Chapter 11. The Division of Labor and the Concept of Productive Activity

CHAPTER 11

THE DIVISION OF LABOR AND THE CONCEPT

OF PRODUCTIVE ACTIVITY

PART A

THE ROLE OF MONEYMAKING IN

PRODUCTIVE ACTIVITY

1. The Division of Labor and Productive Activity

T he existence of the division of labor exerts an influence on the nature of productive activity that is no less profound than its influence on the institutions of private ownership of the means of production, economic inequality, and economic competition. An understanding of this influence is sorely lacking in the present-day world, however. Unfortunately, most people hold a concept of productive activity that would be appropriate only in a non-division-oflabor society.

The Doctrine That Only Manual Labor Is Productive

The notion of productive activity that the majority of our contemporaries hold is that productive activity is manual labor. Productive activity and manual labor are seen as virtually interchangeable concepts. For evidence of this proposition, consider the distinction drawn in the United States by the Internal Revenue Service between “earned income” and “unearned income.” “Earned income” is held to be wages and salaries. Profits, interest, and dividends, on the other hand, are held to be “unearned income.” The basis of the distinction is that the first two are perceived as being received by virtue of the performance of labor. The last three are perceived as being received without the performance of labor.

Exactly the same ideas are held by the labor unions, who believe that their members, who are almost all manual workers, are the people truly responsible for production and thus the rightful recipients of all income. It is on this basis that the unions feel entitled to appropriate every last dollar of profits that they possibly can for wage increases. In their view, the profits rightfully belong to their members in the first place.

The view that productive activity and manual labor are one and the same is an essential doctrine of Marxism and is held by every socialist government. It is in the name of this proposition that the Marxists have sought to expropriate private property and establish socialism, so that the “unearned income” can be given back to its alleged rightful owners, the manual workers. Marxism also provides intellectual inspiration for the labor unions and the tax authorities. It is the leading source of their conviction that they are appropriating unearned income for the benefit of those who are entitled to it.

But the notion that only manual labor is productive long predates Marxism. It was propounded by the classical economists in most respects, and, more than that, it is a reasonable conclusion if one’s only experience is that of the conditions of a non-division-oflabor society. In a non-division-oflabor society, where production means, essentially, the growing of food, the making of clothing,

442 CAPITALISM and the building of shelter, on a household basis, the producers are those who do these things, and the nonproducers are those who do not. In a non-division-oflabor society there is no room for any category of producer much beyond that of toiler in the field or at the loom.

The doctrine that only manual labor is productive—a mental inheritance originating in the primitive conditions of earlier times and then frozen, as it were, by virtue of a failure to consider the radically new conditions established by the development of the division of labor— underlies the condemnation of an immense proportion of the productive activity of a capitalist society. Because of its influence, many people have no conception of perhaps what half of the present-day economic system is for. In addition to its most serious consequence of excluding the activities of businessmen and capitalists from the category of productive activity, the manual-labor doctrine excludes many other important productive activities performed in a capitalist society. Thus, retailing and wholesaling are widely perceived as having nothing to do with production, but serving merely as a pretext for adding on “markups” to the prices charged by manufacturers and farmers. Advertising is routinely considered to be nonproductive, indeed, to be inherently fraudulent. The stock and commodity exchanges are regularly denounced as mere “gambling casinos,” with virtually no connection to productive activity. The banking and financial system in general is regarded with similar suspicion.

The manual-labor doctrine rests on an ignorance of the requirements of a division-of-labor society and is far too narrow in its view of what constitutes productive activity. A proper concept of productive activity must make room for the activities of businessmen and capitalists, retailers and wholesalers, and advertisers, and of the stock, bond, and commodity exchanges and financial system in general. 1

In another respect, however, the manual-labor doctrine leads to a view of productive activity that is actually far too broad. For it regards as productive activity all activity that represents manual labor. Thus, it leads to the very popular notion that there is no basis for distinguishing between the labor of unpaid housewives and that of paid housekeepers who perform the same work. Both are held to be equally productive on the grounds that both perform the same manual labor. It also leads to the very popular view (contrary to the teachings of Adam Smith on this subject) that there is no basis for regarding the labor of government employees as inherently unproductive, inasmuch and insofar as they perform the same type of physical work as the employees of private business.

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The appropriate concept of productive activity for a division-of-labor society has a variety of characteristics which distinguish it from the concept of productive activity appropriate to a non-division-oflabor society. The aspect which can most easily be explained in a way that is fully self-contained is the connection between productive activity and moneymaking. As a result, this aspect will be our starting point in the elaboration of a proper concept of productive activity. It will take us into the distinction between production and consumption in the context of a division-of-labor society, between capital goods and consumers’ goods, producers’ labor and consumers’ labor, and producers’ loans and consumers’ loans. It will make us aware of the existence of a category of spending—productive expenditure—that our investigations in later chapters of this book will show to be larger than consumption expenditure and to be the source of most consumption expenditure, and yet whose very existence is almost entirely overlooked in contemporary economics. 2

The application of the concept of productive expenditure to economic analysis will take place to an important extent later in this chapter, in the critique of the conceptual framework of the Marxian exploitation theory and the validation of the productive activity of businessmen and capitalists. Productive expenditure and the closely related concepts of capital goods and producers’ labor will also turn out to be the foundation of the system of aggregate economic accounting that I develop in Chapter 15, and an essential basis of the theory of aggregate profit and the average rate of profit that I present in Chapter 16.

2. Productive Activity and Moneymaking

In a division-of-labor economy, the earning of money becomes an essential aspect of productive activity. This is because in order to live in such an economy, one must obtain the goods and services of other people. Those goods and services are not given away for free, nor, to any significant extent are they, or could they be, obtained through barter. To obtain the goods and services of others, one must possess money. Thus, if one’s productive activity is to be appropriate to life in a division-of-labor society, that is, to be the means of obtaining the goods and services of others, it is essential that it be moneymaking. Only then, does one’s activity make it possible for one to share in the benefits of a division-of-labor society. However productive an activity may be in a purely physical sense—that is, result in physical products—it is not productive in the context of a division-of-labor economy unless it is carried on for the purpose of earning money. If it is not carried on for the purpose of earning money, it does not provide the means of obtaining the goods and services of others, and it thus renders one’s

THE DIVISION OF LABOR AND PRODUCTIVE ACTIVITY 443 activity incapable of providing for the support of one’s life in the context of a division-of-labor society. Without the earning of money, one must attempt to produce and live at a level somewhere between that of Robinson Crusoe and the inhabitants of Tobacco Road.

Thus, in the context of a division-of-labor society, productive activity can appropriately be defined, just as it often is in practical life, as activity the purpose of which is the earning of money.

I refer to purpose rather than to the actual fact of whether or not money is earned, because purpose is more fundamental. An activity is productive or economic so long as moneymaking is its purpose, even if, in a given instance, it fails to make money, or actually loses money. The principle is the same as applies to a carpenter, say, who is nonetheless a carpenter, even though, on occasion, the actual result of his action may not be the result he intended and may even be destructive of some of his material; or to a musician, who, on occasion, strikes a sour note. By the same token, the accidental receipt of money resulting from the performance of an activity would not be sufficient to render it productive—any more than, say, the accidental typing of a word by a monkey playing with a typewriter would qualify as writing. The purpose of moneymaking is the essential element.

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To avoid a possible misunderstanding, it must be pointed out that common criminal activities, such as robbing banks, do not qualify as productive activity, even though the ostensible purpose of such activities may be the bringing in of money. The earning of money, as opposed to its mere receipt, implies the existence of voluntary trade, which precludes the obtaining of money by force or fraud.

In addition, activities which can be proven to be inherently destructive of innocent human life, such as, presumably, the manufacture and sale of narcotics, are not to be classified as productive, even if the money is obtained from the customer without the use of force or fraud. This is because the concept of productive activity ultimately rests on the promotion of human life and wellbeing and must always be consistent with that ultimate purpose. 3

It must also be noted that the standard of human life and wellbeing implies that the paid manufacture of weapons of defense can come under the heading of productive activity. For example, American defense contractors, who produce weapons to defend a division-of-labor, capitalist society against foreign aggression, perform an invaluable service on behalf of the protection of innocent human life. The fact that they are paid for their goods and services qualifies their activity as fully productive in the sense appropriate to life in a division-of-labor society.

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The main concern of this discussion, of course, is not the moral aspects of productive activity, but the economic aspects. And returning now to the economic aspects, it should be clear that manual labor is, indeed, too broad a standard for gauging productive activity. Manual labor is not productive if it is not performed for the purpose of earning money. In such a case, it does not enable the worker to obtain the goods and services he requires from others. Thus, his labor is not productive in the sense required by life in a division-of-labor society.

The recognition of this fact implies that the labor of housewives, for example, is not productive, while the physically identical labor of paid housekeepers is productive. Even though the physical labor of the two is the same, there is an essential difference between the two cases, in that because the labor of the housekeeper is paid, it is a source of her being able to obtain the goods and services of others, while because the labor of the housewife is unpaid, it is not a source of her being able to obtain the goods and services of others.

Consumptive Production

In a division-of-labor society an activity that is physically productive but is not carried on for the purpose of earning money is not only not to be classified as productive, but actually represents consumption.

In a division-of-labor society, the physically productive activity of every individual begins with the use of means of production—materials, tools, equipment, and so forth—produced by others, and for which money has had to be expended. These means of production are physically used up or worn out in the course of production. Sooner or later, they must be replaced, which will require fresh outlays of money. If their use does not bring in money, they cannot be replaced, except by means of an outside source of funds. They certainly cannot be replaced by virtue of the nonmoneymaking activity in question. Thus, the activity in question is a consumptive production, in that it uses up the means of production with which it begins and does not make possible their replacement.

The activities of housewives and home hobbyists provide countless instances of consumptive production. For example, it is certainly an act of physical production when a housewife makes her own clothes, or when a hobbyist makes his own furniture. It is an act of physical production when a housewife bakes a cake or prepares a meal, and even when one simply makes a sandwich or butters a piece of bread. But all of this production is a consumptive production in that the production requires

444 CAPITALISM the using up of materials and the wearing out of tools, equipment, or implements, all of which must sooner or later be replaced, while the product disappears without bringing in the money necessary for their replacement.

3. Productive Expenditure and Consumption

Expenditure

The above discussion of consumptive production implies that it is necessary to distinguish between two fundamentally different types of expenditure: productive expenditure and unproductive expenditure—which latter represents consumption expenditure.

Productive expenditure is buying for the purpose of subsequently selling (and, implicitly, at a profit, for there can be no other reason to buy for this purpose).

Unproductive expenditure is buying not for the purpose of subsequently selling. It is buying for any other purpose than subsequently selling.

Productive expenditure is synonymous with reproductive expenditure, for it is money which is both laid out and brought back by virtue of productive expenditure.

Though all expenditure represents a using up of funds at hand, the term “consumption expenditure” can be employed as a synonym for unproductive expenditure, and the term “consumer” can be reserved exclusively for those who make unproductive expenditures—insofar as they make them. This is because, in the context of the whole process of which it is a part, productive expenditure does not constitute a using up of money, while unproductive expenditure does constitute a using up of money. Funds that are productively expended subsequently return, usually with the addition of a profit. Funds that are unproductively expended, as a rule, either do not return at all or return only in a smaller amount, and thus are simply consumed. Funds that are productively expended are advanced against the receipt of a larger sum of money, while funds that are unproductively expended simply disappear from their owner’s possession. In the one case, there is replacement and increase. In the other, simply decrease.

For example, both a restaurant and a housewife buy roast beefs. The restaurant cooks the roast beef, serves it, and is paid for it by its customers, who physically consume it. In this way, its expenditure is returned to it and, most likely, with the addition of a profit. In the context of the entirety of the process, the restaurant has not consumed its funds, but has obtained additional funds, which are available for other purposes, such as expanding its business or enabling its owner to make consumption expenditures. The restaurant’s expenditure is both self-sustaining, in that it subsequently makes possible the purchase of a second, replacement roast beef, and more than self-sustaining, in that it subsequently makes possible the purchase of additional goods besides.

The housewife, on the other hand, cooks the roast beef, serves it, and, of course, is not paid for it. The roast beef simply disappears in the physical consumption of her family, and with it, all trace of the housewife’s expenditure. Her money is simply used up and gone forever. Her purchase of a roast beef does not provide any funds for the subsequent purchase of a second roast beef, but simply annihilates, as it were, the funds expended. Her purchase, once made, is not thereafter self-sustaining, but on each new occasion must be sustained by the infusion of fresh funds from outside sources. If a second roast beef is to be purchased to replace the first, and then a third to replace the second, and so on, the funds must be obtained from an outside source, such as, typically, a job held by the housewife’s husband. 4

Similarly, both a housewife and a laundromat buy washing machines. In the course of their use, both machines undergo wear and tear and natural deterioration. Eventually, they will have to be scrapped, at which time they will command prices much below their initial purchase price. Every time the laundromat’s machine is used, however, it is paid for this use. And out of the payments thus received, it obtains the money to pay for repairs of the machine and, when the day arrives, for a new machine. Plus, it normally earns a profit on the machine, and the laundromat’s owner, therefore, like the restaurant’s owner, can purchase more than just a replacement.

The housewife does not receive any payment for the use of her machine. Both repair bills and the difference between the price of a new machine and the eventual scrap value of her present machine have to be met from outside sources of revenue. Her washing machine is used up more slowly but just as certainly as her roast beef, and with it, again, disappears, if not the whole, at least the major part of her expenditure for it.

From a physical standpoint, to be sure, the washing machine is productively consumed, in making clothes clean. It differs in this respect from the roast beef dinner, which is unproductively physically consumed (though not from the raw roast beef, which is productively consumed in being cooked.) 5 But it makes no difference. This is because the products of the washing machine, the cleaned clothes, are unproductively physically consumed without bringing in any money—as they would for a laundry or laundromat. At most, recognition of the fact that the housewife’s washing machine has a physical product might cause us to say that the housewife’s expenditure for the machine, instead of disappearing bit by bit with each operation of the machine, disappears bit by bit each time the clothes it cleans get dirty again.

It happens, of course, that productive expenditures are sometimes accompanied by losses, while consumption expenditures occasionally result in gains. But, as previously noted, these are accidental phenomena, not following from the nature of the activity, and do not necessitate any change in the classification of any given expenditure.

The great, practical difference between productive expenditure and consumption expenditure is that an individual grows richer through productive expenditure and poorer through consumption expenditure. Two people, both beginning with identically the same sum of money (we might imagine two brothers sharing equally in an inheritance), the one productively expending his funds, the other unproductively expending his funds, will almost necessarily arrive at opposite stations in life. The one will be richer; the other will be impoverished.

4. Capital Goods and Consumers’ Goods

Closely paralleling the concepts of productive expenditure and consumption expenditure are the concepts of producers’ goods and consumers’ goods.

Producers’ goods or, what is a synonymous expression, capital goods, are goods purchased for the purpose of making subsequent sales.

Consumers’ goods are goods purchased not for the purpose of making subsequent sales.

The distinction between capital goods and consumers’ goods is exclusively one of the purpose for which the goods are purchased—for business purposes or not for business purposes—and not at all a matter of their physical characteristics. The roast beef purchased by a restaurant and the washing machine purchased by a laundromat are both capital goods. Exactly the same kind of roast beef and washing machine purchased by a housewife are consumers’ goods.

The reason that the purpose for which they are purchased is the crucial distinction has already been indicated. Physically, the roast beef and the washing machine are consumed, whether purchased for business purposes or purchased not for business purposes. In both cases, there is, in this instance, a physical production that takes place in which the goods are consumed: the raw roast beef is consumed in producing a cooked one, and the washing machine is consumed in producing cleaned clothes. And thus, both for the housewife and for the business enterprises, there is even a productive consumption in the physical sense.

But beyond the physically productive consumption comes a physically unproductive consumption: the cooked roast beef is eaten and the cleaned clothes get dirty in the wearing. At this point, all trace of the goods purchased by the housewife has simply disappeared from her possession. (In the case of durable goods, such as the washing machine, all trace of the relevant portion of the good’s life has disappeared.) But by this same point, or earlier, the restaurant and laundromat have obtained the means of replacing, and more than replacing, the goods they have purchased. The goods they have purchased, when one allows for their replacement by way of purchase, with funds earned from their very own employment, are not consumed—they are replaced by virtue of their own use, together with a surplus.

The roast beef of the restaurant and the washing machine of the laundromat, by virtue of being purchased for the purpose of making subsequent sales, and then by way of using the resulting sales proceeds to make replacement purchases, are reproductively employed. The restaurant’s roast beef and the laundromat’s washing machine are, as it were, employed in the production of roast beefs and washing machines, or their equivalent in other goods, as wheat seed is employed in the production of wheat. And thus in the fullest sense they represent wealth employed in the production of wealth, and are capital goods, even though from a strictly physical standpoint, a roast beef cannot be used to produce roast beefs, and a washing machine cannot be used to produce washing machines.

Actually, it is not necessary that the restaurant or laundromat use its proceeds to buy specifically a second roast beef or a second washing machine, or even a good playing the same role in production as a roast beef or a washing machine. What counts is that, because he earns revenue by the use of the roast beef or washing machine, the restaurant’s or laundromat’s owner is enabled to obtain the equivalent, and more than the equivalent, of his roast beef or washing machine by the time it is physically consumed, while a housewife is not in this position. Whether that equivalent takes the form of a new roast beef or washing machine, of goods employed in a different line of business, or even of consumers’ goods, the essential fact remains that he is engaged in a process whose inherent tendency is to preserve and increase his initial wealth rather than decrease it.

Classification of Capital Goods and Consumers’

Goods Not Based on Physical Characteristics

The principle that goods are capital goods or consumers’ goods depending only on the purpose for which they are purchased, and not on their physical characteristics, needs to be illustrated with additional examples. Thus, a box of breakfast cereal purchased by a grocer or a restaurant is a capital good; one purchased by a housewife is a consumers’ good. Knives and forks and tables and chairs purchased by a restaurant are capital goods; those purchased for (nonbusiness) use in the home are

446 CAPITALISM consumers’ goods. A house purchased in order to be rented out is a capital good; one purchased in order to be occupied by its owner is a consumers’ good. A lathe purchased by a business enterprise is a capital good; one purchased not for moneymaking purposes, for instance, by a hobbyist, is a consumers’ good. A bulldozer purchased by a construction company is a capital good; a bulldozer purchased by a government, say, for use in constructing military airfields or dams for flood-control projects, is a consumers’ good—as, indeed, would be a bulldozer factory that was not operated for profit-making purposes. Freeways, public school buildings and their fixtures, nonprofit hospitals and their equipment, courthouses, military bases, fire houses and fire trucks, government river and harbor improvements—all these are consumers’ goods, because they are not operated for the purpose of earning money, and thus do not make possible their own replacement when they have been physically consumed.

The acquisition of every good, except the crudest, most primitive kind, presupposes an outlay of money. Money must be spent not only if one wishes to acquire a good ready-made, but even if one wishes to produce the good oneself. All physical production worthy of the name can begin only after an outlay of money has been made to provide the means with which to produce. Without money to buy food, an oven, knives, forks, dishes, tables and chairs, and a structure within which to cook and serve, neither a housewife nor a restaurant could do more perhaps than serve wild berries on a stone, in a cave. Without money to buy steel, concrete, and the use of construction equipment, and to hire labor, neither a construction company nor a government could do more perhaps than build a dam that would compare unfavorably with those built by beavers.

While an expenditure of money is at the base of all physical production in a division-of-labor society, only the activity of business enterprises is so designed as to recoup this expenditure. It cannot be too strongly stressed that because of this only business activity is self-sustaining. The activity of all others, however massive and durable the goods they may employ, however complex and elaborate their physical production may be, is not designed to recoup this expenditure. The goods of these others, therefore, are all on the path toward disappearing from their possession without leaving a trace. They either reach a point of unproductive physical consumption within their possession—as, for example, the housewife’s roast beef dinner and her clean wash; or they simply pass from their possession—as, for example, government gifts of surplus wheat. In either case, having made an unproductive expenditure, the party who made it has less and less to show for it until absolutely nothing at all would remain, were it not for the infusion of fresh funds received from outside sources.

Government a Consumer

A government dam or road or factory, therefore, is consumed just as fully and in the same sense as a housewife’s roast beef or washing machine; and for this reason, like these, they are consumers’ goods, not capital goods. And in the same sense as the housewife, the government is not a producer, but a consumer, who is dependent on producers. All of its physical production, like hers, is, in the last analysis, a consumptive production. It is a production which cannot replace the means with which it began and which ultimately leaves no trace in the government’s possession; it is a production which leaves the government poorer by the amount of funds it has expended. In order to continue the activity, resort must be had to an external source of funds—in the government’s case, the taxpayers or the printing press.

Producers’ Labor and Consumers’ Labor

The distinction between capital goods and consumers’ goods applies equally to labor. Labor employed for the purpose of (its employer) making subsequent sales is producers’ labor. Labor employed not for the purpose of (its employer) making subsequent sales is consumers’ labor. 6

It must be stressed that the distinction between producers’ labor and consumers’ labor is always from the perspective of the employer, not the employee. From the perspective of the employee, all labor is productive which is performed for the purpose of earning money. Those whose work is consumers’ labor earn money no less than those whose work is producers’ labor, and they are productive in the sense appropriate to life in a division-of-labor society. The same is true, of course, of those who produce consumers’ goods. They too earn money and are productive in producing consumers’ goods. The distinction both between capital goods and consumers’ goods, on the one side, and between producers’ labor and consumers’ labor, on the other, is from the perspective of the buyer—in the one case the customer for the good, in the other, the employer of the labor.

Thus, for example, a maid employed by a hotel is producers’ labor. The same maid employed by a housewife is consumers’ labor. In the one case, the payment of the maid’s wages is a source of subsequent revenue to her employer, which enables the employer to continue the payment of her wages and to purchase other things besides. In the other case, the payment of the maid’s wages is simply a use of the revenue of her employer, with the means for each fresh payment of wages having to be supplied by an outside source of funds. The owners

of a hotel grow richer by the employment of a maid—for her work helps to bring in paying guests—while a housewife grows poorer by the employment of a maid; that is the practical difference.

Further to illustrate the concepts: a secretary employed by a business enterprise is producers’ labor; one employed by a government bureau or private nonprofit organization is consumers’ labor, as is one employed by a wealthy individual to handle social engagements. 7 A welder employed by a private shipyard is producers’ labor; one employed by a naval shipyard is consumers’ labor. A musician employed by a night club owner or concert promoter is producers’ labor; one employed by a bride’s father to play at her wedding is consumers’ labor. All government employees, from judges to public school teachers, whether their services are necessary and beneficial or not, are consumers’ labor. The payment of their wages uses up the government’s revenue rather than providing the government with the means of earning revenue. The fact that the government must turn to taxes to maintain its operations is the result precisely of the fact that its expenditures do not generate the revenue to sustain them.

Producers’ Loans and Consumers’ Loans

The same fundamental distinction that applies to expenditures, goods, and labor applies also to loans. Loans taken out for the purpose of the borrower making subsequent sales are producers’ loans. Loans taken out not for the purpose of the borrower making subsequent sales are consumers’ loans.

Again, the great practical distinction is that producers’ loans, by virtue of bringing in sales revenues, provide the funds required for their own repayment, and usually more besides. Consumers’ loans, on the other hand, must be repaid by means of an outside source of revenue, because the expenditure of the funds which are borrowed does not serve to bring in funds.

Government Borrowing

It should be obvious that government borrowing is in the category of consumer borrowing. But there is a vital difference between the borrowing of private consumers and the borrowing of the government. Namely, when private consumers borrow, it is they as individuals who are responsible for repaying. When the government borrows, the responsibility for repayment is that of the taxpaying public, including, insofar as they too are taxpayers, the lenders! Indeed, if as is very often the case, the government chooses to repay by means of inflating the money supply, the lenders can easily end up paying for the greater part of the government’s borrowing.

