it.

So, Where Does This All Lead?

Well, alas, I don't have good news here. While I'm pro-welfare, the fact is that it doesn't work. Not for the reasons you might be thinking: the fact that someone is getting a living without working for it isn't a big deal, as I've just shown, three out of four people do that already. It's the fact that welfare doesn't solve the underlying systemic problems in capitalism.

Neither does working for a living. That just gets you a better slice of the shrinking pie.

This whole game might have gone on a lot longer - well, a century or so, maybe - if Keynesian economics hadn't been railroaded in the 1980's or if more of the world hadn't adopted a capitalist variant when they did, but they did and it was inevitable that this would happen.

Free market capitalism suffers from the same flaw, oddly, as socialism: greed means that people won't play by the rules. In capitalism, people stop competing to gain monopolies when they can. In socialism, people refuse to share and reduce their wants down to needs. Any system which ignores the combination of greed and cleverness which are the hallmarks of humanity, is doomed to fail.

History shows that modern capitalism will change. If it can't change fast enough, it will be torn down in a revolution to be replaced with something which claims it's very different, but in reality ends up being very similar. Given the current state of affairs, I'd have to say that this is the most likely outcome.

Unless there's a major shift away from the radical right in the UK, Canada and the US - especially the US - within the next eight years, and unless Keynsian economic methods are reintroduced (which may not be possible anymore), then the gap between earnings and costs will become too great and the population will be forced to break out of the system.

I'm inclined to say that if things continue as they are, this will happen within twenty years starting in the US (southern US in fact, probably California). The UK is next likely - the EC tends to moderate that probability somewhat.

Unfortunately, there's no simple solution as long as we have a system of resource distribution based on earnings and cost alone. We can't continue trying to distribute goods and services to an ever increasing population - its very size becomes the bottleneck as the available resources in proportion to the population dwindles.

It's going to be a rough ride.