“Running a profitable enterprise is not the same thing as Smaug guarding a pile of gold.”
One of the more regrettable developments in recent years is a resurgence of interest in the ideas of Karl Marx. For example, Matt McManus published an article earlier this year at Quillette about “Why We Should Read Marx.” More recently, Ben Burgis published an article at Arc Digital defending Marx’s theory of exploitation. These essays, by intelligent and thoughtful philosophy professors whose political sympathies align with Marx’s critique of capitalism, comport with what Quillette editor Toby Young calls a neo-Marxist takeover of our universities. Indeed, as tabulated by Phillip W. Magness, Senior Research Fellow at the American Institute for Economic Research: “…as of 2015 Marx stands nearly alone as the most frequently assigned author in American college classrooms, only surpassed by the ubiquitous Strunk and White grammar manual.”
This resurgence parallels the political traction gained by democratic socialism, Bernie Sanders, and Alexandria Ocasio-Cortez, as well as the popularity of left-wing journalistic outlets like Current Affairs and Jacobin magazine, the latter a quarterly print magazine with 50,000 subscribers, and an online “audience of over 2,000,000 a month,” and as a Google search indicates, a venue which adamantly endorses a Marxist worldview. In the aftermath of the Great Recession, this interest in Marx is perhaps unsurprising, similar to how the Great Depression fostered skepticism about the virtues of capitalism. Nonetheless, it is apparent that the end of the Cold War—and the booming nineties—were not the death knell for Marxism they once seemed to be.
At its core, Marxism is a theory of exploitation. “Capitalism” is purportedly characterized by an irrepressible class conflict between “capitalists” and “laborers”: between those who own the “means of production” and those who do not. As owners of the means of production, “capitalists” set the terms of production and employment. They hire workers to work the machines, deliberately minimizing wages to maximize profit. Laborers capitulate because selling their labor is their only way to survive. They are set “free” into the wilderness of “capitalism” and quickly realize they must yoke themselves to the iron law of M – C – M’, turning money (M) into commodities (C) and commodities into more money (M’). The world is divided between rich fat cats sitting on a pile of gold, deploying their riches to reel in poor hungry souls who sadly (but helplessly) surrender their capacity for labor to the commodification of life in the service of profit accumulation.
When capitalists sell commodities to workers at a profit, workers confront their externalized labor as a hostile force. False consciousness keeps workers oblivious to their alienation, while the M – C – M’ cycle of surplus value creation churns on, further enriching capitalists while the masses of workers earn wages not high enough to afford all the commodities they are conditioned to fetishize. Inevitably, after repeated crises resulting from the inherent contradictions spawned by high prices and low wages, workers will awaken from false consciousness and revolt, pulling down capitalists from atop their piles of gold and democratically deciding how to spread the wealth.
If this all sounds like a fantasy, that’s because it is.
If this all sounds like a fantasy, that’s because it is. To see why, consider the origins of industrialization in America. The first commercially successful cotton-spinning mill in America was built in 1790 in Pawtucket, Rhode Island. As the late historian William G. McLoughlin writes in a history of Rhode Island:
“At the outset, the thought of making Rhode Island an industrial state seemed not only risky, but bizarre. Where would it get the capital? How could it possibly compete with British textiles? Where would it obtain the machinery and the skilled mechanics to build, service, and operate the necessary machinery?”
Rhode Island’s eventual success was the result of waterpower and a favorable climate, as well as protective tariffs, canals and railroads, immigration for labor, raw material from the South, and the domestic market of a growing nation. But the original “capitalist” was Moses Brown, “a Quaker abolitionist and member of the well-to-do Brown family in Providence.” He “proved to be the man with the vision, the capital, and the persistence to carry out the initial experiment.” In retrospect, “it all seems so logical as to be inevitable.” At the start, however, “it seemed an almost hopelessly visionary notion.”
The textile mill would replace sea power as the engine of prosperity in Rhode Island, contributing to the economic transformations of nineteenth-century America. But it was not predestined. “Rhode Island,” McLoughlin writes, “had always been a sheep-raising community” whose “men and women knew how to spin wool, cotton, linen, or flax and how to weave them into various kinds of cloths.” The “refusal of the British government to allow the colonies to engage in manufacturing and the British prohibition against the exportation of textile machinery (or even the blueprints for that machinery) seemed to doom Americans to remain consumers or traders, rather than producers.”