There are sound reasons for private individuals to borrow as consumers—namely, to be able to have the enjoyment of goods sooner rather than later. By being able to borrow the price, or the better part of the price, of a house or automobile, an individual can obtain the enjoyment of the good years sooner than he could if he first had to save up the full price himself. But in the case of government borrowing, any such possible advantage is more than outweighed by the injustice of imposing an unchosen obligation on individual citizens to repay who may attach little or no value to the purpose for which the funds are spent. Indeed, government borrowing obligates individuals to repay who may be too young to have a voice, or not even have been born, at the time the decision to borrow is made. It is thus incompatible not only with the free choice of individuals but also with the theory of representative government, because it obligates people who cannot be represented when the decision to borrow is made—at least not by representatives of their own choosing.

Capital Goods and Consumers’ Goods Internally

Produced; Other Revenues

In defining capital goods and consumers’ goods, it was necessary deliberately to define them in a way that, strictly speaking, is too narrow. This was required in order to exhibit their distinguishing characteristic in the strongest possible light, free of all considerations that might divert attention from the essential point.

Taken strictly, those definitions imply that every capital good and every consumers’ good must itself be purchased. That, of course, is not necessary, and no such idea was intended to be conveyed. In fact, a number of the illustrations offered contradict such a view.

Many capital goods and consumers’ goods are not themselves purchased, but are produced, with means of production that have been purchased. For example, in the illustration concerning the restaurant and housewife, the cooked roast beef as well as the raw roast beef was a capital good in the one case and a consumers’ good in the other, even though only raw roast beef was purchased. By the same principle, not only the boxes of breakfast cereal purchased by a grocer or a restaurant are capital goods, but also those in the inventory of the manufacturer of breakfast cereals, who purchases only the means of producing them, not boxes of breakfast cereal themselves. Again, on the same principle, a privately owned steel mill is a capital good even though it itself may not be purchased, but only the means of constructing it. By the same token, public schools and government roads and dams are consumers’ goods, even though such things are almost never purchased ready-built.

To be more exact, the definitions of capital goods and consumers’ goods must be broadened as follows:

448 CAPITALISM

Capital goods are goods purchased for the purpose of making subsequent sales, and, by extension, goods produced, with means of production that have been purchased, for the purpose of making subsequent sales.

Consumers’ goods are goods purchased not for the purpose of making subsequent sales, and, by extension, goods produced, with means of production that have been purchased, not for the purpose of making subsequent sales.

Thus both concepts embrace internally produced semi-finished and finished inventories and internally constructed facilities.

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The definitions presented not only of capital goods and consumers’ goods, but also of productive expenditure and consumption expenditure, producers’ labor and consumers’ labor, and producers’ loans and consumers’ loans, might be taken to imply the presence or absence of the purpose of earning sales revenues exclusively as the decisive point of differentiation. Such a restriction is not intended. Although sales revenues are the revenues earned in the overwhelming majority of cases, there are numerous and important instances in which businesses earn rental revenues—for example, landlords and car rental companies—or interest revenues, as is the case with banks and other financial institutions. Indeed, probably every business earns some interest revenue. There are also cases in which businesses earn royalty or commission revenues—for example, research laboratories and professional agents, respectively.

No less than in the case of sales revenues, it is the presence or absence of the purpose of earning revenues of these types that serves as the differentiating point. The words “subsequently selling” and “making subsequent sales” must be understood as embracing these kinds of revenues as well as sales revenues. The expenditures of a landlord for the purpose of earning rental revenues, of a bank for earning interest revenues, and so on, are productive expenditures. The goods they purchase for that purpose, the labor they employ, the loans they take out are capital goods, producers’ labor, and producers’ loans respectively.

Capital and Wealth

I have already defined capital as wealth reproductively employed. 8 In a division-of-labor society, capital is the wealth employed by business enterprises.

There is, of course, wealth employed outside of business enterprises. Such wealth includes the houses and furnishings of individuals, their personal stocks of food and clothing, their automobiles and appliances, and so forth. It also includes a country’s highways and dams and river and harbor improvements, insofar as they are owned by the government, and all other assets owned by the government. Such wealth may be termed “consumers’ wealth,” in contrast to capital, which is the wealth employed by business enterprises. So long as it is wealth, consumers’ wealth has not yet been consumed, but it is in the process of being consumed. In the nature of the case, it is poised for being used up and its owner’s purpose does not prepare it for making possible its own replacement. It is thus on the road to being consumed and is properly described as consumers’ goods.

Jewelry, precious metals, and the land sites of owner-occupied houses usually represent a substratum of consumers’ wealth which is not consumed beyond a certain point. To be sure, there is typically a maintenance cost which must be incurred in connection with all three— cleaning and repairing the jewelry, storing and insuring it and the precious metals, keeping up the appearance of the land site. But the materials from which the jewelry is made—gems and precious metals—are physically imperishable and always retain at least some substantial portion of their original value. Land sites too are physically imperishable (unless they become submerged under water), and so long as the area remains inhabited, they too almost always retain at least some substantial portion of their original value.

Capital Value and Investment

The goods owned both by business enterprises and by consumers reflect prior expenditures of money, either for the goods themselves or for the means of producing them. The prior expenditure reflected in the possession, say, of a quantity of roast beef that is owned either by a restaurant or a housewife is simply the price per pound that has been paid for it times the number of pounds in question. The prior expenditure reflected in the possession of a durable good, such as a washing machine owned either by a laundromat or a housewife, is the price that has been paid for it less a cumulative allowance for wear and tear and obsolescence known as depreciation. The prior expenditure reflected in the possession of a good one has produced or has had produced is the sum of the prices times the respective quantities of the means of production physically consumed to produce it, less, if it is a durable good, a cumulative allowance for depreciation.

For example, the prior expenditure reflected in an inventory of dresses in the possession of a dress manufacturer (or, as far as the items are applicable, in the possession of a housewife who makes her own clothes) would be the sum of the following, for each dress: the price paid per yard of cloth times the number of yards used up in making the dress, the wage rates paid to cutters and sewing machine operators and so forth times the

respective number of hours of their labor spent in making the dress, the prices—under some accounting systems— paid for the various tools and machines employed times the respective fractions of their useful lives expended in making the dress, plus all other sums similarly expended to make the dress. (Depending on the particular accounting system used, the prior expenditure reflected in the inventory of dresses might not incorporate an allowance for the fraction of the useful lives of the tools and machines expended. Such expenditures might show up simply in a cumulative periodic depreciation charge against the assets concerned and in a corresponding charge against sales revenues. This is even more likely to be the case in connection with depreciation accounting for a factory or any other kind of building used in a business.)

The prior expenditure reflected in the possession of goods—whether productive expenditure in the possession of capital goods, or consumption expenditure in the possession of consumers’ goods—is known in accounting as their book value. This concept is of no practical importance for the ordinary consumer, but it is of great importance for business enterprises. It is the necessary base for calculating profits and losses. For example, to have a profit, the dress manufacturer must sell his dresses for more than their book value and the depreciation charged against the book value of the factory and plant and equipment used to produce the dresses (insofar as this depreciation does not enter into the book value of the dresses themselves). The concept of book value is the basis of constructing both balance sheets and income statements.

Book value can be said to reflect a putting of money into goods. The putting of money into goods for the purpose of making subsequent sales is investment. The book value of any aggregate of goods in which money has been invested, i.e., of capital goods, is the book value of capital, that is, of wealth reproductively employed. 9 Under a system of commodity money, such as a gold standard in which physical gold serves as actual money in the form of coins passing from hand to hand or coins or bullion providing full backing for the paper currency or checking deposits in use, the concept of capital would also include the money held by business enterprises. This is because in such a case the money would be both actual wealth, inasmuch as it was a physical commodity, and it would be reproductively employed. As wealth reproductively employed, it would be capital.

Now just as the concept of property possessing market value was shown to be wider than the concept of wealth, so the concept of capital value refers to more than the value of wealth reproductively employed, that is, to more than the value of capital goods or capital. 10 By the same token, the concept of investment refers to more than investment in capital goods. The concepts of investment and capital value also respectively refer to investment in, and the accompanying purchase or acquisition value of, such intangible assets as stocks and bonds, mortgages and other types of loans, and patents and copyrights. One can invest in such intangible assets, and their purchase or acquisition value constitutes capital value.

Nevertheless, intangible assets no more constitute capital than they constitute wealth. Investment in capital occurs only when business enterprises buy either tangible goods or labor of the kind that is vested in tangible goods. (Of course, such investment is carried forward when capital goods are productively physically consumed, to the products produced—for example, the dress manufacturer’s investment in cloth is carried forward to the dresses made out of the cloth.) The value of capital is the value of the tangible goods purchased by or produced within business enterprises, plus, insofar as it itself constitutes actual wealth, the money they hold. It is, to this extent, their cash and the value of their raw, semifin-ished, and finished inventories, of their furniture and fixtures, plant, equipment, and all other tangible property, including, of course, their land. The objective expression of the value of these capital assets is their accounting book value, which derives from their purchase prices.

In the following pages of this book, whenever investment is spoken of, it should be understood that in the absence of qualification, what is meant is always investment in capital.

The most important respect in which capital value in the economic system differs from the value of actual capital goods is the result of the use of savings to finance such things as home mortgages and consumer installment loans. Because owner-occupied housing and personal automobiles and the like are not capital goods, the mortgage loans and installment loans that finance them, while representing investment and the existence of capital value from the perspective of the lenders, do not represent investment in capital goods. Such investments, to be sure, represent a significant part of the total savings and capital value of the economic system.

Matters are complicated somewhat by the use of the expression “investment of capital” to signify the purchase of such assets. Insofar as the money invested were itself a physical commodity and thus represented wealth reproductively employed in being invested, the expression would be a perfectly legitimate one, though it would still be necessary to realize that what the capital had been invested in, in such cases would not itself represent capital, but only intangible assets possessing capital value. Of course, today money is not a physical commodity; it is not even in part a claim to a physical commodity.

Nevertheless, common usage regards the investment of fiat money as the investment of capital. For the sake of avoiding departures from common usage that would serve little practical purpose, I will follow it, even though what is being invested in the case of fiat money is not actual wealth, but at most an intangible asset that can easily be exchanged for wealth.

Consistent with this discussion, I follow the common practice of regarding anyone who invests money in intangible assets as a capitalist, even though such assets do not themselves represent actual capital but merely possess capital value. Insofar as such capital value represents the financing of the purchase of consumers’ wealth, such as homes and personal automobiles, I will take it into account whenever necessary in close connection with my treatment of the degree of capital intensiveness of the economic system. For the accumulated savings of the economic system are invested not only in capital but also in intangible assets, above all, home-mortgage loans, which represent claims against consumers’ wealth. 11

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It would be possible to adopt a somewhat different approach to the meaning of investment than that taken above. It could be argued that all putting of money into goods is investment, whether the purpose is or is not to make subsequent sales. In this case, it would be necessary to distinguish between productive and unproductive investment. One would then show the derivation of capital from productive investment, and consumers’ wealth from unproductive investment.

The objection I have to this approach is that it would shatter the customary distinction between consumption and investment. Perhaps half or even more of consumption expenditure would then turn out to be investment expenditure, at the same time that it was consumption expenditure. This is because under such a procedure, the purchase of houses, automobiles, and all other consumer durable goods would have to be classified as investment expenditures. So too would the purchase of materials of production by consumers, such as all food needing further preparation.

Thus, it seems expedient to restrict the concept of investment in the way I have done, and not to introduce the concept of unproductive investment.

Productive Expenditure and Capital Value

While capital value reflects prior productive expenditure, not all productive expenditure results in capital value, because not all productive expenditure is invested. Productive expenditure for such things as advertising, lighting and heating, and the labor of administrative and clerical employees does not directly bring any tangible physical goods into the possession of a firm. Such things are neither tangible goods themselves, nor in any direct way are they vested in tangible goods, in the manner of the cloth and the services of a sewing machine operator that go into a dress. As a result, it is a common practice in accounting to treat such productive expenditures as expense items. That is, such productive expenditures are written off—expensed—as they are made, and thus do not show up in capital value.

Some accounting systems, however, seek to capitalize as many productive expenditures as possible, and do add the outlays for advertising, lighting and heating, administrative labor, and so forth to a firm’s capital value, if possible in the form of its investment in inventory. The outlays are then subtracted later on, typically when the goods to which they are judged to contribute are sold. At that time, the outlays form a part of “cost of goods sold”—along with the outlays for materials and direct, manufacturing labor and, in some cases, along with depreciation.

Common Confusions About Capital Goods

There are three currently popular definitions of capital goods. All of them are physicalistic, i.e., assume that the distinguishing characteristic of capital goods lies either in their physical nature or in their relationship to physical production. According to what is perhaps the definition most favored among professional economists, capital goods are tools, implements, machinery, and durable goods. According to what seems to be the most popular definition among laymen, capital goods are the same as the above, but with the durable goods more or less limited to factory and office buildings. According to the third definition, capital goods are all previously produced factors of production, which would include the materials employed in production along with the components of the layman’s definition.

Like the misconceptions concerning productive activity in general, these definitions are both too broad and too narrow. They are too broad in that they all embrace consumers’ goods to varying degrees, and too narrow in that they fail to embrace many capital goods.

Those who hold these definitions seem strangely unaware in propounding them that production in its physical sense is almost an omnipresent phenomenon, and is undertaken by consumers with the aid of means of production that in principle, and sometimes in actual concretes, are no different than those employed in any factory. Strictly speaking, it is an act of physical production when one cuts the food on one’s plate and raises it to one’s mouth on the prongs of a fork. As already discussed, the activities of a housewife constitute acts of physical production. Certainly, cooking, cleaning, washing, baking, and, a few generations ago, the making even of clothes

THE DIVISION OF LABOR AND PRODUCTIVE ACTIVITY 451 and soap in the home, are all instances of physical production.

And this production, no less than the production that takes place in giant factories, entails the use of materials, tools, implements, machinery, buildings, and other installations. The food in one’s refrigerator is a material— indeed, so is a slice of bread in one’s hand which one intends to butter. Household hammers and screwdrivers are tools; can openers, knives, and forks are implements; sewing machines, washing machines, automobiles, vacuum cleaners, toasters, television sets, tape recorders, and record players are machines; the home, in which so much physically productive activity takes place, is a building employed in production; a wash line is an installation. Indeed, there are very few consumers’ goods which do not fit under these or other categories connected with physical production. And the few that do not fit, such as stocks of clothing and certain types of furniture and fixtures owned by consumers, are almost all embraced by the category of durable goods.

All three of these definitions, as soon as they are accompanied by any attempt to apply them to reality, lead to a progressive reduction in the goods classified as consumers’ goods and a progressive increase in the goods classified as capital goods. Indeed, this change in classification is well under way.

It has long since, if not always, been taken for granted that government river and harbor improvements and the pieces of construction equipment owned by a government are capital goods, simply because their connection with physical production is so obvious. What has prevented the less spectacular means of production that are found in the home from being classified as capital goods seems to be only the fact that the classical economists succeeded in fairly well establishing the idea that housewives do not produce.

Of course, in recent generations, this last idea has come to be held in an erroneous way. Instead of having the conscious realization that housewives do not produce only in the sense that they do not earn money, and why this fact is decisive, one proceeds as though housewives did not produce even in the physical sense. This then acts as a sort of blinders, which prevent one from perceiving the kind of physical means of production housewives employ. Furthermore, in the present day, the idea that housewives do not produce is widely disputed. For example, it is often presented as a shortcoming of the statistics of gross national product, or gross domestic product, that they do not include an allowance for the work performed by housewives in the home.

The stage is well set, therefore, for a “revolution” in economics on this subject. That is, at practically any moment someone could come along, write a book or article forcefully making people aware that housewives do physically produce and employ machinery and the like, and then, without a knowledge on anyone’s part that the earning of money is the crucial criterion, succeed in almost totally destroying the concept of consumers’ goods by discovering that they are all “capital goods.”

For the time being at least, the physically productive activities of the housewife and the physical nature of the goods she employs have not sufficiently impressed themselves on the minds of observers. As a result, the main breaches in the concepts of consumers’ goods and capital goods have been in the somewhat related areas of durable goods and government activity.

Nonprofit universities refer to their building funds as “capital funds.” Government officials wish to remove expenditures for roads, schools, dams, and the like from the ordinary budget and place them in a separate “capital budget.” (This has long been the practice in New York City, for example.) Government statistics of gross product and national income treat the purchase of houses to be occupied by their owners as “investment.” Few economists see any theoretical reason why the treatment now accorded to owner-occupied houses in these statistics should not be extended to personal automobiles, household furniture, and all major household appliances. The more consistent wish to add stocks of personal clothing to the list. Only the weakening forces of custom and tradition, established by the classical economists, stand in the way of a major collapse in classification here.

The belief that the government employs capital goods has been greatly reinforced both by the inclusion of durable goods in the concept of capital goods and by what must be called an eagerness to perceive in its case the fact that it is physically productive. And the idea that the government employs capital goods then lends strong support to the notion that it is a producer. If, for example, a government schoolhouse is a capital good, then it follows naturally that government school teachers must be productive in the same sense as was previously thought to be reserved to the participants in private business.

Indeed, we have been told that to deny the proposition that government officials are productive, to hold instead that their salaries and their activities simply represent consumption, is to labor under the influence of a collection of old wives’ tales known as “the conventional wisdom.” 12 Not surprisingly we have also been told from the same quarter, that there is no essential difference between government deficits and corporate “deficits”— i.e., between consumers’ loans and producers’ loans.

The current concepts of capital goods, however, are not merely overblown, to the point where they destroy any firm concept of consumers’ goods. As stated, they also do not even embrace all capital goods. The first two

definitions I cited ignore materials, which certainly must be included when purchased by business enterprises. The second and third appear to ignore such goods as furniture and fixtures, because they are not integrally connected with physical production, but which must be termed capital goods when purchased by business enterprises. All three leave no room for finished inventories, which are also capital goods when owned by business enterprises, despite the fact that they do not serve in any further physical production undertaken by the firms that own them, or, perhaps, in any further physical production whatever.

Answers to Misconceptions of the

Concepts Presented

A number of questions frequently arise concerning the application of the concepts presented to specific cases— questions which reflect serious misconceptions of the concepts. The nature of the misconceptions, the questions, and the answers to them, are as follows:

i. Productive Consequences of Consumption Do Not

Make Consumption Into Production

It is a fact that if a person did not eat some minimum amount of food, wear at least some kind of clothing, and have some type of shelter in which to sleep, he could not physically work and thus could not earn money. On this basis, the question is asked: Shouldn’t the expenditure for such goods, to the extent that they contribute to one’s ability to work and earn money, be termed a productive expenditure, and such goods themselves, capital goods?

The answer is no. In order for any action to be productive, either monetarily or physically, it is not sufficient that the action have productive consequences. The action must be undertaken for the purpose of production. For example, in driving one’s car, one wears it out. Eventually, as a result of one’s action, it will be scrap iron, and then it will most likely contribute to the production of steel. Nevertheless, this fact does not make one a steel producer. It does not make one’s expenditure for the car a productive expenditure and the car a capital good. The scrap iron, even though the result of the process of driving one’s car, is not the product of driving one’s car. It is a fresh, original, unproduced factor of production, just like iron ore in the ground. In the same way, the fact that eating, wearing clothing, and possessing a shelter result in one’s being alive, and thus capable of working and earning an income, is not sufficient to render these things acts of production. Like the scrap iron, a person’s ability to work, based on the fact that he is alive, is a fresh, original, unproduced factor of production, not a product.

The decisive point in establishing whether an expenditure is a productive expenditure, or whether a good is a capital good, is the purpose for which the expenditure is made or the good bought, not the consequences it has. Food, clothing, shelter, and the like are consumers’ goods, and the expenditure for them a consumption expenditure, even insofar as their consequence is an ability to work and earn money—because working and earning money are not their purpose. On the contrary, the ability to buy such goods is the purpose of working and earning money.

The essential point can be reinforced by the following considerations. If it were the case that expenditures for the goods and services necessary to enable one to stay alive and thus be able to work were regarded as productive expenditures, the effect would be that one would have to deduct these expenditures as costs from the income one earned as normally understood. One would then regard one’s net income—the measure of one’s gain from working—as the difference between one’s income as normally understood and the cost of one’s subsistence. Thus, for example, if a wage earner makes, say, $300 per week, and his cost of “subsistence” is calculated as $200 per week, he would calculate his net income—the measure of his gain from working—as $100 per week. This shows the fallacy of the whole procedure. The fact that of the worker’s $300 wage, $200 is necessary to cover the cost of his subsistence, does not at all reduce his gain from working from $300 to $100. His gain from working is $300. The greatest, most important part of a person’s gain from working is that it enables him to stay alive. A worker who works even to receive merely a subsistence wage has an enormous gain from his work: he gains the preservation of his life, a value greater than which there is none. The fact that the portion of one’s wage that covers subsistence is itself a gain—the most important gain one earns—means that it is inappropriate to deduct subsistence as a cost. And on this basis it is inappropriate to regard the expenditures for the means of subsistence as productive expenditures, even though they are essential to one’s ability to work. Their purpose is not the earning of income, but the support of one’s life.

ii. Consumption Expenditures Imposed by Work Are

Still Consumption Expenditures

A second, closely related question is this: Isn’t a maid employed by a working mother to look after a young child an instance of producers’ labor, in that the mother could not go to work and thus could not earn money if she did not employ the maid?

Again, the answer is no. The mother does not employ the maid for the purpose of earning money, but for the purpose of meeting a need of her personal life—namely, caring for her child. To be sure, she is unable to meet this need herself as a result of the fact that she leaves the house to go to work, but that is irrelevant. Earning an

THE DIVISION OF LABOR AND PRODUCTIVE ACTIVITY 453 income does not take place in a vacuum. It is integrated into the rest of one’s life, and compels a person to meet certain of his needs or desires by making expenditures he would not have to make if he did not have to earn an income. For example, many people who work, automatically have a higher food bill because they have to eat their lunches out. They probably have a transportation expense of getting to and from work. Possibly their work requires that they live in an area which has a cold climate, and in which, therefore, they must buy extra winter clothing and pay high fuel bills.

Though all of these expenditures are imposed by the earning of an income, they are still consumption expenditures, because their purpose is the direct satisfaction of one’s needs or desires, not the earning of money. The working mother does not employ a maid to make money, any more than the man who must eat his lunches out because he works, eats out to make money. The commuter on the way to work does not pay his fare to make money, but because he wants to avoid walking, or to be able to live in the suburbs, just as the man whose job is in a cold area does not buy extra winter clothing or pay high fuel bills to make money, but to keep warm.

iii. A Smaller Consumption Expenditure

Is Still a Consumption Expenditure

A third frequently asked question is this: In view of the fact that the purchase of a house typically means a saving of expense in comparison with renting, shouldn’t it, for this reason, be considered a productive expenditure, and the house itself, a capital good? Likewise, if the purchase of a washing machine by a housewife makes it possible for her family to reduce its expense for laundry, shouldn’t the expenditure for the washing machine be considered a productive expenditure and the washing machine itself, a capital good?

Once more, the answer is no. These questions rest on the idea that the saving of a consumption expenditure is a source of income. The saving on rent or laundry is supposed to be an extra income which the purchase of the house or washing machine brings in and which makes that purchase a productive expenditure and the house or washing machine a capital good.

The saving of a consumption expenditure, however, is not a source of income. It simply means that a smaller consumption expenditure takes the place of a larger one. The smaller consumption expenditure is still a consumption expenditure. And thus the conclusion contained in the question is false. If, for example, a person buys a house and has a monthly expense of $1,000 for mortgage payment, fuel, repairs, and the like, instead of, say, a $1,200-per-month rent bill for comparable living quarters, it is not true that his income is thereby increased by

$200 per month. What is true is that instead of consuming $1,200 per month for shelter, he now consumes $1,000 per month for shelter—in addition to having expended his down payment on the house for consumption. The $1,000 per month and the down payment are consumed because the house does not bring in any money revenue. It physically depreciates and must be maintained and eventually replaced by funds supplied from outside sources. Both the house and what is spent for it are simply used up and gone—consumed. In exactly the same way, if the purchase of a washing machine enables a family to reduce its expense for laundry from, say, an average of $20 per week to an average of $10 per week, what has occurred is that the family now consumes $10 per week for laundry instead of $20 per week. For its outlays, too, do not make possible the means of their being repeated, but depend on an outside source of funds for their continuation, and thus represent consumption. The case is exactly the same in principle as if the family had simply found a lower-priced laundry.

