Does capitalism create inequality?

This article was originally published in the May ’14 issue of the Central Circuit.

by Casey Jaywork | Editor in Chief

George Orwell, the author of Animal Farm and 1984, was what Leftists call a “fellow traveler”—never solidly enough committed to one of the “smelly little orthodoxies” around him to be reliably Anarchist or Socialist, but reliable enough that his wandering allegiances never strayed outside their central hostility toward authoritarian social structures, fascist militarism, and capitalist wage labor. Orwell seems to have known little of Karl Marx, architect of the Leftist critique of capitalism, but he didn’t let it stop him from hating capitalism just the same.

We can do better than Orwell. My purpose in this essay is to explain in plain terms the central concept underlying Marx’s economic critique, which—for all its reputed abstruseness and complexity—is really not that complicated. Marx had one central insight: in capitalism (i.e. a society in which resources are distributed via the mechanism of private property, which is enforced by state violence), it takes money to make money.

That’s it. Everything else flows from this idea. For example: if I only have enough income to meet my basic survival needs, I can’t invest any of it into education or stocks. I will never get out of poverty because I’m spending all my money just staying alive. On the other hand, if a fat inheritance (i.e. investment capital) suddenly drops into my lap, I can spend that money in activities like job training or buying rental property. In other words, I use my inheritance to produce even more money.

What happens when this process continues over time? If someone starts with $100 and invests it to produce $110 (10% profit), what’s to stop her from taking that $110 and re-investing it to produce $121 (again, 10% profit)? And again, to produce $133.1, and so on? Big piles of money have a tendency to turn into bigger piles of money. Or to put this another way: in capitalism, the rich tend to get richer.

I should pause to note that the person making money via investment is not “working” in the normal sense that most wage laborers work. As Adam Smith notes in The Wealth of Nations (Bk. I, Ch. VI), profits from investment “bear no proportion to the quantity, the hardship, or the ingenuity” of the investors; on the contrary, profits “are regulated altogether by the value of the stock employed.” Smith’s insight is born out by by the facts: only about a fifth of the income of people who make $10 million or more per year comes from wages or salaries. So working hard and smart may be the path to success if the only thing you’ve got to sell is your labor, but for rich investors it’s the size of their pocketbook that counts. (Even if the investor is an idiot, he can afford to hire smart investment managers to do his thinking for him.) So profiting from investments is different from getting paid for work.

To return to our self-expanding piles of cash: it’s clear that the rich tend to get richer and the poor tend to stay poor. But what about rich investors in competition with each other? After all, competition is capitalism’s bread and butter: through competition, prices are supposed to be driven down, thus benefiting customers.

Does this claim withstand scrutiny? Imagine one investor starts with $100 and another with $200. Both expect a profit of 10%. Let’s track their money over time:

 

Investor 1

$100 –> $110

$110 –> $121

$121 –> $133.1

$133.1 –> $146.41

$146.41 –> $161.05

Total profit: $61.05

 

Investor 2

$200 –> $220

$220 –> $242

$242 –> $266.2

$266.2 –> $292.82

$292.82 –> $322.102

Total profit: 122.102

 

The investor who started with $200 finished with twice as much extra profit as the one who started with $100: more money grows faster. In other words, capitalism has a built-in tendency to increase inequality over time: not just between rich and poor, but also between rich and richer. Money, and the social power that accompanies it, concentrates into fewer and fewer hands as time passes.

Now imagine that Investor 1 and Investor 2 get into a price war with each other in a limited market, like a Mom n’ Pop retailer competing against Walmart. Who’s going to win? Pretty obviously, Investor 2: her extra-big pile of money allows her to buy more advertising, to sink her prices lower for longer, etc. So bigger, richer companies will tend to push smaller companies out of the market over time, reducing competition and giving a select few companies enormous control over the economy.

In summary: at least conceptually, capitalism tends to make the rich richer and keep the poor poor, and it also tends to make fewer and fewer people rich and more and more people poor. Built into the system is an inexorable drive toward perfect inequality.

But does the story sketched here match the real world? In short, yes. While it’s notoriously difficult to connect simplified economic models to the inconceivable complexity of human behavior, scholars at UC California and Harvard found that in 1774, America had a fairly even distribution of wealth compared to their European counterparts. Back then, the richest 1% of Americans controlled only 7% of national wealth. By 1860, when capitalism was going into overdrive via the Industrial Revolution, they controlled 10%. Today, they control between 1935%, depending on whose numbers you use, while 84% of US wealth is controlled by the richest 20% of Americans. The picture doesn’t get any better globally: the richest 1% of human beings control about half of the world’s wealth, while the poorest half of human beings control about 1%.

French economist Thomas Piketty’s recent book Capital in the Twenty-First Century has further confirmed this explanation. Reviewing tax data from multiple countries over more than a century, Piketty and colleagues from Oxford and Berkely have tracked how capital accumulation (self-expansion of big piles of cash) have consistently outpaced overall economic growth. While Piketty’s analysis differs in important ways from Marx’s, the bottom line—that capitalism tends toward polarized wealth because of how capital works—is the same.

In short: both conceptually and empirically, capitalism leads to staggering inequality.

The obvious question is, What can we do to fix that inequality? Should we return to old-fashioned aristocracy, or turn to a state-controlled economy in the mold of Stalin’s Russia?

No. There is a better way: direct democracy. Capitalism is an economic system in which private property is the only mechanism for organizing resources. Why not keep private property on the individual level—everyone keeps their shoes, house, car, etc.—while democratizing higher-level production and distribution? Why not keep the efficiency of markets while removing the social inequality of private accumulation? For example:

  • Require private businesses to adopt a co-op model, so that they are ultimately controlled by their workers’ votes.
  • Put upper and lower limits on wealth, so that everyone is guaranteed enough money and resources to survive and invest in themselves while no one can accumulate enough wealth to coerce others. (Psychological research shows that there’s no reason for this to discourage productivity, despite conservatives’ unsubstantiated claims to the contrary.)
  • Socialize finance: take credit out of the hands of private banks and make it public property. This would essentially retain the existing model of corporations, but replace private stockholders with the public.

These specific policies can be adopted, modified, or discarded as needed. The larger point is that democratic self-governance is different from, and an alternative to, capitalism. Fans of capitalism like to equate the two by pointing out that consumers ‘vote’ with their dollars. But because capitalism tends toward unequal wealth, a few people get billions of these ‘votes’ while billions of people only get a few ‘votes.’

There is a fundamental antagonism between capitalism and democracy, between private property and shared decision-making, as forms of social organization—an antagonism that’s intensified since the 2008 financial crisis and the grassroots democratic movements it triggered, such as Occupy Wall Street and the fast food workers’ strikes. The fact is that the world’s future is in our generation’s hands. Will we accept a society of growing inequality, where many starve while a few feast? Or will we get organized and force change?

I can’t predict the future. But speaking for myself, I’d rather fail in the struggle for justice than succeed in the race for greed.

 

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