“Moses Brown and his business partner, William Almy,” McLoughlin continues, “made the first efforts to overcome these obstacles in 1787.” After two years of failed efforts trying to construct a workable machine, Brown closed his mill. “The problems seemed insoluble,” McLoughlin writes. Enter Samuel Slater, an English immigrant who heard about Brown’s efforts. Having “worked for seven years in the cotton-spinning factories of Derbyshire, England,” he “wrote to Brown on December 2, 1789, and offered his services,” claiming “he could reproduce from memory the complicated blueprints for the most up-to-date British spinning machinery” invented by Richard Arkwright.
What Slater had lacked thus far was “someone with enough faith in him and enough capital to build it in America.” Brown provided Slater with “the funds and assistants to build the first successful Arkwright cotton-spinning machine in America.” The machine “was installed in Brown’s Pawtucket watermill in December 1790.” The rest is history. “Brown’s persistence had paid off.” The three-year effort would unleash dramatic changes in American life besides “carding and spinning more thread and yarn than the hand weavers could possibly utilize on their home looms.” Among these changes was the rigid regimentation of labor. Home weavers were not accustomed to the “implacable regimentation” of working in mills. They protested. In fact, McLoughlin claims, the “first workingmen’s strike in American history occurred in Slater’s mill in 1800, when the weavers walked out and left their looms idle in protest against Slater’s hard-driving system.” But home-weaving could not compete with “the relentless pace of the machines.”
In the ensuing decades, industrial progress bloomed, though not without dramatic social and cultural changes. The interplay between industrial progress and structural dislocations in society are worthy of examination and certainly have not been ignored by historians. At this point, Marxists may insist that the speed and disruptiveness of economic change was exactly Marx’s point when he wrote, with Engels, in the Communist Manifesto, that “[t]he bourgeoisie cannot exist without constantly revolutionising the instruments of production, and thereby the relations of production, and with them the whole relations of society.” But what Marx deemed a dynamic instability unique to “capitalism” is simply the crooked march of events shoehorned into a theory of exploitation. Industrialization and commercial prosperity were not divinely ordained by the gods of history. Moreover, they were facilitated not only by technological innovation but by a banking revolution, as economist Cameron Harwick explains in this paper (though addressing a separate topic):
“…the advent of sustained economic growth starting with the Industrial Revolution was accompanied by a banking revolution as well. Moneylending lost its stigma, and, with financial and actuarial innovations, trade and industry were able to flourish.”
In addition, the Slater mill illustrates that “capitalists” come, and “capitalists” go. I am referring, of course, to the concept of risk. If “capitalism” refers to an historical phenomenon and not just the protection of profit and private property, it refers to the evolution of more sophisticated ways to efficiently allocate risk capital. Risk is an inherent feature of all economies—but more so as the pace of change quickens. Rhode Island’s industrial position solidified throughout the nineteenth century, but nevertheless would be upstaged by agglomeration economies set up by Boston merchants in Massachusetts. According to the late Peter J. Coleman in The Transformation of Rhode Island 1790-1860:
“The inability or unwillingness to adopt the Lowell style of operation as well as the continued use of outmoded forms of production brought about a gradual decline in Rhode Island’s status within the American cotton industry. Though it remained a leading producer…Massachusetts, not Rhode Island, came to dominate the industry.”
Despite its successes, industrial development was not immediate in Rhode Island. As Coleman writes, “the Rhode Island cotton industry developed so slowly that many years elapsed before a full-fledged factory system emerged.” One reason was England’s restrictions on “the emigration of craftsmen and the export of machinery.” Another was the “difficulty of recruiting factory workers,” in part “attributable to the cotton weavers’ vested interest in their craft.” The “cotton weavers and knitters resented the development of factories, and, like farm workers, submitted reluctantly to factory regimentation.”
As industry settled in, additional frictions arose with the transitions from waterpower to steam power, and from joint-stock partnership to “the adoption of the corporate form of business organization [which] also facilitated industrialization.” On the latter point, “most early manufacturing corporations failed within a few years,” in part due to the inability to raise sufficient capital. Again, capitalists come, and capitalists go. Return cannot be separated from risk. To this day, data on entrepreneurship from the U.S. Bureau of Labor Statistics show that “about 20 percent of small businesses fail within their first year. By the end of their fifth year, roughly 50 percent of small businesses fail. After 10 years, the survival rate drops to approximately 35 percent.”