It is true that a reduction in consumption expense allows any given, already existing money income to go further. In this respect it achieves the equivalent of a rise in income in terms of buying power (assuming, of course, that what the reduced expenditure buys really is the equivalent of what the larger expenditure bought before). But the reduced expenditure does not itself bring in any income. Its ability to achieve the equivalent of a rise in income in terms of buying power presupposes the existence of an income which it itself does not bring in. A correct description of things would be to say that while the ability to obtain equal satisfactions for a reduced expenditure of money achieves the equivalent of a rise in income in terms of buying power—assuming that an income already exists—the reduced expenditure itself is still a consumption expenditure.

The idea that a reduction in consumption is the earning of income totally perverts the meaning of consumption by making it into its exact opposite. It seeks to wipe out the difference between spending money and making it; as though because one tended to use up one’s funds and grow poorer less rapidly, one thereby earned funds and grew richer.

The difference between consumption expenditures and productive expenditures can be seen precisely in terms of the profound difference that exists in the respective ways in which they contribute to buying power. The only way that consumption expenditures can contribute to buying power is through their reduction, i.e., through their comparative nonexistence, not through their positive presence. Their positive presence is always merely a using up of buying power provided by other sources.

Productive expenditures, on the other hand, contrib—

ute to buying power through their positive presence, for it is their positive presence that brings in revenue and income. This is no less true in cases in which reductions take place in the productive expenditures required to produce a given product—i.e., in which the production of the product becomes more efficient and thus less costly. The reduced productive expenditures to make that product bring in sales revenues and are made for that purpose, and using the funds saved in producing that particular product to make other productive expenditures will now bring in still more sales revenues. Thus, for example, if a home builder or washing machine manufacturer finds a way to reduce his unit costs, his lesser outlays are still the source of his revenues and are still made for the purpose of bringing in those revenues, and if he devotes the savings in his outlays to fresh productive expenditures—in increasing his production of homes or washing machines or in branching into different lines of business—his sales revenues will further increase. 13

Thus, consumption remains consumption, even when it is carried on in a more economical fashion. 14 iv. Government Expenditure Is Consumption

Expenditure Even When It Serves to Increase the

Capacity of the Citizens to Pay Taxes

Certain government expenditures, such as for highways and education, if not made with the grossest inefficiency, have the potential for contributing to the productive capabilities of the citizens, and thus to their ability to work, earn income, and pay taxes. On this basis, the question is sometimes asked if such government expenditures could not be construed as productive expenditures—at least if the expenditures were made by the government for the purpose of bringing in tax revenues.

The answer is no, even in the event that the government really did make expenditures for the purpose of increasing the tax base and thus its tax revenues. So long as the highways are not self-supporting toll roads, so long as the education is provided for free or at only a nominal charge, the activities represent consumption. The very fact that taxes must be resorted to in order to support them fully confirms this fact. Taxes are not a revenue earned in production and exchange. They are not paid in exchange for the use of roads or for instruction—i.e., as the condition of receiving these things. What actually brings about their payment is the threat of being imprisoned if one does not pay them.

In providing such things as highways and education for free, the government is as much a consumer as would be a private individual who had the peculiar habit, let us imagine, of making gifts of encyclopedias to bright children. His gifts could well increase the capacity of the recipients later on to work and earn money. But the gifts would still leave him that much poorer. For him, they would still be consumption. Nothing would be changed if this individual combined his habit of gift giving with a program of systematic burglaries carried out against victims who had first been fattened up, so to speak, by the receipt of such gifts—victims whose capacity to earn incomes and thus to yield more ample caches to burglars was increased by the gifts. (The analogy is accurate insofar as the government’s collection of taxes constitutes the appropriation of property against the will of its owners.)

To put the matter as succinctly as possible, the government is no less a consumer, merely because its activities have the effect of increasing the ability of the citizens to pay taxes and thus to support its consumption.

Similar considerations apply to the classification of government employees engaged in the collection of taxes. Such employees are not to be classified as producers’ labor even though their work directly serves to bring in money to the government. So long as taxes are collected under the threat of physical force for nonpayment, they cannot be described as the result of any kind of productive activity on the part of the government or its agents. They are obtained as the result of coercion pure and simple. In such circumstances, the concepts of production, productive expenditure, and producers’ labor simply do not apply. They are no more applicable than is the concept of capital goods to burglary tools, which also very likely serve to bring in more money than they cost. Consistent with what I have already pointed out, all concepts pertaining to production and productive activity of any sort preclude the obtaining of wealth by means of force. Expenditures made for the purpose of carrying out the use of force belong in a separate, third category, that is neither productive expenditure nor ordinary consumption expenditure—namely, that of destructive expenditure. True enough, when such expenditure is made for the purpose of bringing in money, the funds of the perpetrator are not decreased, but the funds of the victims certainly are. Moreover, to the degree that such expenditures exist and serve to victimize people, the effect is to diminish the incentives and the means for producing wealth. Thus the gains of the perpetrators result in more than equivalent losses to others. This is obviously a process far more at odds with the preservation and increase of wealth than is consumption.

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In a very different, but nevertheless related vein, workers employed as part of a charity organization’s fund-raising efforts are to be classified as consumers’ labor rather than producers’ labor, despite the fact that money is brought in by their activities. This is because the money brought in is charitable donations, not pay—

THE DIVISION OF LABOR AND PRODUCTIVE ACTIVITY 455 ments made in exchange for the receipt of goods or services. The payment of the salaries of such employees no more represents a productive expenditure than does a student’s payment for the stationary on which he writes letters to his parents asking for money. The expenditure in both cases is a consumption expenditure which, fortunately for those who make it, is as a rule substantially more than defrayed by the charity of the recipients of the appeal.

Of course, the workers who are employed by a charity, whether as fund raisers or in any other capacity, are themselves productive in the sense appropriate to life in a division-of-labor society, inasmuch as they earn money. However, they earn money as consumers’ labor, not as producers’ labor.

v. “Human Capital” Is Not Capital

The last question to be considered here primarily concerns education. Is education, and other improvements in people’s personal capacities that enable them to produce more efficiently and thus to earn a higher income, a form of capital? Is it, as many economists describe it, “human capital”?

If an education is obtained for the purpose of earning money, as is the case with vocational education, then the expenditure could, indeed, plausibly be termed a productive expenditure. Nevertheless, the fact that as productive expenditures, the outlays would have to be deducted as costs from wage incomes leads me to conclude that they should still be treated as consumption expenditures. This is because treating them as productive expenditures, which give rise to costs, would in turn require thinking of wages as analogous to sales revenues and having to regard the income of wage earners as a form of profits earned on the receipt of wages. That is to say, that merely because they had paid something in order to learn their trade, one would suddenly have to regard carpenters, plumbers, electricians, and the like as earning profits on their wages rather than as simply earning wages. At the same time, such productive expenditures and costs would have absolutely no bearing on the amount or rate of profit earned by actual businesses. Thus, radical conceptual change would be required in order to deal with a relatively small set of concretes, which concretes would have no bearing on the amount or rate of profit that is of actual concern. To avoid such a fruitless procedure, it is far simpler for all practical purposes to regard such productive expenditures of wage earners as consumption expenditures. The only exceptions should be cases in which the individuals involved actually do function as businesses, such as champion professional athletes who employ trainers and coaches and the like, and whose incomes really can be regarded as profits earned on business sales revenues.

Beyond this, even if one were to regard such expenditures as productive expenditures, it would still be an error to consider improvements in an individual’s personal capacities to be a form of capital or any other kind of wealth. They are preconditions to the production of wealth or to the greater production of wealth, but not themselves wealth. 15 An essential characteristic of wealth in general, and of capital in particular, is its alienability. The possession of wealth and capital makes it possible for an individual to live without having currently to exercise his productive abilities—to live by means of selling off part of his wealth or capital and consuming the proceeds. It is not possible to do this with socalled capital that is part of one’s very person. Such “capital” is inseparable from one’s person and thus cannot be sold off. In this respect it differs radically from wealth and capital, and should not be placed in the same category.

The concept “human capital” would overcome this objection in a society that sanctioned slavery. A slave owner could regard greater personal capacities in his slaves as representing additional capital to him. But even then the concept of human capital would be improper— not only on all the grounds that make slavery improper, but also on the specifically economic grounds that neither human labor nor the persons of human beings constitute wealth. 16 And since capital is a specific form of wealth, they do not constitute capital. Indeed, as I have stated before, slavery is an institution hostile to the production of wealth by virtue of depriving the slaves of the incentive to produce it. And because of this, slavery is also hostile to the formation of capital. This last will become clear after I have shown that capital accumulation depends on all the factors that promote the production of wealth in general. 17

In addition, there is a further major and specifically economic objection to the concept of human capital in the form of slaves. This is the fact that a society that sanctions capital in the form of the existence of other human beings thereby deprives itself of capital in the true sense of wealth reproductively employed. Such immoral and fictitious capital displaces actual capital. This is because people want to possess capital in some determinate ratio to their level of consumption, not in an infinite ratio. Thus to the extent that they think themselves rich on the basis of the ownership of slaves—which means that they think themselves rich merely because of the existence of workers—they feel no need to accumulate and possess genuine capital, that is, capital in the form of actual wealth. As illustration of the consequences, consider the difference in conditions between the North and South prior to the Civil War. A Northern manufacturer regarded his capital as his factory and machines, and his inventory of materials and finished products. He did not count as any part of his capital the persons of his

456 CAPITALISM employees. The Southern plantation owner, on the other hand, considered himself rich by virtue of the mere presence of his workers, who were his slaves. Thus he did not consider it necessary to accumulate substantial capital in the form of nonhuman means of production, because he thought he already had capital—in the possession of his slaves. The institution of slavery thus operated to deprive the South of the accumulation of actual capital, because people believed that their ownership of other people constituted their capital. The results of this deprivation of actual capital in the antebellum period contributed to the South lagging far behind the North in economic development for generations to come.

Adam Smith on “Productive and Unproductive Labor”

It is appropriate to acknowledge here the contribution of Adam Smith to the grasp of the essential connection between productive activity and moneymaking and the decisive role this connection plays in the distinction between production and consumption. To be sure, Smith commits the error of holding that in order for an activity to be productive, it must produce tangible physical goods, as though that were essential to its earning of money. He also made the error of including acquired personal abilities in the concept of capital. 18 In the very passages in which he makes the error of holding the need for the production of a tangible physical good, however, the essential role of moneymaking, as enabling the activity to be self-sustaining and a source of profit stands forth very clearly. It is worth quoting him:

There is one sort of labour which adds to the value of the subject upon which it is bestowed: there is another which has no such effect. The former, as it produces a value, may be called productive; the latter, unproductive labour.

Thus the labour of a manufacturer adds, generally, to the value of the materials which he works upon, that of his own maintenance, and that of his master’s profit. The labour of a menial servant, on the contrary, adds to the value of nothing. Though the manufacturer has his wages advanced to him by his master, he, in reality, costs him no expense, the value of those wages being generally restored, together with a profit, in the improved value of the subject upon which his labour is bestowed. But the maintenance of a menial servant never is restored. A man grows rich by employing a multitude of manufacturers: he grows poor by employing a multitude of menial servants. 19

And, very importantly, in regard to the activities of government:

The labour of some of the most respectable orders in the society is, like that of menial servants, unproductive of any value, and does not fix or realize itself in any permanent subject, or vendible commodity, which endures after that labor is past, and for which an equal quantity of labour could afterwards be procured. The sovereign, for example, with all the officers both of justice and war who serve under him, the whole army and navy, are unproductive labourers.

They are the servants of the public, and are maintained by a part of the annual produce of the industry of other people.

Their service, how honourable, how useful, or how necessary soever, produces nothing for which an equal quantity of service can afterwards be procured. The protection, security, and defence of the commonwealth, the effect of their labour this year, will not purchase its protection, security, and defence for the year to come. 20

Smith did not realize that the labor of “menial servants” can contribute to the earning of revenue by their employer, and thus to the subsequent payment of their wages. This is the case, for example, with the employment of maids by a hotel or waiters by a restaurant. Nor did he realize that the employment of “manufacturers”— workers producing tangible physical goods—need not always be a source of revenue to their employer. It is not in such cases as workers employed in a shipyard owned by the navy. 21 For the same reasons, he did not see that an employer can increase his wealth by the employment of “menial servants” and consume his wealth in the employment of “manufacturers.” 22 He did not see that the question of whether or not tangible physical goods are produced is simply irrelevant to the question of whether labor should be classified—in our terminology—as producers’ labor or as consumers’ labor.

Nevertheless, in comparison with his grasp of fundamental truths in connection with the tie of productive activity to moneymaking, Smith’s errors are relatively minor, and do not significantly detract from the value of his accomplishments. Sadly, however, Smith’s contributions here are almost completely overlooked nowadays. This is only in part because of his confusion concerning the need for the production of a tangible physical good to qualify an activity as productive. The main reason, I will show, has to do with the much more important matters discussed in Part C of this chapter. 23

5. Critique of the Concept of Imputed Income

The concepts of income and cost pertain to receipts and outlays of money. As the preceding section made clear, this essential fact can easily be overlooked. For example, this was the case when one regarded the saving of an expenditure—the absence of a cost—in the purchase of a home or washing machine as the earning of an income. 24 For many years, I myself overlooked the essential connection of income and cost with the receipt and expenditure of money. I did so until I became aware of the requirements of explaining aggregate profit in the economic system as an excess of the money sales revenues of business over the money outlays of business that later on show up as costs deducted from the sales revenues. Solving the problem of how business in the aggre—

THE DIVISION OF LABOR AND PRODUCTIVE ACTIVITY 457 gate could regularly and consistently sell for more money than it bought placed me under the necessity of looking for a monetary source of the surplus and of focusing on matters for the first time strictly in terms of money outlays and money revenues. When I saw the fruitfulness of this approach, I began to recognize the great importance of not confusing actual receipts and outlays of money with any form of fictional outlays and receipts of money. 25

Contemporary economics, in contrast, continually ignores the vital connection of income and cost with the receipt and outlay of money. It does so insofar as it propounds the doctrines of “imputed income” and “opportunity cost.” 26 The doctrine of imputed income openly and systematically avows that the absence of a cost constitutes income. The doctrine of opportunity cost, on the other hand, holds that the absence of an income constitutes a cost. Contemporary economics thus deals in nonexistent incomes and costs, which it treats as though they existed. Its formula is that money not spent is money earned, and that money not earned is money spent.

As I have indicated, these doctrines stand in the way of developing an understanding of the determinants of aggregate profit and the average rate of profit in the economic system. In addition, they turn out to be riddled with contradictions and absurdities.

I have already described the procedure of the imputed-income doctrine in some detail in the case of owner-occupied housing. This procedure is explicitly and officially endorsed by the U.S. government in its compilation of statistics of national income and gross national product. The rationale for the procedure is to be able to perform an alleged measurement of production which would otherwise be omitted from the statistics. In the words of an official U.S. government publication:

The imputation for the rental value of owner-occupied homes is made to provide comparable treatment between rented and owner-occupied housing. It assumes that home ownership is a business producing housing services which are sold to the homeowner in his capacity as tenant. These sales are estimated in terms of the sum for which the particular type of home could be rented, and the expenses of the home owners are deducted to obtain imputed net rent.

The imputed gross total becomes a part of sales to persons, or consumer expenditures, and imputed net rent becomes a

part of the rental income of persons. 27

To make clear the meaning of this quotation, we need only recall the example I presented of the individual who instead of renting a house for $1,200 a month buys a comparable house and incurs monthly expenses of $1,000 in keeping it up. The homeowner’s $200 a month saving of expense is treated as a $200 increase in his monthly income. The only difference between the government’s procedure and that of my example is that the government’s procedure counts the depreciation on the house in the homeowner’s costs rather than any repayment of principal on the mortgage, which is appropriate if one holds the bizarre context.

The nature of the government’s procedure and all the twists and turns it involves can be grasped by taking seriously the claim that a homeowner has an additional income of $2,400 per year by virtue of owning his home and thereby saving an expense of $200 a month in comparison with renting. If this claim is taken seriously, the question immediately arises of what has become of this $2,400 of alleged additional income? If it has been received as income, it must show up either as an addition to the individual’s consumption expenditure or to his savings or, in some measure, to both. But where is it? For his consumption expenditure and the change in his savings add up only to his income in the normal sense of money actually received or due. The “solution” is to claim that not only does the homeowner receive $2,400 per year in income he doesn’t receive, but that he also consumes this $2,400 per year in paying—to himself— the very rent he was originally supposed to be spared! He does not and yet simultaneously does, it is alleged, incur $200 per month of housing expense.

This “solution,” when worked out in detail, entails a whole host of fictions and contradictions. The first is that the $1,200 which, by the very conditions of the case, are not paid in rent, are paid in rent. They are allegedly paid in rent by the homeowner to himself. This gives rise to the further fiction that the homeowner is a landlord, and that he is so precisely in a respect in which he cannot be—namely, with regard to the house which he himself occupies and which he therefore withholds from the rental market. From the fiction that the homeowner is a landlord follows the still further fiction that his $1,000 monthly expense for mortgage interest and so forth is a business expense, and thus the still further contradiction that a nonbusiness expense is a business expense. It is by subtracting this nonbusiness business expense of $1,000 from the nonrental rental, nonrevenue revenue of $1,200 that the nonincome income of $200 per month is arrived at, which is allegedly consumed in housing expense in contradiction of the fact that by the nature of the case this $200 is not consumed in housing expense. And, as one last touch of the absurd, this phantom income of $200 is raised to the status of a phantom who is his own grandfather. There could be no phantom income of $200 if there were no phantom revenue of $200 in excess of the phantom business expense. This extra phantom revenue, however, can only exist if there is first a phantom consumption of $200. But there can be no phantom consumption of $200 unless there is first a phantom income of $200. But, of course, in dealing with phantoms, one need not quarrel over any contradictions in the order of their descent.

The absurdities to which the doctrine of imputed income leads in the effort to measure production that is not brought to market are limited only by the extent of its application. Thus, if one applies it to housewives, and asks how much a man would have to pay to obtain from the market the same services his wife provides for free, one can easily come to the startling conclusion that the income attributable to the average housewife is higher than the income of her husband, despite the fact that she does not earn an income, while he does.

The application of the imputed-income doctrine to the services of housewives is frequently advocated by textbooks dealing with “macroeconomics.” They typically consider it a deficiency of the gross product statistics (GNP or now GDP) that the statistics do not allow for the value of services performed in the home. For example, Samuelson and Nordhaus write: “Consider also do-it-yourself work done in the home—cooking meals or insulating walls. Because the values added are not bought or sold in markets, they never enter into the goods and services of the GNP . . . . An estimate of NEW [“net economic welfare”] will need to include the value of similar do-it-yourself activities.” 28

An imputed value of housewives’ services was actually calculated by a major New York City bank in the 1960s, which arrived at a figure that exceeded the income of the average working husband. The bank made its calculation by applying the wage rates of cooks, housekeepers, chauffeurs, maids, governesses, nurses, and so forth to the hours the average housewife is supposed to spend in each of these respective activities, and then adding up the result. (Much more recently, in 1992, legislation was proposed in Congress to compel the Department of Commerce to include such an allowance in the calculation of gross domestic product. Inclusion would reportedly add $1.46 trillion a year to the GDP. 29 )

If one were to ask how the average husband is supposed to be able to pay for these services that are allegedly beyond his income, one would be driven to the counterbalancing absurdity that the average housewife supports her husband—she turns over to him her earnings in these capacities so that he may be able to buy her services from her. This bookkeeping procedure accords perfectly with that which is used in the case of the imputation for owner-occupied housing, in which the imputed income is allegedly used to finance the alleged additional consumption that makes its own alleged existence possible. Here the wife’s imputed income finances the husband’s alleged additional consumption.

Curiously, the devotees of the imputed-income doctrine omit an imputed value of the wife’s sexual services from their calculations. Were they to include it, they would no doubt discover that her income exceeds her husband’s by an even more substantial margin, for the prices of call girls’ services are much higher than those of cooks and housekeepers, and so forth. And on a national basis, the national income and gross domestic product of the country would most likely be doubled at least, with sex emerging as far and away the nation’s largest industry, and sexual intercourse as the most important component of the index of industrial production, which economists might then follow with far more rapt attention than they do the output of steel and automobiles. Though logical consistency requires such an imputation, it has not been attempted or even suggested. The supporters of the imputed-income doctrine are willing to regard wives as interchangeable with hired cooks and housekeepers and thus to obliterate the nature of marriage in this respect, but they are unwilling to go the whole route and claim that wives are prostitutes—and husbands their customers, enabled to afford their services by living off the proceeds of their wives’ prostitution.

When applied in the attempt to measure “net economic welfare,” the doctrine of imputed income can easily make beggars into millionaires. Consider the expenses one saves by not being blind and thus not having to hire a nurse, or by virtue of not having cancer, or not needing a psychiatrist. When such savings are added to a person’s income, in the attempt to measure his economic welfare, he can easily turn out to “earn” $100,000 a year—even though he may not be able to afford to buy a cup of coffee.

Consider how easy it is to raise one’s income when it consists of such fictions. A wife who buys a $2,000 fur coat instead of a $5,000 fur coat, avoids an expense of $3,000. She thus allegedly secures the equivalent of a $3,000 raise for her husband. And if the husband could elevate his wife’s tastes sufficiently, to the point where she would set her heart on a $15,000 fur coat, her expenditure of $2,000 would allegedly secure for him the equivalent of a $13,000 raise—enough to pay both for the coat for her and for a small sports car for him besides.

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At the base of all these absurdities is the failure to realize the importance of earning money as the means of living in a division-of-labor society. As a result of this failure, contemporary economics does not consider the earning or nonearning of money to be a significant matter. As a further result, it does not know how to distinguish between production and consumption. It regards consumption as though it were production, merely because the physical aspect of production is present— failing to see that such production is a consumptive production.

In addition, contemporary economics considers as one of its main tasks the measurement of total production

THE DIVISION OF LABOR AND PRODUCTIVE ACTIVITY 459 and total welfare in the economic system, and believes that such measurement can be performed by adding up the number of dollars for which goods and services exchange or might be exchanged. The notion that the expenditure or potential expenditure of money in an economic system, is a measure of the goods and services which are produced in that economic system is totally mistaken. What the aggregate expenditure of money in an economic system reflects, and thus indirectly measures, is nothing but the quantity of money in the economic system!

As we shall see when we come to the discussion of the quantity theory of money in the next chapter, it is the quantity of money, not the volume of physical production, that determines the volume of spending in the economic system. Essentially, increases in the production of goods and services are accompanied by a rise in the total spending for goods and services only insofar as they are accompanied by an increase in the quantity of money. Otherwise, the increase in production results in a fall in prices, with basically no greater total expenditure of money taking place.

Money is important within the economic system, as the means of individuals exchanging their goods and services and as the basis of their performing economic calculations. It has no significance as a measure of the production of the economic system as a whole. Contemporary economics fails to see the real significance of money—in the activities of individuals—and focuses instead on the illusory significance of money as a measure of aggregate production.

This is not to say that a system of aggregate economic accounting is of no value. As will be shown later in this book, it is of very great value, but as a means of improving understanding of the functioning of the economic system, not as a system of measuring the production of the economic system.

6. Critique of the Opportunity-Cost Doctrine

An opportunity cost is an imputed cost—a cost which does not actually exist in the sense of an expenditure of money being made, or having been made, but which is treated as though it existed. An opportunity cost is said to exist by virtue of the failure to earn a revenue or income that otherwise might be earned or might have been earned. It represents the absence of a revenue or income, just as imputed income represents the absence of a cost.

The treatment of the subject by Samuelson and Nordhaus is typical:

. . . the economist generally includes more items in cost than do accountants or businesspeople. Economists include all costs—whether they reflect monetary transactions or not; business accounts generally exclude nonmonetary transactions.

We have already encountered . . . examples of true economic costs that do not show up in business accounts. The return to an owner’s effort, the normal return on contributed capital to a firm, a risk premium on highly leveraged owner’s equity—these are all elements that should figure into a broadly conceived set of economic costs but do not enter business accounts. . . .

The notion that can help us understand this distinction between money costs and true economic costs is the concept of opportunity cost. The opportunity cost of a decision consists of the things that are given up by taking that particular decision rather than taking an alternative decision. 30

The opportunity cost of a decision is subsequently described as “the value of the best available alternative.” 31 Practically every elementary textbook of economics, including Samuelson and Nordhaus, offers an example of the following kind to illustrate the concept of opportunity cost and explain the need for it.

An accountant informs the owner of a neighborhood hardware store that he has made a profit of $50,000 during the preceding year. Naturally, the owner may be quite pleased with having made such a profit. But this, interjects the textbook author, shows how little this businessman and his accountant know of economics. Have they considered, he asks, that by selling the hardware store and investing the proceeds elsewhere, the store owner could make $15,000 per year in interest, and, by going to work for someone else, make $45,000 in wages or salary? These forgone opportunities or passed-up alternatives, the textbook author then argues, must be counted as costs of the owner’s business, just as much as the store’s payment for merchandise and the labor of hired help, if its actual profit is to be computed. And thus, the textbook author concludes, far from having the $50,000 profit that the store owner and his accountant naïvely believed he had, the store owner has incurred a $10,000 loss. In the words of Samuelson and Nordhaus, in reference to their particular variant of this example: “Thus, while the accountant might conclude that such a typical small business was an economically viable enterprise, the economist would pronounce the firm an unprofitable loser.” 32

Now the need for the concept of opportunity cost is simply supposed to be to make the store owner aware of the fact that he might be financially better off by selling out and going to work for someone else. But if this is so, there is no reason why it cannot be stated very simply that one can be financially better off making a larger income in the form of interest and wages than a smaller income in the form of profit. One is better off making a

combined $60,000-interest-and-wage income than a $50,000-profit income. In order to make this point, there is no need to deny that the store owner’s profit is a profit, and to call it a loss instead. And there is no reason for the store owner to think he has done badly merely because he might have done better. There is certainly no grounds, as Samuelson and Nordhaus believe, to challenge the accountant’s judgment that the enterprise is viable. It is indeed viable. It recovers in sales all the outlays it expended to bring in those sales, and a profit besides. Thus it is self-sustaining and more than self-sustaining. It is not a “loser”—not of a single dollar of the capital with which it began the year’s operations.

The doctrine of opportunity cost is not required for ascertaining how one might do better. Its sole contribution is obfuscation, not perception. Consider its implications.

Our store owner, if we are to believe such authors as Samuelson and Nordhaus, has lost $10,000. Nevertheless, he has gone through the year consuming $40,000 and adding $10,000 to his net worth. He has bought a car and taken a vacation, and, at the same time, added $10,000 to his bank account. If he in fact had had a loss of $10,000, this would not have been possible. Consuming $40,000, while losing $10,000, would have meant a decline in his net worth of $50,000. How can this discrepancy of $60,000 between the facts and the implications of the opportunity-cost doctrine be reconciled? How can the $10,000 increase in the store owner’s net worth, which in fact occurs, be reconciled with the $50,000 decrease in his net worth which the opportunity-cost doctrine implies?

The solution to this puzzle is a second step into unreality, a second fiction to balance the first. It is that in addition to incurring the loss he never incurred, the store owner is alleged to receive income he never received! For not only does he have a $10,000 loss, it is claimed, but he also earns $15,000 in interest and $45,000 in wages. His $50,000-profit income is, it is claimed, in reality[!] a $10,000 loss accompanied by $60,000 in interest and wage income! And thus, paradoxically, the very interest and wage incomes which were not earned, and the failure of which to earn supposedly gave rise to the need for counting them as costs, are treated as being earned! They are held to be simultaneously not earned and earned.

What is involved in this juggling must be spelled out more fully. The store owner forgoes $60,000 in interest and wage income by virtue of remaining in his present business. This $60,000 which he does not make is treated as an outlay of his business, despite the fact that no such outlay exists. This nonexistent outlay then causes a nonexistent loss. The nonexistent loss, however, contradicts the change in the store owner’s net worth. To reconcile this contradiction, the store owner is then credited with a nonexistent interest and wage income equal to his nonexistent payment of interest and wages. He allegedly now earns the interest and wage income he doesn’t earn and which, in not being earned, created the whole alleged problem in the first place. He supposedly pays the interest and wages he doesn’t pay, to himself, so he now receives from himself the interest and wages he doesn’t receive.

An analogy to this procedure would be the following. One gains ten pounds, but might have gained twenty pounds. This is then taken to mean that one has lost ten pounds. When one’s alleged loss of weight cannot be reconciled with the fact that one is now ten pounds too large for one’s clothes, one’s oversize is explained on the grounds that one’s clothes have shrunk the equivalent of twenty pounds. Or: one marries a pretty woman, but might have married a very beautiful woman. This is then taken to mean that one has married an ugly woman. When the woman’s alleged ugliness cannot be reconciled with the fact that she is pretty, her prettiness is then explained on the grounds that she has had plastic surgery.

The opportunity-cost doctrine leads to further absurd implications. It follows from this doctrine that it can be more advantageous to have losses than profits. Our store owner allegedly suffers a $10,000 loss because he forgoes $60,000 in interest and wage income in making his $50,000 profit. But suppose that instead of being the owner of a hardware store, he were only a poor pushcart vendor or street-corner newspaper dealer. His profit in such a case might be only $20,000. Yet if the interest he had to forgo on his tiny capital and the wages he had to forgo on his very limited talents amounted to only $15,000, the opportunity-cost doctrine would claim he had made a profit of $5,000. Obviously, it is much better to suffer the $10,000 “loss” than to make this $5,000 “profit.”

It follows from the opportunity-cost doctrine that precisely to the degree that one is confronted with profitable ways to invest one’s capital, and precisely to the degree that one’s services are in great demand, one’s income must be less—in a word, that one must suffer by virtue of possessing the very qualities that create one’s success. For example, it follows from this doctrine that companies reduce their profits by having successful research departments. The effect of these research departments is to create profitable alternative opportunities for investment. According to the opportunity-cost doctrine, to the degree that they do this, they must raise the costs of these firms and thus reduce their profits. For example, if an innovative computer company or pharmaceutical company is able to make a rate of profit of 30 percent on some product, that profit must allegedly be reduced to 1 percent if its research department develops some other

THE DIVISION OF LABOR AND PRODUCTIVE ACTIVITY 461 product which could afford a 29 percent rate of profit on the same capital. And if the new product could yield 31 percent, then the company’s rate of profit must allegedly still be cut to 1 percent, because then the profit on the original product would constitute the opportunity cost. And if the company’s research department develops two truly spectacular products, the one yielding a 50 percent rate of profit, the other a 49 percent rate of profit, again its rate of profit must allegedly be cut from 30 percent to 1 percent on the capital in question. Conclusion? The first step for a company to take if it wants to raise its rate of profit is to close down its research department.

Similarly, it follows that the president of General Motors must suffer from the fact that Ford and Chrysler would like to employ him, for to the degree that they become aware of his talents, it serves to raise his opportunity costs. He would allegedly make a higher income if no other auto firm were interested in him. Conclusion? Raise your income by striving to give the impression to potential employers that you are incompetent. If you can succeed in this endeavor sufficiently, you will make more money, the opportunity-cost doctrine implies, even if your “mere” accounting income falls, provided it doesn’t fall by as much. And, of course, the best and quickest way to raise one’s income is simply to make oneself blind to all alternative possibilities for investment and employment, and thus to remove them as opportunities, thereby totally eliminating all “opportunity costs.”

Yet another manifestation of the absurdity of this doctrine can be seen if it is applied to the stock market. Imagine that an individual is considering investing a million dollars, and must decide between two stocks, A and B. Both stocks are currently selling at $10 per share. The individual decides on stock A. It goes to $20 per share. In the same period, however, it turns out that stock B goes to $30 per share. If one believes the opportunity-cost doctrine, this is grounds for leaping from the nearest skyscraper—one has lost a million dollars. Conversely, imagine that stock A drops to $3 per share, while stock B drops to $1 per share. In this case, if one believes the opportunity-cost doctrine, one has made $200,000 and can afford to buy a Rolls Royce.

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The criticisms I have made of the opportunity-cost doctrine should by no means be interpreted to mean that I deny the relationship between the cost of producing an individual good and the value of the alternative products which can be produced with the same factors of production. On the contrary, I fully acknowledge that costs of production are influenced by the value of alternative products which must be forgone if the product in question is to be produced. Indeed, previous portions of this book were devoted actually to demonstrating just how this process takes place. 33 For example, insofar as it depends on the price of wheat, the cost of producing bread is determined on the basis of the value buyers attach to other wheat products, such as meat produced from animals fed with wheat—products which cannot be produced because the means of producing them are devoted to the production of bread and are thus unavailable to produce those alternative products. 34

But these costs of production are money costs of production. The actual money price of wheat (and of all other factors of production that exist in a given supply) is determined by a process of bidding that emanates from all the different uses and users of the factor of production. The price of the factor emerges as the result of the bidding of different sums of money by the various users and potential users. This process does not at all represent the concoction of any kind of make-believe costs. The costs are actual, in the full business and accounting sense.

The supporters of the opportunity-cost doctrine generally recognize the process by which money costs are determined, then confuse the alternative opportunities whose competition in bidding gives rise to the money costs with the phenomenon of cost itself, and thereafter ignore the necessity of a money outlay actually being present. In other words, they identify a cause of the determination of money costs, confuse the cause with the effect, and proceed to ignore the effect, which is nonetheless essential.

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The first part of this chapter was dedicated to dealing with those errors in connection with the concept of productive activity that define it too broadly, by failing to take into account the vital importance of moneymaking. The second part of this chapter, of course, will deal with the deadly errors of defining the concept of productive activity too narrowly and excluding from it such vital activities as those of businessman and capitalist, retailer and wholesaler, and so forth.

The imputed-income and opportunity-cost doctrines constitute a kind of bridge between the two types of errors. In leading people to perceive the existence of productive expenditures, wages, and costs where there are in fact no productive expenditures, wages, or costs, and to deny the existence of profits where profits do in fact exist, they encourage an utter misconception of the foundations and mutual interrelationships of these phenomena. In particular, they blot out the essential role of businessmen and capitalists in the making of productive expenditures and the payment of wages, and proceed as though productive expenditure and wages could exist without businessmen and capitalists. In so doing, they thoroughly distort the nature of the activities of businessmen and capitalists and the relationship between those

activities and the respective heights of wages and profits. Thus, they play a major role in preventing a just conception of the productive role of businessmen and capitalists and in making the Marxian exploitation theory appear plausible. This will become clear in what follows.

PART B

THE PRODUCTIVE ROLE OF

BUSINESSMEN AND CAPITALISTS

1. The Productive Functions of Businessmen and Capitalists

As previously observed, the productive role of businessmen and capitalists can be understood only within the context of a division-of-labor society. While in a non-division-oflabor society, manual workers alone are productive, because there is nothing more to production in such a context than the physical making of goods, in a division-of-labor society new aspects, new dimensions, of productive activity appear. Moneymaking is only one such aspect, though an essential one, to be sure. In addition, the productive role of businessmen and capitalists emerges. Their productive role is to raise the productivity of manual labor, and thus its real remuneration, precisely by means of creating, coordinating, and improving the efficiency of the division of labor. 35

Businessmen and capitalists create division of labor in founding and organizing business enterprises, in providing capital, and in making productive expenditures. They coordinate the division of labor among the various firms and industries by the very fact of seeking to make profits and avoid losses; they coordinate the division of labor within each individual firm insofar as they perform the functions of management. They improve the efficiency of the division of labor both by means of their competitive quest to earn the highest possible rate of profit, and to avoid losses, and by means of providing capital and seeking to maximize the efficiency with which capital goods, no less than labor, are employed.

Each of these aspects of the productive role of businessmen and capitalists requires elaboration.

Creation of Division of Labor

Business firms are the central units of a division-of-labor society. The division of labor exists both between the various individual business enterprises and within each individual business enterprise that comprises the labor of more than one person. Each business firm is more or less specialized in its production. Frequently, its activities are confined to a single industry; rarely do they extend to more than several industries. The cases in which firms do participate in more than a few industries will generally be found to be the result of artificial incentives created by the tax laws. 36 In absolutely no case, does any firm come even remotely close to engaging in all branches of production. Thus, each firm represents more or less specialized productive activity vis-à-vis the rest of the economic system. Furthermore, within each firm, there are separate divisions, departments, sections, and branches, all representing further aspects of the division of labor.

In these ways, business firms are the central units of a division-of-labor society, representing division of labor both in their external relationships to other business firms and in their internal organization.

It follows that in founding and organizing business firms, businessmen and capitalists create division of labor—they construct the building blocks of the division-of-labor society.

The provision of capital by businessmen and capitalists is no less essential to the existence of the division of labor. As explained in the discussion of the dependence of the division of labor on saving, the provision of capital is indispensable to the existence of any significant vertical division of labor. This is because it makes possible the existence of a necessary division of payments in the productive process. In its absence, the only source of payments to producers would be the ultimate consumers, with the result that many groups of producers would be compelled to wait intolerable lengths of time between the completion of their contribution to production and their receipt of payment. This is the problem of the auto workers and steel firms having to wait to be paid until the cars they help to produce are sold, or, if the cars are sold on credit, as they often must be, until the installment payments come in. It is the problem of the steel workers and the iron-mining concerns having to wait all this length of time plus the additional length of time that elapses between their contribution to production and the payment for the automobiles, and so on, with the problem growing worse and worse, the further back in the chain of production one stands. It is the problem of the equipment and construction industries and their workers having to wait decades for payment, and even generations and centuries, insofar as equipment and buildings are used in the production of further equipment and buildings. 37

In contrast, the provision of capital makes possible payment to producers at numerous points in the productive process, and thus within a reasonable period of time following the performance of their contribution to production. Indeed, in a modern economic system the great majority of wage earners are paid out of the capital of the firms which employ them. This makes it possible for

them to be paid in most cases not only far in advance of payment by the ultimate consumers, but also even well before the business firms at the next stage of production pay for the products to which their labor contributes. For example, steel workers are paid not only years in advance of the payment for automobiles by the ultimate consumers but also well in advance of the payment for steel by the auto companies. Wages are paid out of the capital of the firm that employs the wage earners in every instance in which payment must be made to the wage earners after a shorter interval of time than that in which payment is received by the firm for the goods or services to which their labor contributes. This, of course, occurs in the typical case in which wages are paid after a week’s work and payment from the customer for the goods or services to which the wage earner’s labor contributes is payable to the firm as late as thirty days later, without penalty.

There is a closely related point of great importance. Namely, later portions of this book—of this chapter— will show how the saving and productive expenditure of businessmen and capitalists are responsible for the existence of the entire demand for labor in the production of products for sale—both for first creating that demand and then increasing it relative to the demand for consumers’ goods. 38 It will be shown that to the degree that businessmen and capitalists save and productively expend, they increase the proportion of “national income” that is constituted by wages and the proportion of consumption expenditure that takes place out of wages in contrast to other forms of income, notably, profits and interest. Indeed, it will be shown later in this chapter that it is the saving and productive expenditure of businessmen and capitalists that make possible the very existence of a class of wage earners separate and distinct from the sellers of products, and thus of the existence of the division of labor insofar as it depends on the existence of wage earners. 39

It should not be forgotten that the provision of capital also vitally contributes to the division of labor in its horizontal aspect—that is, the extent to which it can be carried at any given stage of production. This is because greater division of labor at any given stage of production requires the existence of larger-scale production, which in turn requires the existence of greater amounts of capital. 40

Thus, in founding and organizing business enterprises, in providing capital, and in making productive expenditures, businessmen and capitalists create division of labor.

Coordination of the Division of Labor

Businessmen and capitalists are responsible for the coordination of the division of labor among the various branches of production by virtue of their striving to make profits and avoid losses. As the discussion of the price system showed earlier in this book, in striving—other things being equal—to make the highest possible rate of profit, businessmen and capitalists are led to counteract the mistake of relative underinvestment and relative underproduction. This is the mistake of failing to carry investment and production in specific industries far enough relative to investment and production in the rest of the economic system. For example, the mistake of failing to carry investment and production in the automobile industry far enough relative to investment and production in the housing industry, or investment and production in the manufacture of nails far enough relative to investment and production in the lumber industry. By the same token, in seeking to withdraw their capital from industries suffering losses or earning below-average rates of profit, businessmen and capitalists are led to counteract the mistake of relative overinvestment and relative overproduction—that is, the mistake of carrying some branches of production too far relative to the other branches of production. To be sure, the desire to make profits and avoid losses leads businessmen and capitalists to strive to avoid making mistakes representing either kind of discoordination in the first place.

In these ways, the profit motive of the businessmen and capitalists operates as the great engine maintaining coordination and balance among all the different branches of the division of labor. It is what prevents the division of labor from degenerating into any sort of “anarchy of production.” 41

The coordinating function of businessmen and capitalists is present not only among the different branches of production, and the various individual firms which comprise them, but also within each individual firm. Insofar as businessmen and capitalists exercise the functions of management, which to some extent they do inescapably in deciding the activities and organization of their enterprises, they are engaged in a further process of coordinating the division of labor. It is the essence of management to direct the activities of subordinates—individuals and groups of individuals comprising subordinate units—in such a way as to achieve the cohesive, overall goals of the enterprise at large. This is precisely the coordination of the elements of division of labor within the enterprise.

Of course, as I explained in Chapter 9, as far as the economic system is free of government interference, the managerial activities of the businessmen and capitalists represent profit management as opposed to bureaucratic management. The latter is the nature of management in government enterprises. It appears in private enterprises only to the extent that they are subject to government interference. 42

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By now one should be able clearly to appreciate just

why comprehension of the division of labor is the key to understanding the productive activities of businessmen and capitalists. If one ignores the division of labor, and focuses instead on the conditions of production in a society of self-sufficient farmers or hunters, there is no specific productive activity for businessmen and capitalists to perform. There is no division of labor to coordinate and no division of labor to create in the first place, and thus there is no possibility of grasping that precisely these are the productive functions of businessmen and capitalists. Nor, of course, on such a view is it possible to grasp the vital productive role of businessmen and capitalists in improving the efficiency of the division of labor.

Improvements in the Efficiency of the Division of Labor

The discussion of the price system earlier in this book, in particular that of the uniformity-of-profit principle, also makes very clear how the profit motive of businessmen and capitalists brings about a progressive improvement in the methods of production and in the quantity and quality of the products produced. 43 We saw major confirmation of this principle in the discussion of the nature of economic inequality in a capitalist society, in particular in connection with the building of great industrial fortunes. 44

It is only necessary to recall the fact that under the freedom of competition of capitalism, to earn an exceptional rate of profit a producer must introduce a better product or a more efficient method of producing an already existing product. And, further, that the effect of the freedom of competition is subsequently to erode any special profit made in this way, as the improvement becomes more and more widely adopted by others and becomes the normal standard of the industry, with the result that to go on earning an exceptional rate of profit, it is necessary to introduce repeated improvements in production.

Later discussion of saving and capital accumulation in Chapter 14 of this book will show how the saving and productive expenditure of businessmen and capitalists result in a growing supply of capital goods and thus in the achievement of a further indispensable precondition for a rising productivity of labor. That discussion will also show how the efficiency that the profit motive leads businessmen and capitalists to achieve in the utilization of the capital goods already existing at any given time further powerfully promotes capital accumulation and the rise in the productivity of labor. 45

Thus, in these ways—namely, the introduction of continuous improvements in products and methods of production and the achievement of capital accumulation both through saving and productive expenditure and the efficient use of already existing capital goods—the activities of businessmen and capitalists bring about a progressive improvement in the efficiency of production under the division of labor.

2. The Productive Role of Financial Markets and Financial Institutions

The fact that in a division-of-labor society, production begins with an outlay of capital, and is thoroughly dependent upon the availability of capital, underlies the productive role of financial markets and financial institutions—namely, of the stock and bond markets, the banking system, and financial markets and financial institutions in general. The essential productive role of these markets and institutions is to promote the investment of savings and the efficiency of the investment of savings, as well as the overall degree of saving, and thereby to raise the demand for and productivity of labor and the general standard of living. Essentially, it is similar to the productive role of businessmen and capitalists themselves insofar as they provide capital and are responsible for a growing supply of capital goods.

The existence of financial markets and financial institutions makes it possible for individuals to earn a rate of return on capital without having to employ that capital in businesses of their own. It makes it possible for them to invest in businesses owned and operated by others, and to earn a rate of return on capital in the form of interest and dividends rather than in the form exclusively of profit. For many people, the existence of these markets and institutions provides the only opportunity of earning a rate of return on their savings.

In the absence of financial markets and financial institutions—of lending and borrowing and of investing for dividends—the only way that individuals could earn a rate of return on their savings would be by investing them in businesses under their own management. The possibility of investing in the enterprises of friends or close associates in the form of lending or accepting a partnership in which one plays no role in the management already represents the existence of a primitive, highly circumscribed form of financial market. Such limited possibilities may be of significant value to those to whom they are open, but they are obviously of substantially less value than the existence of full-fledged financial markets and the vastly greater opportunities for investment that the latter afford. Moreover, they are of no value for the great majority of individuals, whose friends and close associates are unable to offer the prospect of worthwhile investments.

Thus, in the absence of financial markets and financial institutions, for the great majority of people, if not for

everyone, the only means of earning a rate of return on their savings would be investment in businesses under their own management. Yet there are many individuals for whom it would be highly disadvantageous to have to run a business of their own, given the alternative of being employed for wages that are higher than the profits they could hope to make in business for themselves. This in fact is the case for the great majority of people today, who can work as employees in fairly well-paying positions, but who, if they had to live by being in business for themselves would earn much less, or even lose the capital they invested.

Then, of course, there are many other people who possess savings, but who are completely unqualified to run a business, such as almost all underage orphans and many widows. In addition, there are still other people who possess savings and who might be financially more successful in business than in their present occupations, but who are simply unwilling to devote the necessary time to business activity. In this category are probably a significant number of professionals, such as doctors, lawyers, engineers, and professors.

Still another, partly overlapping group is constituted by all those people who possess savings and have successful businesses of their own, but who cannot employ all of their savings efficiently within the limits of their own businesses. In this category are many professionals in private practice, large numbers of small businessmen, and a significant number of large businessmen. For example, a doctor in private practice often easily accumulates far more savings than he can employ efficiently in his practice. The owners of many successful stores and shops are in the same position. If such people are unable or unwilling to open branches or enter into additional lines of business, or cannot do so efficiently, then they simply cannot employ all of their savings, or, at least, cannot employ them efficiently.

On the basis of these facts, it should be obvious that the absence of financial markets and financial institutions would mean that to an important extent individuals who had savings would have no incentive to invest them. Individuals in such a position would thus have no alternative but to hold their savings in the form of hoards of money or accumulations of consumers’ goods, such as jewelry, housing, and works of art. The consequence would be that their savings would not serve to make possible a demand for capital goods or for labor. The result of the lesser demand for capital goods would be that the extent to which the economic system concentrated on the production of capital goods would be correspondingly less. And thus the ability to achieve a production of capital goods sufficient to make possible capital accumulation would be correspondingly less. The effect would almost certainly be economic stagnation at an extremely low level of productivity of labor. The standard of living of the average worker would also suffer from the fact that savings that are hoarded or held in the form of accumulations of personal consumers’ goods do not contribute to the demand for labor and the payment of wages, as do savings that are invested.