The two most fundamental concepts in finance are return and risk. Returns (or profit, or surplus value, or whatever you want to call it) are compensation for taking risk. The most fundamental error in Marx’s theory of exploitation is the idea that profit is akin to theft, whereby “capitalists” nefariously whisk away the “surplus value” created by laborers. Certainly, nothing gets done without workers putting machines to work. But there are no machines to work, and no mills in which to work them, without “capitalists” like Moses Brown who put capital at risk and persevere until, in Brown’s case, he found the right technical expert in Samuel Slater. It was then up to Brown, Almy, Slater and innumerable other mill owners and managers to figure out how to make mills work as profitable ventures. The implication that mill owners parasitically extract the proceeds of production done by others, rather than earn compensation for their own arduous efforts involved in starting and running inherently risky enterprises, is preposterous and is not worth taking seriously.
Therein lies the fatal flaw in Marx’s theory of exploitation. The distinction between capitalist and laborer is a false dichotomy. Running a profitable enterprise is not the same thing as Smaug guarding a pile of gold. The “capitalist” is as much a worker as anyone else and should be compensated for the effort he puts into the business. Moreover, given human capital, everyone is a capitalist (even if one acknowledges these critiques of human capital theory). As I wrote in a Letter exchange with Matt McManus, it is true that “the laborer cannot survive in capitalism without selling his labor,” but “it is also the case that capital cannot survive if it cannot hire labor to operate machinery.”
Capital can hold out if it wants, but then machinery is idle, nothing gets produced, profits are not made, everyone starves, and society breaks down. Perhaps it was this potential threat that explains why there was fierce resistance to the labor movement which eventually gave us forty-hour work weeks, the end of child labor, and other laws for which I am, as we should all be, quite thankful. If so, resistance seems to reflect not simply an insatiable but self-destructive impulse for profit accumulation for the few at the expense of the many, but a responsible, if self-serving and myopic, cautiousness about the implications of labor agitation for industrial development. “Bourgeois conservatism” reflects a lack of long-term vision rather than a staunch thirst for material exploitation.
Marx saw returns, i.e. surplus value, as stemming solely from the efforts of hired hands. But supply and demand are the fundamental determinants of value.
Finance, which in many ways made civilization possible, involves the allocation of capital across various opportunities for incremental return on investment. But with return comes risk. Investors do not study returns and risks alone but examine returns and risk together. One can study discounted cash flow analysis, price multiples, or Dupont analysis to get a sense of the complexities of analyzing returns, or Value at Risk, standard deviation, semi-standard deviation, tracking error, skewness, kurtosis, beta, and alpha to get a sense of the complexities of analyzing risk. But high return investments may come at the cost of high risk, and low risk investments can be expected to generate low returns. What matters is not return or risk alone but return in relation to risk. One can spend some time analyzing the pros and cons of the Sharpe ratio, Omega ratio, Treynor ratio, Information ratio, and Sortino ratio to get a feel for the complexities of risk-return analysis.
Marx saw returns, i.e. surplus value, as stemming solely from the efforts of hired hands. But supply and demand are the fundamental determinants of value. Firms produce things because consumers want to buy them. The distinction between use value and exchange value is another false dichotomy. Relative prices reflect the incremental value of goods and services as a function of the technology it takes to produce them and the preferences of consumers who purchase them. Labor is an input. So is capital, land, managerial expertise, entrepreneurial initiative, and technology. Each is compensated in accord with its marginal productivity. Firms produce at the point where the ratio of each input’s marginal productivity to its price is equal across all inputs (achieved by substitution among inputs in response to changes in their marginal productivity and prices). Meanwhile, the ratio of each good’s marginal utility for consumers to its price is equal across all other goods in the economy. This is the point at which supply and demand reach equilibrium, where incremental value is optimized across the broad and complex range of inputs and outputs used up in the system of economic activity. A concise way of summarizing the point is that income is determined by the scarcity of your contribution, not the value of human worth, a point I explore here.
Of course, economies are dynamic, not static. Equilibrium is perpetually in flux; inefficiencies arise. Indeed, none of this is to suggest that free markets seamlessly solve all problems. But neither is it the case that profit is the root of all evil. Profit is simply the compensation for risk-taking by “capitalists.” One could delve into the complications of rent-seeking, accounting profit versus economic profit, and so on. But the basic takeaway is that profit is not exploitation. It is a return on investment. Yes, inequalities arise and must be addressed, and society can engage in perennial debates about how best to put profit to work (e.g. by taxing corporate profits to fund policies that address the skills gap). But profit is not theft. It is compensation for those who put capital at risk to start and run businesses. To see profit as a pile of gold hoarded by Smaug is a remarkable error of economic reasoning. Unfortunately, like Marx’s influence, it persists to this day.
Jonathan David Church is an economist and writer. He is a graduate of the University of Pennsylvania and Cornell University, and he has contributed to a variety of publications, including Quillette and Areo Magazine.