In contrast, the existence of financial markets and financial institutions, and the rate of return they provide, greatly encourages the investment of all such savings. The fact that financial markets and financial institutions exist thus raises the relative demand for and production of capital goods and thereby powerfully contributes to capital accumulation and a rising productivity of labor. At the same time, it raises the relative demand for labor and payment of wages. 46

In addition, and also very important, the existence of financial markets and financial institutions enables individuals who have the opportunity of investing in their own businesses, to invest more productively in businesses owned by others. This, too, powerfully contributes to capital accumulation and the rise in the productivity of labor and the general standard of living. It does so, above all, by making possible the existence of the large aggregations of capital necessary for such undertakings as electric utilities, railroads, and, indeed, most largescale modern industries. In this way, the surplus capital accumulated by such people as doctors and shopkeepers can be employed far more effectively than in further enhancements of such things as office furniture or perhaps a store’s inventory.

The effect of this change in the pattern of investment made possible by the existence of financial markets and financial institutions is that with the same degree of demand for capital goods and concentration on the production of capital goods, the economic system is able to produce far more. This is because now it has capital goods in the form of electric power plants and the like, rather than in the form of such things as minimally useful additional office furniture. The effect of the greater ability to produce that this change in the pattern of investment makes possible is a larger supply not only of consumers’ goods, but also of capital goods. For the existence of electric power plants, railroads, steel mills, and so forth contributes as much to the production of a larger supply of capital goods as it does to the production of a larger supply of consumers’ goods. Thus, in this way too—by bringing about a higher productivity of capital goods—the existence of financial markets and financial institutions powerfully contributes to capital accumulation and the rise in the standard of living. And, as we shall see in later discussion of capital accumulation, the effect of a higher productivity of capital goods is a continuing

one, making possible a permanently higher rate of capital accumulation. 47

To an important extent the existence of financial markets and financial institutions encourages not only the investment or more efficient investment of savings already made but also an increase in the rate of saving itself. In enabling individuals who otherwise could not have earned a rate of return on their savings now to earn one, or to earn a higher rate of return than they otherwise could have, it increases the overall rate of saving.

It is important to realize that this does not occur to any great extent by increasing the incentive to save. Most people would desire to have savings even in the absence of any rate of return—simply as a means of providing for future needs that they could not expect to provide for otherwise. And to the extent that people already have savings for such reasons, the effect of the ability to earn a rate of return, or a higher rate of return instead of a lower rate of return, may be as much to motivate them to consume more in the present as it is to give them an incentive to save more in the present. This is because counterbalancing the fact that each dollar saved today will now turn into more dollars in the future is the prospect of the higher future income that will be available as the result of the higher rate of return on the savings one already has. The prospect that one will be better off in the future than in the present operates as an inducement to consume more and save less in the present. Thus, the overall effect of being able to earn a rate of return, or a higher rate of return, on the incentive to save may well be neutral or close to neutral.

Nevertheless, the ability to earn a rate of return does powerfully promote saving. It does so insofar as it enables individuals whose consumption would otherwise be at the expense of their accumulated savings to consume without decumulating their savings. For example, the fact that an individual with accumulated savings of, say, one million dollars can earn a rate of return (in real terms) of 2 or 3 percent a year enables this individual to consume twenty or thirty thousand dollars a year without depleting his savings.

In the absence of his ability to earn a rate of return, the greater part of the savings accumulated by an individual would later on be decumulated, as they came to be used for current consumption. Instead, the ability to earn a rate of return serves to enable an individual with accumulated savings to consume out of income rather than his accumulated savings. 48 In so doing, it makes possible a far higher overall rate of saving and correspondingly greater degree of capital accumulation and demand for labor.

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Once again, it must be emphasized how the productive role of such a segment of the economic system as financial markets and financial institutions can be understood only within the context of a division-of-labor society, and only after one has understood the role of capital in production in such a society. It is absolutely impossible to understand it, if one’s context is essentially limited to that of Robinson Crusoe producing on a desert island and standing outside the division of labor and the use of money. In that case, one simply cannot appreciate the fact that in a division-of-labor economy production must begin with outlays of money, and that the productivity of labor depends both on the relative production of capital goods and on their productivity, both of which are greatly increased by the existence of financial markets and financial institutions and the greater saving, investment out of saving, and more efficient investment that they make possible.

The Specific Productive Role of the Stock Market

A widespread misconception is that the stock market is somehow divorced from genuine productive activity except insofar as it is the source of funds going directly to corporations in exchange for newly issued stock. On this view, the overwhelming bulk of stock market activity, which consists of the trading of already outstanding shares, makes little or no contribution to the productive process.

It should be realized that the ability of stockholders to sell their shares provides a major inducement to the purchase of those shares in the first place. If it were not for the existence of the stock market and its continuous trading in already issued stock, any purchaser of newly issued stock would be faced with the prospect of not being able to sell his stock, or of being able to do so only with great difficulty. Such a prospect would greatly discourage the initial purchase of stock from the issuing corporations and would thus greatly reduce the availability of capital to those corporations. The existence of the stock market and its continuous trading in outstanding shares makes it possible for the individual investor to liquidate his investment at virtually any time, even though the funds initially supplied to the corporation itself may be invested in assets that have a productive life of several decades or more and cannot be recovered from business operations in any less time than that, and, indeed, will most likely be permanently retained by the business enterprise in which they have been invested.

Furthermore, it should be realized that the sale of already issued stock can be, and very often is, the source of funds for investment in the actual physical assets of a business by the individual shareholders who sell their holdings. For example, the owner of a drug store or restaurant who owns stock in IBM or General Motors,

say, may very well decide to sell his shares, or use them as collateral on a loan, in order to raise money to expand his own business activities. In this way, the stock market provides a source of funds for investment in physical assets of business through the trading in already outstanding shares.

The determination of the price of stock in the market for already outstanding shares plays a major role in deciding whether or not it is worthwhile for the present stockholders to have their corporation issue additional shares. Other things being equal, the higher is the price of a share of its stock, the smaller is the percentage of the corporation that must be given up in order to raise any given sum of money, and thus the more likely is it that it will be worthwhile for the present stockholders to have the corporation sell additional stock. By the same token, the lower is the price of its stock, the less likely is it to be worthwhile for the present stockholders to have their corporation sell additional shares. For example, if a corporation has 1 million shares of stock outstanding, and the price of its stock is $10 per share, then in order to raise a million dollars through the sale of new stock, it must sell an interest to outsiders that will amount to one-eleventh of itself—i.e., 100,000 shares out of a new total outstanding of 1.1 million shares. If the price of the corporation’s stock were $100 per share, however, then it could raise an additional million dollars by selling to outsiders less than 1 percent of itself—i.e., only 10,000 shares out of a new total of 1 million shares plus 10,000 shares. By the same token, if its stock had a market value of only $1 per share, it would have to sell 50 percent of itself in order to raise a million dollars. On this basis, it should be obvious that the stock market plays a decisive role in determining whether or not a corporation will find it worthwhile to issue new stock.

In connection with this point, it must be said that the stock market makes it possible for firms that demonstrate their success to obtain capital at a much faster rate than they could if they had to rely exclusively on the reinvestment of their profits. A firm’s demonstration of the ability to earn a high rate of profit on its existing capital operates to raise the price of its outstanding shares and thus to make it possible and worthwhile for the firm to obtain substantial additional capital from the sale of additional stock. In this way, the firm can obtain control over larger sums of capital more rapidly than would otherwise be the case. Indeed, if it increases its equity in this way, the firm correspondingly increases its capacity to borrow and can thereby raise still more capital if it wishes. By these means, successful small businesses are enabled to grow into large businesses and play a more important role in the economic system more rapidly than they otherwise could. At the same time, as an important consequence, they are enabled to challenge the existing large firms all the more rapidly.

Finally, it must be pointed out that the existence of the stock market serves to penalize poor management and to offer a protection against the abuse of stockholders by corporate managements. The effect of poor management, or of the abuse of stockholders, is a low price of the firm’s stock relative to the value of the firm’s assets. This situation invites an outside takeover of the firm, the firing of its present management, and, very often, the sale of some or all of its assets to other firms which are capable of putting them to better use. Apart from anything else, the mere fact of changing circumstances, and the inability of many corporate managements to keep pace with the changes, repeatedly necessitates the breakup of existing corporations, as the land sites their facilities occupy and often the facilities themselves and much of their equipment become more useful in other employments than in their present employments.

Regrettably, in the present-day United States, this important function of the stock market, of serving to bring about the redeployment of the physical assets of business firms in different hands and often for different purposes, is threatened by government intervention designed to protect incompetent managements from the threat of outside takeovers. With the narrow-minded perspective that is typical of opponents of the free market, the enemies of corporate takeovers can see only that some existing “jobs” are eliminated. They do not see the new employment opportunities that are created in other firms, accompanying the availability of the capital assets that have been sold to them. They are unaware that the very fact that the assets of a firm are worth more in being sold off than in being retained is virtual proof that their employment elsewhere will be more productive and thus will contribute to a more rapid rate of capital accumulation and a higher productivity of labor. They do not even see that corporate takeovers, followed by the selling off of assets, are a powerful remedy for previous ill-conceived mergers, whose existence, along with all other mergers, the enemies of capitalism never tire of denouncing.

3. The Productive Role of Retailing and Wholesaling

The productive contribution of retailing and wholesaling becomes apparent as soon as one realizes that in a division-of-labor society, the supply of every product originates in a great concentration, in the hands of a relatively small number of producers. In order for any benefit to be derived from these supplies, they must be moved into the hands of the vast body of consumers which, from the perspective of any one branch of production, is constituted by the producers and their depen—

dents in all the other branches of production. Retailing and wholesaling, along with exchange and money, are the means whereby goods are moved in this way. 49 Thus, the existence of retailing and wholesaling is essential to the solution of a problem that exists only in a division-of-labor society, in which the producers of any given item are different individuals than the overwhelming majority of its consumers.

The failure to appreciate the value of retailing and wholesaling rests on the failure to keep in mind the existence of the division of labor and then to approach the subject of production and consumption as though all that were required to consume was physically to produce. In such a view of the economic world, dominated by the image of conditions in a pre-division-oflabor society, it appears that retailing and wholesaling are useless appendages to what really counts: i.e., the mere physical production of goods. On such a view, what is accomplished by retailing and wholesaling appears to be nothing but the addition of “markups” by useless “middlemen” to the prices charged by manufacturers and farmers, which prices are all that the consumers justly ought to be made to pay.

In the reality of a division-of-labor society, however, retailing and wholesaling play an essential role in the benefit derived from physical production. They are responsible for a major reduction in the amount of time and money that would otherwise need to be spent in obtaining goods, and for an equally major increase in the variety and quality of goods available.

In the absence of retailing and wholesaling, either the consumers would have to go to the producers or the producers would have to come to the consumers. The difficulty of the consumers going to the producers is evident if one simply imagines what it would be like to assemble the ingredients of an ordinary breakfast. A person would have to drive out to the countryside to buy bacon, eggs, and milk. And, if he wanted choice among his suppliers, he would have to drive to more than one farm for each item. In all probability the cost just of fuel and wear and tear on his automobile would be far greater than any “markups” added by retailers and wholesalers. In addition, we must consider the fact that all the time he had to spend in such activities would mean that he would have that much less time available either for earning a living or for leisure.

These points would apply even if individual consumers got together and formed groups for the purpose of purchasing supplies. For example, one might imagine a group of neighbors or fellow employees getting together to send representatives to the producers for the purpose of purchasing in bulk and coming back with supplies for all members of the group. They might agree that every week one of their number would make a series of trips for all of them. They might pool their resources and buy a small truck to be used for this purpose. Perhaps the activity would become the full-time employment of one or two of them. But all of this sort of activity would simply represent consumers’ attempting to do for themselves what retailers and wholesalers can do for them with far greater efficiency.

Comparable difficulties would exist if the producers were to attempt to come to the consumers.

In the circumstances of an economy in which towns and cities are surrounded by large numbers of family farms that are relatively unspecialized, the local farmers can regularly bring a wide variety of farm products into the towns and cities and sell them in farmers’ markets. However, to the degree that an economic system is characterized by a higher degree of division of labor, this becomes unfeasible. For one thing, the degree of specialization of the various farms and agricultural districts increases, because of the greater efficiencies in production that such specialization achieves. Thus each agricultural district now tends to concentrate on the production of just one or a very few items. For example, one area concentrates on dairy farming, another on growing grain, a third on growing apples, a fourth on raising citrus fruits, and so on. At the same time, because of further efficiencies in production, there is the development of largescale processing and manufacturing facilities. For example, most of the meat packing and flour milling in the United States now take place in a relatively small number of locations; canned goods, frozen foods, and a wide variety of baked goods, are also produced in plants in a relatively small number of locations. The same is true of clothing and furniture manufacture, automobile and appliance manufacture—of the production of most goods. These developments are incompatible with the existence of any wide range of nearby, local producers. Thus, it is more and more out of the question for the producers to come to the consumers. It would be one thing for a dairy farmer on Long Island to bring his butter and cheese into New York City. It is out of the question for a dairy farmer in Wisconsin to do so—or for a meat packer in Cincinnati or a biscuit manufacturer in Chicago to do so. Even more fantastic would be the prospect of a coffee grower in Brazil attempting to do so. (These difficulties, of course, would apply equally to consumers attempting to go to the producers.)

If products had to meet the requirement of being available directly from the producers, whether at the farm or the factory, or in local producers’ markets, the producers for the most part would have to be local, correspondingly small and less efficient, and perhaps altogether incapable of producing the product desired. A

possible exception would be cases such as automobiles, in which the items produced were of sufficient value to justify the manufacturer setting up his own specialized distribution network. (In actual practice, however, even in such cases the distribution network is almost always made up of independent retailers, who buy from the manufacturer rather than being part of the manufacturing firm itself. For example, automobile dealers are independent business firms, not part of the automobile companies themselves. This type of arrangement exists because the auto firms and other major manufacturers find it more efficient. They do so for such reasons as not having to invest as much capital of their own as would otherwise be required and because of the greater incentives ownership provides to the dealers.)

Another possible exception to the rule that the producers can no longer come to the consumers is the case of a manufacturer’s mailorder business. Mail order in general, however, is a feasible method only in cases in which one does not need to physically examine the specific goods before buying them and can wait a more or less extended period of time for receipt of the goods (which last typically precludes perishable goods other than those sent by express, at a substantially higher cost). In the case of buying by mail order directly from a manufacturer, the additional requirement must be met that the customer is willing to go to the trouble of expending the time and effort to place the particular order, a circumstance which militates against buying any large number of inexpensive items from a host of separate manufacturers. The disproportionately high cost of advertising relatively inexpensive items that are offered singly or together with only a small number of other such items also militates against the use of mail order. Because of these facts, many mailorder businesses are retailers, which carry the merchandise of a large number of manufacturers. This enables the firms to advertise a large number of items at the same time, thereby saving on advertising costs and thus making it possible to charge lower prices for the products. At the same time, it enables the customer to order a variety of items at one time, thereby saving him substantial time and effort, not to mention expense.

Exactly the same advantages that are present in mailorder retailing are present in the more usual form of retailing through stores, plus, of course, the further advantages of being able physically to examine the goods one is buying and, as a rule, to take possession of them immediately. Retailing and wholesaling make it possible for producers to specialize in the production of an extremely narrow range of goods, such as just paper clips or just rubber bands, just spinach or just lettuce. Because of retailing and wholesaling, the producers of such isolated goods avoid the enormous wastes that would be entailed in attempting to advertise and sell them one at a time to the consumers. They avoid such absurdities as having to place newspaper ads describing the availability and price just of paper clips or just of spinach, and of having to have a special sales representative and rent a special space to sell just this one item.

This discussion provides the appropriate basis on which to judge retailing and wholesaling. True enough, the costs of retailing and wholesaling and the profits of retailers and wholesalers must be added to the prices charged by manufacturers and farmers to arrive at the prices charged to the ultimate consumers. But, in the great majority of cases, the prices charged by manufacturers and farmers at their factories or farms are far from the total of what consumers would actually have to pay if the services of retailers and wholesalers were not present. In the great majority of cases, the consumers would then have to pay an addition to the prices charged by manufacturers and farmers at their production sites that would be far higher than the addition attributable to retailing and wholesaling. They would have to pay an addition that would cover the costs either of their inefficiently going to the producers or of the producers inefficiently coming to them. And, of course, in most cases, the prices charged by the producers even at their production sites would have to be substantially higher, because of the higher costs of production when markets must be local and small and the volume of production correspondingly limited; and, in still many other cases, the products would simply be completely unavailable. Thus, in comparison with the alternatives that would exist in the absence of retailing and wholesaling, it is obvious that retailing and wholesaling reduce the cost of goods to consumers, not increase them.

Retailing and wholesaling represent division of labor in the process of distribution. Instead of each group of consumers having to have a few volunteers or one or two hired hands, instead of each producer having to have his own distribution network—instead of the enormously wasteful duplication of labor and facilities that these things would entail—a relatively small number of retailers and wholesalers bring together in convenient locations to buyers the goods of an enormous variety of producers, and almost always at a far lower cost than would be possible for the consumers or producers acting on their own. A retail store frequently carries the products of dozens or even hundreds of different manufacturers or farmers, and usually of competing producers of the same product. Every such store means the saving of expense to consumers of not having to send their own purchasing agents, trucks, and so forth out to the dozens or hundreds of manufacturers or farmers whose products the retail store carries. It means the saving of expense to producers

of not having to send out their own salesmen and establish their own distribution outlets wherever they sought to sell their goods. Each retail store almost always buys in larger quantity, greater variety, and more efficiently than could any group of consumers. And it holds the products it buys in constant readiness to meet the demands of its customers at their convenience. At the same time, the existence of retail stores (and retail mailorder houses) makes it possible for producers to reach far more consumers than they could possible do on their own, and to do so far more economically than they could do on their own. Thus, as I say, retailing and wholesaling reduce the cost and increase the variety of goods available to consumers, as well as make them available far more conveniently.

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A few special words need to be said in connection with the economies achieved by the existence of wholesalers. The existence of wholesalers permits a radical reduction in the number of transactions that would otherwise have to exist between retailers and manufacturers. Imagine, for example, the existence of a thousand retailers in a given territory who each carry the products of a hundred different manufacturers—for example, small newsstands that sell cigarettes, candy, paperback books, magazines, and a variety of other such items. If each of these retailers had to deal with each of the manufacturers, there would be a hundred thousand different transactions. There would be a hundred thousand combinations of salesmen’s visits, letters, phone calls, and so on. Each transaction would be for a relatively small amount of merchandise.

Now, in contrast, imagine the existence of a wholesaler, who stands between the retailers and manufacturers. In this case, there need be only a thousand large transactions between the retailers and the wholesaler, in which each retailer orders the goods of the hundred manufacturers all at the same time from the wholesaler’s representative, and an additional hundred very large transactions between the wholesaler and the manufacturers, in which the wholesaler orders all at the same time merchandise from each manufacturer that is sufficient for all one thousand retailers. This means a total of only eleven hundred combinations of salesmen’s visits, letters, phone calls, and so on, instead of a hundred thousand. And this, in turn, means a major reduction in transactions costs, and probably also in manufacturing costs, insofar as it permits manufacturers more easily to estimate the volume of production they need to prepare for. It also means that merchandise can be stored much more economically. The wholesaler can store merchandise in a warehouse, in a low-rent district, rather than each retailer having to store substantial amounts of merchandise on his premises, which are typically in a higher— rent district, or in his own separate storage facility, which would entail further diseconomies of the kind associated with unnecessary duplication.

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It is necessary to consider the complaints often voiced about the seeming injustice that exists when the retail price of a good rises at the very same time that the price received by the farmers or manufacturers who physically make the good falls. For example, the retail price of eggs or potatoes may go up at the very same time that the price of eggs or potatoes received by farmers goes down.

Despite the incredulity often expressed by the news media over such events, there is actually nothing in them that should be surprising or that implies that retailers or wholesalers are somehow exploiting the producers and consumers. This becomes clear when it is realized that the price of a good to its producer constitutes only a portion of the total costs of bringing the good to the consumer. Particularly in the case of inexpensive bulky goods, like potatoes, or goods which require special handling and packaging, like eggs, the price of the good to the producer may well account for less than half of the total cost of bringing the good to the consumer, because other costs, such as transportation and packaging, play such a large role.

In such cases, even though from a strictly physical point of view the product is hardly changed when it reaches the consumer from what it was when it left the producer, the price to the producer represents no greater proportion of the total cost than, say, the price of steel represents in the cost of an automobile. In such cases, a fall in the price of the good to the producer may very well be accompanied by a rise in other components of its total cost that are more than offsetting and thus raise its total cost and necessitate a rise in the retail price of the good. On the basis of the uniformity-of-profit principle, it can be stated with certainty that reductions in the price of goods to producers accompanied by increases in the price of those goods to the ultimate consumers cannot in any circumstances lastingly serve to increase the profits of retailers and wholesalers to a point significantly above what corresponds to the general or average rate of profit. Any increase in the profitability of retailing or wholesaling above the general level would provide the incentive and means for increased investment in those lines and thus a reduction in their profitability back to the general level. 50

It should be realized that any notion of a constant tendency for prices to producers to fall while retail prices rise is an illusion resulting from continuous inflation of the money supply coupled with the greater volatility of many producer prices in comparison with retail prices. The continuous inflation of the money supply results in

a tendency for all prices to rise. Many producer prices, however (particularly those of agricultural commodities), being highly volatile, frequently rise more rapidly than retail prices. These more rapid increases in producer prices are then followed by periods in which producer prices fall back, while retail prices go on rising. The periods of more rapid increases in producer prices are strangely overlooked by those who complain of the fall in producer prices. Over time, there is no tendency for the rise in retail prices to outstrip the rise in producer prices—unless, for some improbable reason, at the same time that inflation goes on, improvements in the productivity of labor at the producer level continually outstrip improvements in the productivity of labor in retailing and wholesaling and thereby retard the rise in producer prices relative to the rise in prices at the retail level. Even in this case, of course, there would be no tendency for the profits of retailing and wholesaling to rise permanently relative to those of any other segment of the economic system.

4. The Productive Role of Advertising

The fact that in a division-of-labor society the individual produces or helps to produce just one or, at most, a very small number of goods, and is supplied by others with almost everything that he consumes, also underlies the productive role of advertising. Since, in almost every instance, the consumers are separate, distinct persons from the producers, they do not possess any direct, automatic knowledge of what goods are available to them, or of where and from whom and on what terms they are available. The productive role of advertising is to supply this knowledge. In the absence of advertising, the resulting lack of knowledge would be equivalent to a radical reduction in the physical amount of production. This is because the goods and services that people would then be unaware of might as well simply not have been produced, inasmuch as they would be incapable of doing people any actual good in such circumstances.

Furthermore, even when people already know what goods are available and where and on what terms, advertising still has the effect of increasing the amount of benefit that is derived from the same amount of physical production. Advertising accomplishes this by increasing the awareness people have of the availability of various goods and by thus inducing them to try goods they would not otherwise have tried, or tried as soon, which they then discover that they prefer to goods they were previously consuming and would otherwise simply have gone on consuming.

To illustrate this point, we can consider precisely the kind of case that is frequently advanced in order to deny the value of advertising. For example, toothpaste brand

A begins to advertise and, as a result, attracts customers who previously used brands B, C, D, etc. 51 Perhaps, because of the increase in its sales volume, the unit cost of manufacturing brand A falls, thereby offsetting, or even more than offsetting, any additional unit cost incurred as the result of the advertising. Now, however, brands B, C, D, etc., begin to advertise. And they win customers from brand A. Even if, as the critics of advertising assume, each brand ends up with essentially the same number of customers when all of them advertise as when none of them advertised, and now has higher total costs as the result of the additional cost incurred in order to advertise, and thus must correspondingly raise its price—even so, advertising still provides a major benefit.

This is because now, as the result of advertising, large numbers of individuals use brands that they like better than the brands they had been using and would have gone on using in the absence of advertising. Even though brand A may end up with no more customers in toto than it had to begin with, the customers it has gained prefer brand A to the various other brands, while the customers it has lost prefer the brands to which they have switched, to brand A. In other words, even though every brand may end up with the same number of customers it had in the first place, the customers for each brand are now different individuals, who are better satisfied. In this way, because of advertising, there is an increase in the amount of benefit derived from the same physical amount of production.

In this particular case, of course, the selling price of the product would end up being somewhat higher because of the increase in total cost as the result of advertising. But this is no more of an objection against advertising than it would be an objection against the addition of flavoring or any other improvement in toothpaste, such as improved cavity-fighting capabilities, which when they were added increased the total cost and thus the price. It is no objection because the higher cost and higher price are necessary in order to provide worthwhile benefits.

Because of the extent of the ignorance surrounding advertising, it must be pointed out that any addition to total cost that advertising might be responsible for is always strictly limited. It is never the case that producers can go on increasing their advertising budgets endlessly, with the first to make the latest increase being spurred on by the prospect of enlarging his sales volume at the expense of his rivals who have not yet made that increase, with the ultimate result being an endless rise in total costs and prices for products finally consisting of little more than advertising puffery. 52

There is such a thing as diminishing returns to advertising. Once a certain degree of awareness of a product is established, additional advertising serves to increase

awareness less and less. Any producer spending excessively for advertising will find himself at the mercy of other producers, who advertise adequately, but less than he does. This is because these producers can then advertise their lower prices, made possible by lower total costs resulting from the avoidance of excessive advertising.

Despite the existence of cases in which advertising provides important benefits in conjunction with a rise in the cost and price of products, its usual effect is to reduce prices. It does so by encouraging new competition and the introduction of new and improved products. It encourages new competition by enabling new entrants into an industry to gain exposure in the eyes of the consuming public. In the absence of extensive advertising of new products, people’s main guide to what to consume would be personal experience, which necessarily would favor the established firms, since they are the only existing firms with which people have had experience. Extensive advertising, however, allows new entrants into an industry to gain entree into people’s awareness alongside of the established firms. 53

The effectiveness of advertising in this regard is closely related to the fact that largescale advertising is usually equivalent to a firm posting a bond with the public, as it were, guaranteeing the value of its product. The equivalence to a bond is based on the fact that advertising usually pays only if, after it induces people to try the product, the product itself is good enough to induce them to buy it again and to recommend it to others. It generally does not pay to advertise products which people will buy only once and then advise others against buying. Products which turn out not to represent a sufficient benefit to the public to induce repeat purchases and recommendations to others usually end up causing a loss of the advertising budgets expended on them. 54 On this basis, people are right to place confidence in highly advertised products. The advertising not only calls the product to their attention, but also signifies that the producer is willing to risk his money in the conviction that they will like his product.

Advertising reduces prices and promotes the introduction of new and improved products by shortening the period of time required for a product to gain a mass market and thus achieve the economies of largescale production. In the absence of advertising, good products, it is true, can eventually gain a mass market on the strength of word-of-mouth recommendations; but advertising allows this to happen sooner.

This shortening of the period of time required for a product to establish its market, which advertising achieves, is the more important, the greater are the outlays that must be made in paying for such things as the research and development costs of a product. The longer the period of time that must elapse between the making of these outlays and their recovery in the sale of the product, the greater must be the sums ultimately recovered, in order to provide the going rate of return on the capital invested in these outlays.

For example, if $10 million must be invested in outlays for research and development, and 10 years must elapse before those outlays can be recovered in the sale of the product, then, with a going rate of return on capital of 10 percent per year, the sales revenue that needs to be brought in to compensate for these outlays is approximately $26 million—i.e., $10 million times 1.1 10 . If, on the other hand, advertising can secure a mass market for the product within, say, 1 year, then the sales revenue necessary to compensate for the research and development outlays is only $11 million—that is, $10 million times 1.1 1 . In this way, advertising reduces the price that it is necessary for a product to sell for in order to yield the going rate of return on its research and development outlays. It thus encourages the making of research and development outlays and the introduction of new products.

In the absence of advertising, there would be products that it would not pay to develop, even if they had the potential eventually to achieve a mass market. This would be because the time required to achieve that mass market would then be so great that the ultimate reduction in manufacturing costs made possible by a mass market would be offset by the increased amount of profit required to provide the going rate of return on the capital invested in the product’s research and development outlays. In such cases, a mass market would never actually materialize because the price of the product necessary to provide profitability even in a mass market would be too high for the existence of such a market. In greatly reducing the time required to achieve a mass market, and thus the price that is necessary in order for a product to be profitable in such a market, advertising makes possible the profitable existence of such markets.

In general, and to repeat, advertising promotes research and development outlays and the introduction of the new products that depend on them, by reducing the extent to which such outlays need to be recovered in the price of the product. It does so by means of establishing a larger market sooner rather than later, thereby permitting the recovery of such outlays to take place sooner rather than later and thus with the accompaniment of a correspondingly smaller amount of profit.

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Finally, it must be stressed that advertising never dictates what people consume. Advertising influences consumption only in the limited sense that it can make people aware of things that they then decide—on the

basis of their own needs and their own experience with the things advertised—that they like or do not like. Successful advertising is advertising that makes people aware of things which have the power to serve needs that preexist in them. If what is advertised serves no preexisting need in the consumer, then it has no foundation for success.

This explains the wellknown fact that it pays to advertise extensively only products that are capable of generating some significant sales even with relatively little advertising. These are the products that advertising can be effective in helping to sell. For example, publishers increase the advertising budgets of those titles that do best with their initial advertising budgets; those are the titles that advertising can help most.

The rule for success is to advertise products of the kind that when tried will be liked and recommended by the buyers. The advertisers have no power over what it is that when tried will be liked and recommended. The advertising of automobiles and electric light in competition with the horse and buggy and candles was highly successful, because people had only to try these new goods in order to appreciate their merit. On the other hand, no amount of advertising of the horse and buggy and candles could have maintained the demand for those goods in the face of the competition of the automobile and electric light. 55

The notion that the consumers simply do what the advertisers tell them implies an inability to recognize any objective foundation in the choices consumers make. It suggests an intellectual void on the part of the critic of advertising, of such dimensions as to imply that he is an utter stranger to life in the modern world, incapable of understanding the most elementary connections between modern material goods and his own life and wellbeing. 56

PART C

BUSINESSMEN AND CAPITALISTS: CLASSICAL ECONOMICS VERSUS

THE MARXIAN EXPLOITATION

THEORY

1. The Association Between Classical Economics and the Marxian Exploitation Theory

The leading source of the denial of the productive role of businessmen and capitalists and of the hostility to profits and interest is the Marxian exploitation theory. The essential claim of this theory is that all income naturally and rightfully belongs to the wage earners, but that under capitalism the wage earners receive only bare, minimum subsistence, while everything over and above this is expropriated by the capitalist exploiters in the form of profits, interest, and land rent, or, in the terminology of Marx, “surplus-value.”

In his development of the exploitation theory (which I will describe in detail in Part A of Chapter 14), Marx employs two leading doctrines that are closely identified with classical economics: namely, the labor theory of value and the iron law of wages. I have already referred to the iron law of wages in connection with my discussion of Ricardo’s theory of land rent. It is the doctrine that, broadly speaking, asserts an inescapable connection between wages and minimum subsistence. The labor theory of value claims that the prices of commodities are determined by the respective quantities of labor required to produce them. I will explain both of these doctrines, in the form in which they were propounded by the classical economists, at length, in Sections 4 and 5 of this part. In particular, I will focus on the views of Smith and Ricardo, the two foremost representatives of the classical school, to whom Marx is assumed to be particularly indebted. On the basis of my discussions in these sections, it will be obvious later on, in Chapter 14, that what Marx meant by the labor theory of value and the iron law of wages are two very different sets of ideas than what the classical economists meant, and are in fact gross distortions of what the classical economists meant.

Nevertheless, mainly because of the prominent role played by “the labor theory of value” and “the iron law of wages,” however different their actual content in the two systems of thought, classical economics is almost universally assumed to lead inexorably to the Marxian exploitation theory.

My reason for writing this part, and presenting it here, is that subsequent chapters in this book depend vitally on leading doctrines I have taken over from the classical economists and reintroduced in a modernized form, doctrines which have been abandoned or forgotten precisely because of the mistaken belief that classical economics inevitably leads to the Marxian exploitation theory. As a result, in order to demonstrate the consistency of my profound intellectual indebtedness to classical economics with my unswerving support of capitalism, it is necessary for me to explain the actual nature of the relationship between classical economics and the Marxian exploitation theory, which, I will show, is ultimately one of the most intense opposition.

Consistent with the ultimate opposition that I will demonstrate between classical economics and the exploitation theory, is the fact that I have already reintroduced two abandoned or forgotten doctrines of classical economics with very positive results for the defense of

capitalism: in Chapters 6 and 10, the role of cost of production in determining the prices of most manufactured or processed goods, and, in Part A of this chapter, the essential role of moneymaking in productive activity and the various concepts pertaining to what constitutes production or consumption. 57 My demonstration that considerations of cost of production rather than elasticity of demand are decisive in price determination under the freedom of competition, played an essential role in my refutation of the profoundly anticapitalistic marginal-revenue, cartel, and pure-and-perfect-competition doctrines in Chapter 10. My elaboration of the concepts pertaining to the connection between moneymaking and productive activity earlier in this chapter have served, among other things, to demonstrate that government spending and government borrowing are inherently consumption, rather than any part of the productive process. This, of course, all by itself implies the need for strict limits on government spending and for the outright prohibition of government borrowing.

Nevertheless, it is certainly true that the Marxian exploitation theory is largely the product of major errors in classical economics, particularly, as I will show, in the writings of Adam Smith. The relationship between classical economics and the exploitation theory represents a tangle of irony and tragedy.

One irony is that while various errors and confusions in classical economics really did contribute to the exploitation theory, the most fundamental and important of these errors and confusions have gone unnoticed and unidentified. These are the errors and confusions pertaining to the conceptual framework of the exploitation theory, which assumes that all income due to the performance of labor is wages and that profits are a deduction from what is naturally wages. They have gone unnoticed and unidentified because the validity of this framework is taken for granted—as being literally unexceptionable and therefore unobjectionable. It is assumed to be correct by the opponents of Marx as much as by Marx; this includes Böhm-Bawerk, the leading critic of the exploitation theory, as will be obvious once I have explained the essentials of his critique of the exploitation theory.

A second and greater irony is that the basis for demolishing both the conceptual framework of the exploitation theory and later the whole of the specific substance of the exploitation theory, is provided precisely by essential elements of classical economics. That is, classical economics makes it possible to understand such propositions as why profits, not wages, are the original and primary form of income and that precisely because of the work of businessmen and capitalists, wages can rise out of all connection with minimum subsistence—literally without limit. 58 I will venture to say, not by the end of Chapter

14, but by the end of the very next section of this chapter, the reader will be able to see how classical economics can be placed so squarely in opposition to the Marxian exploitation theory as literally to serve as the latter’s nemesis rather than as its foundation. (Of course, I do not maintain that the classical economists were themselves aware of the implications I am claiming for their doctrines. The development and demonstration of these implications are major accomplishments for which I myself must claim original credit.)

The tragedy of the relationship between classical economics and the exploitation theory has not only been that errors and confusions in classical economics have supported the exploitation theory and thereby the assault on capitalism and advancement of the cause of socialism. That would have been bad enough. The further tragedy and irony has been that because this support was perceived as necessary and inescapable—as based on the essential nature of classical economics—the opponents of the exploitation theory—that is, the defenders of capitalism from the late nineteenth century on, who had the most to gain from the knowledge provided by classical economics—felt obliged to discard virtually the whole of it insofar as it could not immediately be validated on the basis of the neoclassical principle of diminishing marginal utility, or otherwise independently of classical economics’ basic framework.

Thus, along with “the labor theory of value” and the “iron law of wages,” they discarded such further features of classical economics as the wages-fund doctrine and its corollary that savings and capital are the source of almost all spending in the economic system. (The wages-fund doctrine held that at any given time there is a determinate total expenditure of funds for the payment of wages in the economic system, and that the wages of the employees of business firms are paid by businessmen and capitalists, out of capital, which is the result of saving; not by consumers in the purchase of consumers’ goods. 59 ) Two generations later, the abandonment of the wages-fund doctrine and with it, classical economics’ perspective on saving and capital, made possible the acceptance of Keynesianism and the policy of inflation, deficits, and ever expanding government spending. In similarly paradoxical fashion, and with just about the same time lag, the abandonment of the classical doctrine that cost of production, rather than supply and demand, is the direct (though not the ultimate) determinant of the prices of most manufactured or processed goods led to the promulgation of the doctrines of “pure and perfect competition,” “oligopoly,” “monopolistic competition,” and “administered prices,” with their implicit call for a policy of radical antitrust or outright nationalizations to “curb the abuses of big business.” Thus, along these two further

paths, the errors of classical economics in support of the exploitation theory have served in the assault on capitalism and to advance the cause of socialism. But this time, it was with the implicit support of those who had abandoned classical economics because of its service in the advancement of socialism, and who now, precisely because of that abandonment, were themselves making possible the advancement of socialism, however much they may have believed themselves to be incapable of acting in such a destructive way.

Indeed, so strong has been the conviction on the part of the defenders of capitalism that classical economics is permeated with support for Marxism, that even to suggest such a classical doctrine as that cost of production can be a direct determinant of price, is to invite one’s own censure for allegedly being sympathetic to Marxism—as well as for allegedly being ignorant of all that economics has taught on the subject of prices since 1870. Not surprisingly, in the great majority of cases, this hostility to classical economics on the part of the defenders of capitalism has kept them from any serious study of it.

The essential purpose of this part is to show how classical economics can easily cast off all the aspects of it which contributed to the exploitation theory, while leaving all of its essential and valuable features that were abandoned or forgotten because of its association with the exploitation theory, not only undamaged, but placed in a condition in which they can serve radically to advance the cause of sound, procapitalist economics in the present day. In effect, the purpose of this part is to rescue the classical-economics baby from the Marxist bath water with which he was thrown away, and then, to the extent I have not already done so, raise him up to be the great procapitalist fighting man that it is in his nature to become.

What precise features of classical economics need revision, or outright discarding, will become clear in the next four sections of this part, that is, Sections 2–5. The first of these, a critical analysis of Adam Smith’s support of the conceptual framework of the exploitation theory, will go a long way toward proving the claim I made in the Introduction to this book that “classical economics makes possible a far more fundamental and thoroughgoing critique of the exploitation theory than that provided by Böhm-Bawerk and the Austrian school.” Based largely on the results of correcting Smith’s errors, Section 3 will name and, to the extent necessary, describe the five major aspects of classical economics in need of revision or discarding in order to transform it into the nemesis of the exploitation theory. Two of these aspects, the labor theory of value and the iron law of wages, will then be examined separately and in detail in Sections 4 and 5 of this part.

2. Correcting the Errors of Adam Smith: A Classical-Based Critique of the Conceptual Framework of the Exploitation Theory

The ideas of Adam Smith on the subject of productive activity are among the best and the worst in the literature of economics. As previously shown, Smith’s Wealth of Nations provides a major contribution to the understanding of the concept of productive activity in its grasp of the essential connection between productive activity and moneymaking and the role of this connection in the distinction between production and consumption. 60 Thus, it is not surprising that Smith is the enemy of government spending and government borrowing and that historically his views have been a leading source of fiscal conservatism. 61

But in his discussion of other aspects of the concept of productive activity, Smith’s errors are monumental and overwhelming. For in truth, Smith can justly be called the father of the Marxian exploitation theory. Decades before the birth of Marx, he proclaimed the view of businessmen and capitalists, and of capitalism as a system, as parasitically feeding off the labor of the wage earners. Adam Smith, who, more than any other economist, is viewed by the public as the champion of capitalism, was thus in fact the father of the idea that capitalism deserves to be overthrown and replaced by socialism.

Smith’s Confusion Between Labor and Wage Earning

A hint of Smith’s errors in support of the exploitation theory is present even in one of the passages I quoted favorably in the first part of this chapter: “Thus the labour of the manufacturer adds, generally, to the value of the materials which he works upon, that of his own maintenance, and of his master’s profit.” There is a clear suggestion in these words that the labor of the manual worker creates the employer’s profit.

This notion is propounded much more forcefully in earlier portions of The Wealth of Nations. There, Smith unmistakably expounds the view that the only productive parties in the economic system are wage earners. He clearly regards businessmen, capitalists, and landowners as having no productive function, and as existing as parasites upon the labor of the wage earners.

He begins with the—essentially correct—view that human labor is the fundamental productive agent: “Labour was the first price, the original purchase money that was paid for all things. It was not by gold or by silver, but by labour that all the wealth of the world was originally purchased . . . .” 62 He then goes on to regard labor and wage earning as synonymous, and to hold that all income which is due to the performance of labor is

476 CAPITALISM wages, and that all who work are wage earners.

He considers and quickly rejects the possibility that profits might be an income attributable to the performance of labor by businessmen and capitalists:

The profits of stock, it may perhaps be thought, are only a different name for the wages of a particular sort of labour, the labour of inspection and direction. They are, however, altogether different, are regulated by quite sufficient principles, and bear no proportion to the quantity, the hardship, or the ingenuity of this supposed labour of inspection and direction. They are regulated altogether by the value of the stock employed, and are greater or smaller in proportion to the extent of this stock. Let us suppose, for example, that in some particular place, where the common annual profits of manufacturing stock are ten per cent. there are two different manufactures, in each of which twenty workmen are employed at the rate of fifteen pounds a year each, or at the expence of three hundred a year in each manufactory.

Let us suppose too, that the coarse materials annually wrought up in the one cost only seven hundred pounds, while the finer materials in the other cost seven thousand.

The capital annually employed in the one will in this case amount only to one thousand pounds; whereas that employed in the other will amount to seven thousand three hundred pounds. At the rate of ten per cent. therefore, the undertaker of the one will expect an yearly profit of about one hundred pounds only; while that of the other will expect about seven hundred and thirty pounds. But though their profits are so very different, their labour of inspection and direction may be either altogether or very nearly the same. 63

Thus, Smith believed, as have so many economists who have come after him, that because profits vary with the amount of capital employed, they cannot be caused by the labor of the businessmen or capitalists—that, instead, they are caused in one way or another by capital itself. I shall deal with this idea shortly. But even here it must be stated that it is blatantly false to maintain, as did Smith, that profits “bear no proportion to the quantity, the hardship, or the ingenuity of this supposed labour of inspection and direction.”

The rate of profit is not the same for all enterprises. The amount of profit a firm earns is by no means proportional merely to the quantity of capital it employs. The ingenuity of the “supposed labour of inspection and direction” is decisive. Some firms have losses, because insufficient ingenuity is supplied. Others earn an extraordinarily high rate of profit, because more than the ordinary degree of ingenuity is supplied. It is equally true, contrary to Smith, that profits vary with the quantity and hardship of the “labour of inspection and direction.” Those firms whose owners “burn the midnight oil,” as the saying goes, generally do better than those whose owners take a more relaxed attitude. But even if all firms did earn the same rate of profit on their capital, their profits, as we shall see, would still be the result of what Smith calls the

“supposed labour of inspection and direction.”

It is even true that profits vary with the quantity and hardship of the businessmen’s and capitalists’ ordinary physical labor. This latter variation is imperceptible in the case of large firms, but it is very evident in the case of small concerns. The neighborhood hardware store, for example, typically earns a much higher rate of profit than a large corporation, precisely because the quantity and hardship of the owner’s physical labor bulks so large in its operations. In all such cases, accountants report the full income of the businessmen and capitalists as profit, and then economists, applying the doctrines of opportunity cost and imputed income, arbitrarily deny that that portion of the profit which obviously does correspond to the owner’s labor is profit. They call it wages insofar as wages are what the businessman would receive if he performed similar labor for someone else, or would have to pay to someone else to have similar labor performed for him. Only by first subtracting from profit what in fact is a part of profit, is the obvious variation of profit with the physical labor of businessmen and capitalists eliminated.

The Conceptual Framework of the Exploitation Theory

Having dismissed the possibility that profits could be a labor income, and regarding whatever income might be due to labor as necessarily being wages, Smith arrives at what I consider to be the essential conceptual framework of the exploitation theory. This framework is the belief that wages are the original and primary form of income, from which profits and all other nonwage incomes emerge as a deduction with the coming of capitalism and businessmen and capitalists. The framework and its supporting beliefs easily lead to the assertion of the wage earner’s right to the whole produce or to its full value. Thus, Adam Smith opens his chapter on wages, with the following words:

The produce of labour constitutes the natural recompence or wages of labour.

In that original state of things, which precedes both the appropriation of land and the accumulation of stock, the whole produce of labour belongs to the labourer. He has neither landlord nor master to share with him.

Had this state continued, the wages of labour would have augmented with all those improvements in its productive powers, to which the division of labour gives occasion.

And he continues, a little further on:

But this original state of things, in which the labourer enjoyed the whole produce of his own labour, could not last beyond the first introduction of the appropriation of land and the accumulation of stock. It was at an end, therefore, long before the most considerable improvements were made in the productive powers of labour, and it would be to no purpose to trace further what might have been its effects upon the recompence or wages of labour.

THE DIVISION OF LABOR AND PRODUCTIVE ACTIVITY 477

As soon as land becomes private property, the landlord demands a share of almost all the produce which the labourer can either raise or collect from it. His rent makes the first deduction from the produce of the labour which is employed upon the land.

It seldom happens that the person who tills the ground has the wherewithal to maintain himself till he reaps the harvest. His maintenance is generally advanced to him from the stock of a master, the farmer who employs him,

and who would have no interest to employ him, unless he was to share in the produce of his labour, or unless his stock was to be replaced to him with a profit. This profit makes a second deduction from the produce of the labour which is employed upon land.

The produce of almost all other labour is liable to the like deduction of profit. In all arts and manufactures the greater part of the workmen stand in need of a master to advance them the materials of their work, and their wages and maintenance till it be compleated. He shares in the produce of their labour, or in the value which it adds to the materials on which it is bestowed; and in this share consists his profit. 64

In these passages, Smith actually advances two views that upon examination are astonishing, and which I shall immediately consider in the next two subsections.

Smith’s Failure to See the Productive Role of Businessmen and Capitalists and of the Private

Ownership of Land

First, he advances the view that the division of labor, and the consequent rise in the productivity of labor, has no connection with the activities of businessmen and capitalists, nor with the institution of private property in land, and might have developed just as well in their absence. This is the meaning of the passage just quoted, “Had this state continued, [i.e., the absence of the appropriation of land and the accumulation of ‘stock’—viz., capital], the wages of labour would have augmented with all those improvements in its productive powers, to which the division of labour gives occasion.”

In this and the next passage previously quoted, Smith expresses the belief that the only effect of the activities of businessmen and capitalists and of the existence of private ownership of land is that it denies to the wage earners the ability to keep the whole produce of their labor or its full value. He appears totally unaware of all the ways in which the division of labor vitally depends on the activities of businessmen and capitalists and thus could not have developed without them—namely, on their function of creating, coordinating, and improving the efficiency of the division of labor. 65 He appears equally unaware of the vital contribution to the division of labor made by the institution of private ownership of land, which was demonstrated in earlier portions of this book. 66 Indeed, he is particularly harsh in his views of landowners. He writes:

As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they have never sowed, and demand a rent even for its natural produce. The wood of the forest, the grass of the field, and all the natural fruits of the earth, which, when land was in common, cost the labourer only the trouble of gathering them, come, even to him, to have an additional price fixed upon them. He must then pay for the license to gather them; and must give up to the landlord a portion of what his labour either collects or produces. This portion, or what comes to the same thing, the price of this portion, constitutes the rent of land, and in the price of the greater part of commodities makes a third component part. 67

In this passage, Smith completely overlooks the incalculable contribution to the productivity of labor in agriculture and mining made by the incentives to efficiency and capital accumulation that private ownership and the security of private property provide. He overlooks the fact that the development of the division of labor itself— insofar as it depends on labor being made available for industry and commerce—depends on the rise in the productivity of labor in agriculture and mining brought about on this foundation. In the absence of private ownership of land and the rise in the productivity of labor it brings about in agriculture and mining, the manpower would simply be unavailable for the development of any significant division of labor in industry and commerce, because almost all workers would be required for the production of food.

Smith’s error here rests perhaps on a confusion of the privileged position of the British landed aristocracy of his day, which enjoyed a virtual sinecure through such means as entail legislation and protective tariffs, with that of genuine private landowners who possess full rights of ownership and are subject to the full freedom of competition. Otherwise, it is extremely difficult to understand how he could see as the essential consequence of private ownership the charging of prices for what had previously been free, rather than the enormous improvement in the land and its productive powers. This is as naïve an error as it is possible to make with respect to private ownership of land. 68

The Primacy-of-Wages Doctrine

The second, possibly even more astonishing notion that Smith advances in the passages quoted above is what I call the primacy-of-wages doctrine. This is the doctrine that in a precapitalist economy—the “early and rude state of society”—in which workers simply produce and sell commodities, and do not buy in order to sell, the incomes the workers receive are wages. Wages are the original income, according to Smith. All income in the precapitalist society is supposed to be wages, and no income is supposed to be profit, according to Smith, because work—

ers are the only recipients of income. At the same time, of course, Smith advances the corollary doctrine that profit emerges only with the coming of capitalism and businessmen and capitalists, and is a deduction from what is naturally and rightfully wages.

The primacy-of-wages doctrine and the notion that profits and the other nonwage incomes are a deduction from what is naturally and rightfully wages constitute the conceptual framework of the exploitation theory. They are the starting point for Marx’s detailed development of the exploitation theory.

In a precapitalist economy, production, says Marx, is characterized by the sequence C-M-C. In this state of affairs, a worker produces a commodity C, sells it for money M, and then buys other commodities C. In this state of affairs, there is no exploitation, for there are no profits, no “surplus-value”; all income is, supposedly, wages. Surplus-value—profit—emerges only with the development of capitalism, according to Marx. Here the sequence M-C-M′ applies. Under this sequence, the capitalist expends a sum of money M in buying materials and machinery and in paying wages. A commodity C is produced, which is then sold for a larger sum of money, M′, than was expended in making it. The difference between the money the capitalist expends and the money he receives for the product is his profit or surplus-value. 69

Profits, then, according to both Smith and Marx, come into existence only with capitalism, and are a deduction from what naturally and rightfully belongs to the wage earners.

This is not yet the exploitation theory itself, only the conceptual framework of the exploitation theory. The exploitation theory proper, of course, builds on two further doctrines, also largely supplied by Adam Smith— with a major assist from David Ricardo—and then grossly distorted by Marx: namely, the labor theory of value and the “iron law of wages.”

A full critique of the exploitation theory, to be sure, needs to deal both with the labor theory of value and with the iron law of wages, and ours shall do so in due course. First, however, what it is essential to show is the enormity of the errors involved in the conceptual framework of the exploitation theory—in the doctrines of the primacy of wages and of the deduction of profits from wages.

A Rebuttal to Smith and Marx Based on Classical Economics: Profits, Not Wages, as the Original and

Primary Form of Income

As indicated, classical economics itself provides the basis for demonstrating the enormous errors in the conceptual framework of the exploitation theory. Classical economics implies that it is false to claim that wages are the original form of income and that profits are a deduction from wages. This becomes apparent as soon as we define our terms along classical lines:

“Profit” is the excess of receipts from the sale of products over the money costs of producing them—over, it must be repeated, the money costs of producing them.

A “capitalist” is one who buys in order subsequently to sell for a profit. (A capitalist is one who makes productive expenditures.)

“Wages” are money paid in exchange for the performance of labor—not for the products of labor, but for the performance of labor itself.

On the basis of these definitions, it follows that if there are merely workers producing and selling their products, the money which they receive in the sale of their products is not wages. “Demand for commodities,” to quote John Stuart Mill, “is not demand for labour.” 70 In buying commodities, one does not pay wages, and in selling commodities, one does not receive wages. What one pays and receives in the purchase and sale of commodities is not wages but product sales revenues.

Thus, in the precapitalist economy imagined by Smith and Marx, all income recipients in the process of production are workers. But the incomes of those workers are not wages. They are, in fact, profits. Indeed, all income earned in producing products for sale in the precapitalist economy is profit or “surplus-value”; no income earned in producing products for sale in such an economy is wages. For not only do the workers of a precapitalist economy earn product sales revenues rather than wages, but also those workers have zero money costs of production to deduct from those sales revenues.

They have zero money costs precisely because they have not acted as capitalists. They have not bought anything in order to make possible their sales revenues, and thus they have no prior outlays of money to deduct as costs from their sales revenues. Having made no productive expenditures, they have no money costs.

The profit-difference between sales revenues and zero money costs of production is the full magnitude of the sales revenues. If, for example, one sells a product for $1,000 and has costs of $500, resulting from previous outlays of $500 made in order to bring in the sales revenues, then one’s profit is $500. If one sells a product for $1,000 and has costs of only $100, resulting from previous outlays of only $100 made in order to bring in the sales revenues, then one’s profit is $900. If, going further, one has sales of $1,000 and costs merely of $10, resulting from previous outlays merely of $10 to bring in the sales, then one’s profit is $990. If, going still further, one has sales of $1,000 and costs of just $1, resulting from previous outlays of just $1 to bring in the sales, then one’s profit is $999. If, finally, one’s sales are $1,000, and one’s costs are zero, resulting from zero previous outlays to bring in the sales, then one’s profit is $1,000—

the full magnitude of the sales revenues.

Precisely, this last is the situation of the workers in Smith’s “early and rude state of society” and under Marx’s “simple circulation.” Those workers, selling their commodities, not their labor, earn sales revenues, not wages. And precisely because they are not capitalists, and are not employed by capitalists, there is no buying for the sake of selling, and thus there are no money costs to deduct from those sales revenues.

To state matters in Marxist terminology, the M of Marx’s simple circulation is, in effect, an M′ that has not been preceded by any M to bring it in. This is because in the absence of capitalists, there is no productive expenditure and thus no such prior M. Only with capitalistic circulation does an M appear to be deducted from M′. Hence the full magnitude of the M of Marx’s precapitalist, simple circulation is profit.

Thus, in the precapitalist economy, only workers receive incomes, and there are no capitalists and no money capital. But all the incomes that the workers receive are profits and none are wages. In the precapitalist sequence C-M-C, everything is “surplus-value”—100 percent of the sales revenues and an infinite percentage of the zero money capital. In the sequence of capitalistic circulation M-C-M′, a smaller proportion of the incomes are “surplus-value.”

This same conclusion, that in the precapitalist economy all income is profit, and no income is wages, can be arrived at by way of Ricardo’s badly misunderstood proposition that “profits rise as wages fall and fall as wages rise.” 71 The wages paid in production, according to Ricardo, are paid by capitalists, out of savings and capital, not by consumers. If, as in the precapitalist economy, there are no capitalists, then there are no wages paid in production, and if there are no wages paid in production, the full income earned in Ricardo’s framework must be profits.

Smith and Marx are wrong. Wages are not the primary form of income in production. Profits are. In order for wages to exist in the production of commodities for sale, it is first necessary that there be capitalists. The emergence of capitalists does not bring into existence the phenomenon of profit. Profit exists prior to their emergence. The emergence of capitalists brings into existence the phenomena of productive expenditure, wages, and money costs of production.

Accordingly, the profits that exist in a capitalist society are not a deduction from what was originally wages. On the contrary, the wages and the other money costs are a deduction from sales revenues—from what was originally all profit. The effect of capitalism is to create wages and to reduce the relative amount of profits. The more economically capitalistic the economy—the more the buying in order to sell relative to the sales revenues—the higher are wages relative to sales revenues, and the lower are profits relative to sales revenues.

Thus, capitalists do not impoverish wage earners, but make it possible for people to be wage earners. For they are responsible not for the phenomenon of profits, but for the phenomenon of wages. They are responsible for the very existence of wages in the production of products for sale.

Without other people existing as capitalists, the only way in which one could survive in connection with the production and sale of products would be by means of producing and selling one’s own products, namely, as a profit earner. But to produce and sell one’s own products, one would have to own one’s own land, and produce or have inherited one’s own tools and materials or the money to buy them. Relatively few people could survive in this way. The existence of capitalists makes it possible for people to live by selling their labor rather than attempting to sell the products of their labor. Thus, between wage earners and capitalists there is in fact the closest possible harmony of interests, for capitalists create wages and the ability of people to survive and prosper as wage earners.

And if wage earners want a larger proportion of income in the form of wages and a smaller proportion of income in the form of profits, they should want a higher economic degree of capitalism—that is, in the terminology of Marx, more M relative to M′. For precisely this represents productive expenditure, wages, and costs being higher, and profits being lower, relative to sales revenues. To achieve such change, what the wage earners require is more and bigger capitalists.

Historical confirmation for the theory I am propounding can be found in F. A. Hayek’s Introduction to Capitalism and the Historians. There we find such statements as: “The actual history of the connection between capitalism and the rise of the proletariat is almost the exact opposite of that which these theories of the expropriation of the masses suggest. . . . The proletariat which capitalism can be said to have ‘created’ was thus not a proportion of the population which would have existed without it and which it degraded to a lower level; it was an additional population which was enabled to grow up by the new opportunities for employment which capitalism provided.” 72

The correct theory, as well as the actual history, is the exact opposite of the doctrine of the primacy of wages.

Curiously, even Adam Smith himself comes close to grasping the true state of affairs, when he writes:

His [the wage earner’s] employers constitute the third order, that of those who live by profit. It is the stock that is employed for the sake of profit, which puts into motion the

greater part of the useful labour of every society. The plans and projects of the employers of stock regulate and direct all the most important operations of labour, and profit is the end proposed by all those plans and projects. But the rate of profit does not, like rent and wages, rise with the prosperity, and fall with the declension, of the society. On the contrary, it is naturally low in rich, and high in poor countries, and it is always highest in the countries going fastest to ruin. 73

Here the employers, previously depicted as parasitical and virtually functionless, suddenly emerge with plans and projects regulating and directing all the most important operations of labor, for the sake of profit. And not only that, but the rate of profit is held to be lower to the degree that capitalists exist and have accumulated capital. And earlier, Smith has said that “the demand for those who live by wages, it is evident, cannot increase but in proportion to the increase of the funds which are destined for the payment of wages.” 74 And now we are told that the employers’ capital is the main source of such funds.

But instead of drawing the correct conclusion that the existence of capitalists creates and raises wages and reduces the proportion of total income—viz., national income—which is profit, Smith simply draws a further mistaken anticapitalistic conclusion, namely, that because the rate of profit is lower in a more highly capitalistic economic system, “The interest of this third order, therefore, has not the same connexion with the general interest of the society as that of the other two [viz., the wage earners and landowners].” 75

Now in fact, in the context in which the rate of profit would be lower in a more highly capitalistic economic system, it would only be the nominal rate of profit that would be lower, not the real rate of gain of wealth, which would actually be higher. The interests of the businessmen and capitalists are certainly not opposed to this. And it must be pointed out, incidentally, and will be demonstrated later in this book, that capital accumulation does not cause or presuppose a continually falling rate of profit, but is consistent with an unchanged rate of profit that is sufficiently low. The effect of a still lower rate of profit will be shown to be an acceleration in the rate of capital accumulation and economic progress. 76 Furthermore, it will be shown that there are limits to the fall in the rate of profit, set in part by the more rapid accumulation of capital and wealth themselves that a higher economic degree of capitalism achieves. This is because in achieving a higher rate of capital accumulation and thus more rapid increases in production, a higher economic degree of capitalism tends to be accompanied to an important degree by a more rapid increase in the supply of commodity money, which is an almost inevitable accompaniment of more rapid increases in production in general. This in turn adds something to the rate of profit. 77

However, the central stumbling block for Smith was his utter confusion of a product sales revenue with the payment of wages. His confusion on this point was so great that he could write: “In some parts of Scotland a few poor people make a trade of gathering, along the sea-shore, those little variegated stones commonly known by the name of Scotch Pebbles. The price which is paid to them by the stone cutter is altogether the wages of their labour; neither rent nor profit make any part of it.” 78 Had Smith grasped the obvious fact that the price of the stones is a sales revenue, not a wage payment, he would have understood the fact that workers who sell products, earn sales revenues and profits, not wages; and that if they have expended no funds for the purpose of producing those products, the sales revenues they earn are entirely profit. These realizations might have enabled him to grasp the incalculably important positive productive contribution that businessmen and capitalists make to the economic wellbeing of wage earners. Had Adam Smith understood these facts, the subsequent history of the world would have been very different.

Further Rebuttal: Profits Attributable to the Labor of Businessmen and Capitalists Despite Their Variation With the Size of the Capital Invested

In a precapitalist economy, the income of labor is profit, and profit is thus obviously a labor income. In a capitalist economy, too, profit is an income earned by labor—by the labor of businessmen and capitalists.

An earlier portion of this chapter has described the labor of businessmen and capitalists as consisting in the creation, coordination, and improvement in the efficiency of the division of labor. 79 We have seen that the very fact that the labor of businessmen and capitalists is centered on the division of labor is the reason for its almost total omission from the purview of economists and of people generally, inasmuch as they fail to hold in mind the context of the division of labor and its requirements.

We have also seen how the confusion of labor with wage earning, together with the influence of the opportunity-cost and imputed-income doctrines, has led economists arbitrarily to reclassify profits as wages—precisely in cases in which business and accounting practice clearly recognize income resulting from the performance of labor as profit. (The case of a hardware store owner’s profit being reclassified as wages should be recalled. 80 ) Repeating the error of Adam Smith, the practice of economists has been simply to deny application of the term profit to income earned by virtue of the performance of labor and to reserve the word for describing income received on other grounds, principally the mere ownership of capital. Consistent with this practice, most of what the classical economists called profit, and the gen—

eral public and businessmen and accountants still call profit, has come to be called interest by the last several generations of economists.

What underlies the notion that profits are an income based on the ownership of capital rather than on any performance of labor by businessmen and capitalists is the fact, pointed out by Adam Smith, that profits tend to vary with the size of the capital invested, even though the labor of the businessmen and capitalists is “altogether or very nearly the same.” Smith was absolutely correct in showing the variation of profits with the size of the capital invested. Where he was incorrect was in his inference that this fact precluded profits from being attributable to the labor of businessmen and capitalists. The truth is that profits are both an income fully attributable to the labor of businessmen and capitalists and tend to vary with the size of the capital invested.

The variation of profits with the size of the capital invested is perfectly consistent with their being attributable to the labor of businessmen and capitalists because such labor tends to be predominantly of an intellectual nature—a work of thinking, planning, and decision making. At the same time, capital stands as the means by which businessmen and capitalists implement their plans—it is their means of buying the labor of helpers and of equipping those helpers and providing them with the materials of work. Thus, the possession of capital serves to multiply the efficacy of the businessmen’s and capitalists’ labor, for the more of it they possess, the greater is the scale on which they can implement their ideas. For example, a businessman who thinks of a better way to produce something can apply that better way on ten times the scale if he owns ten factories or ten stores than if he owns only one. The fact that in the one case the same labor on his part leads to ten times the profit as in the other case is perfectly consistent with the whole profit still being attributable to his labor.

The wellknown compound variation of profits with the passage of time is also perfectly consistent with the fact that they are the product of the businessmen’s and capitalists’ labor. The relationship of profits to the passage of time derives from the fact that profits vary with the size of the capital invested in any given period of time. If one can earn profits in proportion to one’s capital in any given period of time, then if investment for a longer period is to be competitive, one must earn the profits that one could have earned in the shorter period plus the profits one could have earned by the reinvestment of one’s capital and its profits.

Closely related to the preceding point is the fact that the attribution of profits to the labor of businessmen and capitalists is also perfectly consistent with their simultaneously reflecting such a thing as the general state of time preference in the economic system (i.e., the preference, other things being equal, for the enjoyment of goods in the nearer future rather than in the more remote future). 81 As Chapter 16 will show, time preference is a factor operating to determine the general or average rate of return on capital. 82 But the individual businessmen and capitalists then earn or do not earn this general or average rate of return, or a higher or lower rate of return, on the basis of their own individual productive accomplishments.

It should be realized that wages, too, which no one disputes are attributable to the labor of the wage earners, vary with things other than the expenditure of labor by the wage earners—for example, with the state of technology and the supply of capital equipment, and with the demand for and supply of labor. In order for an income to be attributable to labor, it is by no means necessary that the performance of labor be the only factor determining its size. The wages of the average worker in the United States, for example, are higher than those of the average worker in practically every other country because of a higher productivity of labor in the United States. This higher productivity rests on the greater extent of capital accumulation in the United States, which, in turn, is traceable to the greater degree of economic freedom and cultural rationality that has traditionally prevailed in the United States in comparison with other countries. Nevertheless, each individual American worker is still responsible for his own earnings. This is merely a restatement of the principle that income is attributable to labor even though it varies with other factors as well.

Nevertheless, precisely this principle is what Adam Smith contradicts in ruling out profits as an income due to the performance of labor. The principle he adopts is that one cannot attribute a greater effect to an agent if the means which the agent employs are greater and more potent.

His argument actually comes to this: One man pulls the trigger of a pistol, another the firing pin of a cannon; one man digs with an ordinary shovel, another with a steam shovel; one man gives orders to a squad of soldiers, another to an army; one man directs a small concern, another a large concern. In each case, the amount of labor performed by the individual in question may be presumed to be equal. According to the principle of Adam Smith, because the amount of labor is equal in each case, the product or result attributable to the labor is equal in each case.

This, of course, is false, and is a contradiction of Smith’s own doctrine that labor is the sole cause of wealth. This last, sound doctrine rests on the principle that the effect is always to be attributed to the guiding and directing intelligence that is present, irrespective of the magnitude and potency of the means employed. (And

irrespective of the presence of all other external circumstances necessary to the outcome, including the existence of such physical phenomena as gravitation and air pressure as well as the existence of the kind of economic and cultural phenomena I described a few paragraphs ago.) If this were not the standard, then it would be impossible to attribute to human beings anything beyond what they could directly and immediately accomplish with their bare hands. One could not only not say that a worker using a steam shovel digs a hole, one could also not say that a worker using an ordinary shovel digs a hole. Indeed, if one applies Smith’s principle that variation of the outcome with the magnitude and potency of the means employed precludes its attribution to labor, then his whole argument against profits being due to labor can be parodied as follows:

The holes that are dug, it may perhaps be thought, are only a different name for the products of a particular sort of labour, the labour of digging. They are, however, altogether different, are regulated by quite sufficient principles, and bear no proportion to the quantity, the hardship, or the ingenuity of this supposed labour of digging. They are regulated altogether by the means employed for digging, and are greater or smaller in proportion to the extent of those means. Let us suppose, for example, that in some particular place, there are two different men, one of whom sets about digging with his bare hands; the other of whom employs a shovel. The one man will expect a hole of only very small dimensions, while the other will expect a hole of much larger dimensions. But though the holes that are dug are so very different, their labour of digging may be either altogether or very nearly the same.

The variation of profits with the size of the capital in no way contradicts the fact that profits are a labor income. Equal labor does not produce equal products. It produces unequal products when unequal means are employed. It is always labor which produces, however, because it is labor which supplies the guiding and directing intelligence in production.

It must be stressed: guiding and directing intelligence, not muscular exertion, is the essential characteristic of human labor, and the basis for attributing all production to labor. As von Mises says, “What produces the product are not toil and trouble in themselves, but the fact that the toiling is guided by reason.” 83

On this basis, all labor is the “labour of direction.” It is because the man directs the tool, that he, and not the tool, produces the product. The tool, whether an ordinary shovel, a steam shovel, dynamite, or an atomic explosive, does not produce, but is the means by which the man who employs it produces—in precisely the same sense that it is not a gun which can commit murder or an automobile which can commit manslaughter, but the man who pulls the trigger of the gun or the man who drives the automobile.

A Radical Reinterpretation of “Labor’s Right to the Whole Produce”

Guiding and directing intelligence in production is supplied by businessmen and capitalists on a higher level than by wage earners—a circumstance which further reinforces the primary productive status of profits and profit earners over wages and wage earners.

The socialists, indeed, have so little conception of the essential role of guiding and directing intelligence in production, that while they claim the product for the manual workers in one breath, they complain in the very next breath of the manual worker’s “alienation” from the product. The manual worker does not know, see, or touch the final product, they complain. Capitalism, they say, confines the worker to a narrow task. It limits his horizon to the job immediately at hand—to a tiny step in his firm’s overall productive operations. 84

Now although the division of labor and capitalism are not in fact responsible for “alienation,” it is true that the manual worker is necessarily concerned with only a small step in his firm’s overall productive operations. For this very reason, it is absolutely impossible that he could be responsible for its products—that the products could legitimately be said to be his products. The socialists evidently believe that a product emerges out of chaos— as a result of the fortuitous interaction of the operations of people engaged in unintegrated, totally isolated steps in its production. They simply do not see the role of businessmen and capitalists in coordinating and improving the efficiency of the division of labor—or in creating the division of labor in the first place.

The fact that profits are an income attributable to the labor of businessmen and capitalists, and the further fact that their labor represents the provision of guiding and directing intelligence at the highest level in the productive process, requires a radical reinterpretation of the doctrine of labor’s right to the whole produce. Namely, that that right is satisfied when first the full product and then the full value of that product comes into the possession of businessmen and capitalists, for they, not the wage earners, are the fundamental producers of products. The employees of the firm are accurately described by the common expression “help.” They are the helpers of the businessmen and capitalists in the production of their—the businessmen’s and capitalists’—products. It should be obvious that thus understood, the realization of labor’s right to the whole produce is exactly what occurs in the everyday operations of a capitalist economy, inasmuch as it is businessmen and capitalists who are the owners first of the products and then of the sales proceeds received in exchange for the products.

By the standard of attributing results to those who conceive and execute their achievement at the highest

level, one must attribute to businessmen and capitalists the entire gross product of their firms and the entire sales receipts for which that product is exchanged. Such, indeed, is the normal standard in fields other than economic activity. For example, one attributes the discovery of America to Columbus, the victory at Austerlitz to Napoleon, the foreign policy of the United States to its President. These attributions are made despite the fact that Columbus could not have made his discovery without the aid of his crew, nor Napoleon have won his victory without the help of his soldiers, nor the foreign policy of the United States be carried out without the aid of the employees of the State Department. The help these people provide is perceived as the means by which those who supply the guiding and directing intelligence at the highest level accomplish their objectives. The intelligence, purpose, direction, and integration flow down from the top, and the imputation of the result flows up from the bottom.

By this standard, the products of the old Ford Motor Company and Standard Oil Company are to be attributed to Ford and Rockefeller. (In many cases, of course, the product must be attributed to a group of businessmen and capitalists, not just to a single outstanding figure.) In any event, labor’s right to the full value of its produce is fully satisfied precisely when a Ford or Rockefeller, or their lesser known counterparts, are paid by their customers for their products. The product is theirs, not the employees’. The help the employees provide is fully remunerated when the producers pay them wages.

Implications for the Incomes of “Passive” Capitalists

The fact that profits, not wages, are the original and primary form of income, and that labor’s right to the whole produce is satisfied when businessmen and capitalists receive the sales proceeds, leads to a very different view than Adam Smith’s of the payment of incomes to capitalists whose role in production might be judged to be passive, such as, perhaps, most minor stockholders and many recipients of interest, land rent, and resource royalties. Adam Smith has committed the double confusion of putting the wage earner in the place of the seller of products, and thus of businessmen and capitalists, and of lumping the active businessmen and capitalists in with the passive capitalists. He believes, in effect, that the workers on Henry Ford’s assembly line pay him his profit and pay the dividends and interest to the other suppliers of the firm’s capital. The fact is, of course, that it is businessmen and capitalists such as Ford who pay both the men on the assembly line and any passive recipients of dividends and interest, etc.

If the payment of such incomes did represent an exploitation of labor, therefore, it would not be an exploitation of the labor of wage earners. The wage earners are totally out of the picture. The incomes of the passive capitalists are paid by businessmen—by the active capitalists—not by the wage earners. They are not a deduction from wages, but from the profits of the active capitalists. If any exploitation were present here, it would be the active capitalists, not the wage earners, who were the exploited parties. What this would mean in practice is that individuals like Ford and Rockefeller would be exploited by widows and orphans, for it is such people who largely make up the category of passive capitalists.

In fact, however, the payment of such incomes is never an exploitation, because their payment is a source of gain to those who pay them. They are paid in order to acquire assets whose use is a source of profits over and above the payments which must be made. Furthermore, the recipients of such incomes need not be at all passive; they may very well earn their incomes by the performance of a considerable amount of intellectual labor. Anyone who has attempted to manage a portfolio of stocks and bonds or investments in real estate should know that there is no limit to the amount of time and effort that such management can absorb, in the form of searching out and evaluating investment possibilities, and that the job will be better done the more such time and effort one can give it.

In the absence of government intervention in the form of the existence of national debts, loan guarantees, and insurance on bank deposits, the magnitude of truly passive income in the economic system would be quite modest. This is because most forms of investment require the exercise of some significant degree of skill and judgment. Those not able or willing to exercise such skill and judgment would either rapidly lose their funds or would have to be content with very low rates of return in compensation for safety of principal and, in many cases, would have to bear the expense of the deduction of management fees by trustees or other parties.

It should also be realized that in a laissez faire economy, without personal or corporate income taxes (a real exploitation of labor) and without legal restrictions on such business activities as insider trading and the award of stock options, the businessmen and active capitalists are in a position to own an ever increasing share of the capitals they employ. With their high incomes they can progressively buy out the ownership shares of the passive capitalists.

In this way, under capitalism, those workers—the businessmen and active capitalists—who do have a valid claim to the ownership of the industries in fact come to own them. Again and again, penniless newcomers appear on the scene and by virtue of their success secure a growing influence over the conduct of production and

ultimately obtain the ownership of vast personal fortunes. An ironic consequence of Adam Smith’s errors in this area, to be counted among all the other absurdities of socialism, is that the socialists want to give the ownership of the industries to the wrong workers! And to do so, they want to destroy the economic system which gives it to the right workers. They want to give it to the manual laborers, while capitalism gives it to those who supply the guiding and directing intelligence in production.

Not surprisingly, the socialists and their fellow travelers, the contemporary “liberals,” denounce capitalism’s giving ownership to the right workers. They denounce it when they denounce large salaries and stock options for key executives. 85

Acceptance of the Conceptual Framework of the

Exploitation Theory by Its Critics

The enormous flaws in the conceptual framework of the exploitation theory have completely escaped the attention of the theory’s critics. Instead, the critics have devoted their attention entirely to the doctrines of the labor theory of value and the iron law of wages. This has been the case because, as I have already pointed out, the critics share that very same conceptual framework. They too accept the notion that wages are the original and primary form of income and that profits (which they often call originary interest) represent a deduction from wages. Where they differ from Marx is in arguing that profits represent a just, rather than an unjust, deduction from wages.

Thus Böhm-Bawerk, the leading critic of the exploitation theory, argues that profits are a justified deduction from wages on the grounds that the capitalists pay the workers in advance of the sale of the products that the workers produce. This fact, in conjunction with the operation of time preference, Böhm-Bawerk holds, enables and entitles the capitalists to pay wages that represent a discounted present value of the wage earners’ future product. Later, when the product is completed and sold, the capitalists sell it at its full, then present value.

A leading example of Böhm-Bawerk’s views is his famous illustration of five workers cooperating in the production of an engine that requires five years to complete, from the making of tools for the mining of iron ore to the assembly of the various components that make up the engine. In this example, Böhm-Bawerk assumes that the completed engine will sell for $5,500 and that the five workers each perform labor of equal quantity and skill. The only difference between the workers is that the worker who completes his work at the end of the first year must wait four years to receive his share of the proceeds, while the worker who completes his work at the end of the fifth year will be paid immediately, with all the other workers having to undergo waiting times between these two extremes.

The fact of unequal waiting times, says Böhm-Bawerk, will lead the workers to make an unequal division of the engine’s value. The worker who completes his work at the end of the first year, and who must therefore wait four years to be paid, will receive more than the mere one-fifth of its value that his equal labor would otherwise entitle him to. Instead of $1,100, he will receive, Böhm-Bawerk imagines, $1,200. By the same token, the worker who completes his work at the end of the fifth year, and who thus need not wait at all to be paid following completion of his work, will receive only $1,000. The other three workers will receive various amounts between these two limits. 86

This, Böhm-Bawerk says, is an unequal division of the engine’s value that the workers themselves would make because of the fact that present goods are subjectively more valuable than future goods of the same kind and number. Because of this fact, an equal sum received immediately upon completion of work is more valuable than the same sum that is not to be received until one to four years later. If the workers received the same sums of money, those who performed their labor earlier and who had to undergo correspondingly more waiting time would receive a subjectively smaller value than the workers who performed their labor later and who thus had to undergo less or even no subsequent waiting time at all. On this basis, Böhm-Bawerk argues, $1,200 received four years after the completion of one’s work is no more than the equivalent of $1,000 received immediately upon completion of one’s work. 87

Having thus set the stage, Böhm-Bawerk now introduces a capitalist. The existence of the capitalist makes it possible for each of the five workers to be paid immediately upon completion of his work. Because of this, in Böhm-Bawerk’s view, the just wage of each of these workers, is $1,000—the same as that of the worker who completes his work last and who by the workers’ own presumed standards of justice would have been paid only $1,000. 88

In this way, according to Böhm-Bawerk, profits emerge as a just deduction from what would otherwise rightfully all belong to the wage earners. The capitalist pays to the worker who completes his work at the end of the first year the sum of $1,000, which is the present equivalent of the $1,200 that worker would otherwise have had to wait four years to receive. He pays $1,000 to the next worker, who completes his work at the end of the second year and who would otherwise have had to wait three years to receive $1,150. And so on. Thus, the capitalist pays to the first four workers the present, discounted value of their share in the future product, takes over from them the activity of waiting, and, ultimately, when what

THE DIVISION OF LABOR AND PRODUCTIVE ACTIVITY 485 began as a prospective future product becomes an actual present good, sells that good at its full undiscounted, present value. In sum, in buying the labor to produce a product worth $5,500 with wage outlays totaling $5,000, the capitalist has paid the present, discounted value of a future good, the rights to which he thereby acquires, and which then ripens, as it were, into a present good in his possession that sells at its full, undiscounted, present value.

For all of its ingeniousness, Böhm-Bawerk’s exposition concedes the notion that the starting point of analysis is a valid claim of wage earners to the full value of the product and that profits are a deduction from what was originally all the income of wage earners. These concessions are totally unwarranted. To be accurate, his account would have had to describe the five workers as initially producing separately, on a hand-to-mouth basis, with no possibility of mutual cooperation in the production of any such time-consuming product as an engine. Each of the workers would also have had to be described as selling a product and earning a profit income, not a wage income, and as having to own or produce his own tools and materials in order to do so. The possibility of living by the sale of one’s labor in the process of producing products for sale would have had to be described as nonexistent in the face of the absence of capitalists. The role of the businessman/capitalist would then have had to be described as creating and organizing the vertical division of labor among these workers that is necessary for the production of such a time-consuming product as an engine, and of making it possible for them to live as wage earners. The engine itself would have had to be presented as the product primarily of the businessman and capitalist, who provides the guiding and directing intelligence in its production. It would also have had to be pointed out that the proportion of profits in the value of the engine is lower than the proportion of profits in the production of the hand-to-mouth goods produced by the manual workers on their own, and that the proportion constituted by wages is correspondingly higher.

Böhm-Bawerk, of course, did none of these things. Instead, along with his attempt to demonstrate the justice of the deduction of profits from wages, he concentrated his fire on the labor theory of value. 89 And because the labor theory of value was generally perceived as the essential element both in the exploitation theory and in classical economics, the unfortunate consequence of Böhm-Bawerk’s critique was to do as much damage to the prestige of classical economics as to the prestige of Marx.

3. Necessary Revisions in Classical Economics

I have shown that while Adam Smith is the father of the Marxian exploitation theory—in providing its conceptual framework—essential propositions of classical economics can be applied to the total demolition of that framework. This is true in particular of J. S. Mill’s proposition that “demand for commodities is not demand for labour” and Ricardo’s proposition that “profits rise as wages fall and fall as wages rise.” 90 (Ricardo’s proposition, of course, must be taken on the understanding that it is capitalists, not consumers, who pay wages.)

There are five revisions that need to be made in the body of classical economics to transform it from a source of support for the exploitation theory into a source of complete and total opposition to the exploitation theory. Three of these I have already made.

The first revision, accomplished in the last section, is the consistent application of Mill’s and Ricardo’s propositions. From this comes the recognition that in the conditions of the “early and rude state of society” assumed by Adam Smith, all income is actually profit, not wages. The further recognition also follows that wages come into being with the emergence of capitalists, and are the greater relative to profits, the more economically capitalistic is the economic system. By “economically capitalistic” is meant the extent to which buying for the purpose of selling—productive expenditure—takes place relative to sales proceeds. In other words, wages are higher and profits are lower precisely to the degree that Marx’s “M” is larger relative to his “M′.”

The second necessary revision is the recognition of the positive productive functions of businessmen and capitalists and of the fact that they are the fundamental producers of products, inasmuch as they provide the guiding and directing intelligence in production at the highest level—and of the further fact that the variation of profits and interest with the size of the capital invested in no way contradicts these incomes being attributable to the labor of businessmen and capitalists. The result of this revision is the realization that labor’s right to the whole produce is satisfied everyday in a capitalist economy—when businessmen and capitalists receive the proceeds from the sale of their products. This revision too was accomplished in the present chapter, largely in the last section. 91

The third necessary revision, accomplished in Chapter 9, is consistent recognition of the role of private ownership of land in raising the productivity of labor in agriculture and mining. This leads to the conclusion that private ownership of land underlies the growth of the division of labor, by making labor available for industry and commerce. It also leads to the conclusion that private ownership of land operates to reduce the economic significance of land rent and thus to enlarge the relative share of “national income” that takes the form of wages, and, still more importantly, to help make possible a

486 CAPITALISM continuous rise in the purchasing power and thus the real income of the average wage earner. 92

All of these revisions are in accord with the fundamental spirit of classical economics, which stands in defense of private property rights and proclaims the harmony of the rational self-interests of all men. The first and third revisions and their derivatives merely represent making classical economics more self-consistent, while the second fills in a major conceptual gap in the classical system, which was largely ignorant of the productive functions of businessmen and capitalists and largely ignored the essential aspect of guiding and directing intelligence in labor.

The fourth and fifth revisions concern two further doctrines of classical economics, which, as I have shown, usually bear the weight of the accusation that it supports the exploitation theory—namely, the labor theory of value and the “iron law of wages.” For after laying down the conceptual framework he has borrowed from Adam Smith, it is these two doctrines that Marx applies to explain the extent of the alleged deduction of profits from wages. (Usually, Marx uses the term “surplus-value” in place of profits, as a catchall for all incomes other than wages.)

In the next section, I will show that the labor theory of value, as propounded by Ricardo—the classical economist who is most closely associated with it—can easily be restated in a way that not only lends no support to the exploitation theory, but, indeed, helps to provide still further criticisms of the exploitation theory. I will show that it is only the socalled iron law of wages that needs to be thoroughly discarded, and that precisely a proper understanding of the labor theory of value provides one of the leading bases for discarding it.

4. The Labor Theory of Value of Classical Economics

The labor theory of value of the classical economists held that the relative quantities of labor required to produce goods is usually the major determinant of their relative exchange values. The labor in question is all the labor directly or indirectly necessary to the production of a good. For example, in the case of an automobile, this would be the labor performed not only in the auto plants, but also in the production of the steel necessary to make the automobile, and in the production of the iron ore necessary to produce the steel. It would also include the relevant portion of the labor required to make the automaking machinery and to build the automobile factory, the relevant portion of the labor required to make the steelmaking equipment and to build the steel mill, and so on. (The relevant portion of the labor in these last cases would be construed as the fraction of the total labor required to produce these things that corresponds to the production of just one automobile. For example, if ten million manhours were required to construct a machine that would last for ten years and that would do nothing but contribute to the production of one million automobiles in each of those years, then the relevant portion of that labor entering into the production of one automobile as the result of the use of that machinery would be one manhour.)

According to the classical economists, the relative prices of, for example, automobiles, motorcycles, bicycles, and roller skates would then reflect the respective relative quantities of labor required to make these goods. If, for example, it required, all in all, a thousand manhours to make an automobile, a hundred manhours to make a motor cycle, ten manhours to make a bicycle, and one manhour to make a pair of roller skates, then the relative values of these goods would be in the same ratios—namely, 1,000:100:10:1. Under a system of commodity money, the labor theory of value would apply to the determination of actual, absolute prices, as well as relative exchange values. Thus, if the monetary unit were an ounce of gold, and it required all in all, say, a hundred manhours to produce an ounce of gold, then the money price of the automobile we have just considered would be 10 ounces, that of the motorcycle 1 ounce, that of the bicycle .1 ounce, and that of the roller skates .01 ounce.

Now I want to say that I myself believe that the quantity of labor required to produce a good is almost always a very important factor determining its price. The best evidence for this proposition is the fact that the use of labor-saving machinery makes goods more affordable. The greater the extent to which machinery reduces the quantity of labor required to produce goods, the less expensive do goods become. Such a result would not be possible if the quantity of labor required to produce goods did not have a significant connection with their price.

Harmonization of the Labor Theory of Value With

Supply and Demand and the Productive Role of

Businessmen and Capitalists

The recognition of the role of the quantity of labor required in the production of goods as an influence on their price does not preclude the recognition of a variety of other factors as well, nor does it imply that the quantity of labor required in production is always an influence on price. Indeed, properly understood, recognition of the role of the quantity of labor is compatible with the recognition both of supply and demand as the determinant of prices and of the role of businessmen and capitalists in raising the standard of living of the average wage earner!

To combine these three elements of understanding— that is, the quantity of labor required to produce goods,

THE DIVISION OF LABOR AND PRODUCTIVE ACTIVITY 487 supply and demand, and the productive role of businessmen and capitalists—all we need do is this: First, realize that the reduction in the quantity of labor required to produce goods makes it possible for the same total quantity of labor in the economic system to produce a larger supply of goods, and thus to increase the supply of goods relative to the supply of labor. Next, realize that this, in turn, implies a fall in prices relative to wage rates, and thus a rise in the buying power and standard of living of the average worker. Then, realize that what brings all this about is precisely the productive activities of the businessmen and capitalists! They, together with scientists and inventors, whose work they continuously seek out and inspire, bring about the steady reduction in the quantity of labor required to produce goods, thus the steady increase in the supply of goods relative to the supply of labor, and thus a steady fall in prices relative to wage rates—viz., a steady rise in real wages. Furthermore, this relationship between the reductions achieved by businessmen and capitalists in the quantity of labor required to produce goods, and the rise in real wages, can be understood in a precise, quantitative way, using the classical economists’ concepts of demand and supply as a ratio of expenditure to quantity sold. 93

For example, a halving of the quantity of labor required to produce the average good in the economic system, would permit a doubling of the production of goods with the employment of the same total quantity of labor, and thus result in a halving of prices on the assumption that the quantity of money and volume of spending to buy goods in the economic system remained the same. Since there is no increase in the supply of labor present, the existence of a constant quantity of money and a correspondingly fixed aggregate demand for labor implies that the average level of money wage rates remains the same while the prices of goods fall in half, because the same total spending for labor continues to purchase the same total supply of labor.

What we have here, in fact, is precisely the state of affairs that Adam Smith thought would have been possible only under the continuation of his “original state of things,” viz., the absence of private ownership of land and the accumulation of capital, but which in fact is possible only with the presence of these things, under capitalism. As previously quoted, Smith wrote: “Had this state continued, the wages of labour would have augmented with all those improvements in its productive powers, to which the division of labour gives occasion. All things would gradually have become cheaper. They would have been produced by a smaller quantity of labour . . . .” 94 This steady rise in real wages owing to the steady reduction in the value of the commodities that the wages purchase is exactly what happens under capitalism—as the result of businessmen and capitalists continuously finding ways to reduce the quantity of labor required to produce any given unit of goods and thus to increase the supply of goods relative to the supply of labor.

Other Classical Doctrines and the Rise in Real Wages

It should be realized that this account of the rise in real wages brought about by the businessmen and capitalists incorporates not only the role of quantity of labor required in the production of goods as a factor determining their prices, and the classical concepts of demand and supply, but no less the socalled wages-fund doctrine and Ricardo’s doctrine of the distinction between “value and riches.” It incorporates the wages-fund doctrine in its implication of a distinct and given demand for labor. 95 It incorporates the doctrine of the distinction between value and riches in its perception of the rise in real wages as proceeding not from a rise in money incomes, which represents merely an increase in an aggregate monetary value, but from a fall in prices, which is the natural consequence of a greater ability to produce—viz., of greater “riches.” 96 Along the very same lines as the distinction between value and riches, it should also be realized that our assumption that the quantity of money and volume of spending remain the same is consistent with the procedure of the classical economists, especially Ricardo, of assuming the value of money to be constant as far as changes on the side of money itself are concerned, and thus all changes in prices to reflect changes on the side of goods other than money. 97

Classical Economics’ Limitations on the

Labor Theory of Value

The classical economists, Ricardo in particular, were well aware of the limitations of the labor theory of value as an explanation of prices.

i. Exclusion of Scarce Goods

According to Ricardo, there was a substantial category of goods to which the labor theory of value did not even apply. Thus, he wrote:

There are some commodities, the value of which is determined by their scarcity alone. No labour can increase the quantity of such goods, and therefore their value cannot be lowered by an increased supply. Some rare statues and pictures, scarce books and coins, wines of a peculiar quality, which can be made only from grapes grown on a particular soil, of which there is a very limited quantity, are all of this description. Their value is wholly independent of the quantity of labour originally necessary to produce them, and varies with the varying wealth and inclinations of those who are desirous to possess them. 98

In order for the labor theory of value to be made

488 CAPITALISM consistent with Austrian economics and the case for capitalism, it is necessary explicitly to enlarge the list of exceptions whose value is determined by their “scarcity alone.” The necessary enlargement must include all the items whose prices I described back in Chapter 6 as being determined by supply and demand rather than cost of production, either on a permanent or temporary basis. 99 The most important addition to the list of exceptions, of course, is the value of human labor itself, both skilled and unskilled. This exception, it should be noted, is clearly called for by classical economics itself insofar as the latter upholds the wages-fund doctrine, according to which wage rates are determined by the ratio of the wages fund (viz., the demand for labor) to the supply of labor. Indeed, practically all of these additions to the list of items whose price is not determined either by cost of production or by quantity of labor required in their production, would have been fully acceptable to Ricardo, who, in fact, explicitly notes them. 100 As we shall see in the next section, only in the case of labor would Ricardo have registered any objection—an objection that is confined to special circumstances and then is thoroughly confused. 101 ii. Ricardo’s Recognition of the Time Factor as an

Independent Determinant of Relative Value

Where the labor theory of value applies, according to Ricardo, is in the production of “such commodities only as can be increased in quantity by the exertion of human industry, and on the production of which competition operates without restraint.” 102 And even in these cases, Ricardo points out, not only is the connection often confined to longrun, equilibrium prices rather than to the market prices that prevail at any given moment, but the longrun equilibrium prices themselves are subject to the operation of another very important factor. He introduces this factor with a section heading in his chapter “On Value,” namely, the heading of Section 4, which reads, “The principle that the quantity of labour bestowed on the production of commodities regulates their relative value considerably modified by the employment of machinery and other fixed and durable capital.” 103

The modification Ricardo has in mind is the principle that “commodities which have the same quantity of labour bestowed on their production will differ in exchangeable value if they cannot be brought to market in the same time.” 104 He illustrates the principle with the following example:

Suppose I employ twenty men at an expense of 1000 pounds for a year in the production of a commodity, and at the end of the year I employ twenty men again for another year, at a further expense of 1000 pounds in finishing or perfecting the same commodity, and that I bring it to market at the end of two years. If profits be 10 per cent., my commodity must sell for 2310 pounds; for I have employed

1000 pounds capital for one year, and 2100 pounds capital for one year more. Another man employs precisely the same quantity of labour, but he employs it all in the first year; he employs forty men at an expense of 2000 pounds, and at

the end of the first year he sells it [his commodity] with 10 per cent. profit, or for 2200 pounds. Here, then, are two commodities having precisely the same quantity of labour bestowed on them, one of which sells for 2310 pounds—the other for 2200 pounds." 105

A more extreme illustration of the same point is the case of aged wine or whiskey. To earn a 10 percent compound annual rate of profit in the production of whiskey that takes eight years to age, $1,000 of capital paid out as wages must result in a product that sells for approximately $2,000, while to earn the 10 percent annual rate of profit in the production of a commodity in which only one year elapses between the outlay of capital and the sale of the commodity, the commodity need sell for only $1,100. Here is a case in which two equal capitals employ two equal quantities of labor, and yet the one product has an equilibrium price of almost twice that of the other product—because of the influence of the different periods of time for which the rate of profit must be compounded.

Ricardo’s examples concerning the effect of the use of machinery and buildings are too complex to bear quoting. But the following, I think, clearly represents his meaning. Imagine two cases in which $1,000 of capital is expended in the payment of wages to the same quantity of labor. Once again, assume that the annual rate of profit is 10 percent. In the one case, the product is an item that will be sold one year later. In the other case, it is a machine that will be used in production over a period of ten years. The item to be sold one year after the outlay of wages will have to sell for $1,100 in order to earn the 10 percent rate of profit. But the machine will have to bring in over the course of its life a sum of at least $1,500. One hundred dollars must be recovered in each of the ten years in the form of depreciation on the machine. Beyond that, in each of the ten years the further sum of $50 must be earned as profit on the average capital outstanding in the machine, which is $500. Thus, in the one case the same quantity of labor results in the production of a product worth $1,100, while in the other it results in the production of a series of services worth $1,500. 106

In a letter to his follower and popularizer J. R. McCulloch, Ricardo named the essential point as follows:

Strictly speaking then the relative quantities of labour bestowed on commodities regulates their relative value, when nothing but labour is bestowed upon them, and that for equal time. When the times are unequal, the relative quantity of labour bestowed on them is still the main ingredient which regulates their relative value, but it is not

THE DIVISION OF LABOR AND PRODUCTIVE ACTIVITY 489 the only ingredient, for besides compensating for the labour, the price of the commodity must also compensate for the length of time that must elapse before it can be brought to market. All the exceptions to the general rule come under this one of time . . . . 107

In the same letter, he even went so far as to write: “I sometimes think that if I were to write the chapter on value again which is in my book, I should acknowledge that the relative value of commodities was regulated by two causes instead of by one, namely, by the relative quantity of labour necessary to produce the commodities in question, and by the rate of profit for the time that the capital remained dormant, and until the commodities were brought to market.” 108 iii. Ricardo’s Implicit Recognition of Changes in the

Rate of Profit as a Further Determinant

Ricardo, in fact, implicitly acknowledges changes in the rate of profit as still a further cause of variations in the relative value of commodities. This fact is not as clear as it might be, because he constantly couples a change in the rate of profit with a change in wages. He reasons in a context in which the total monetary value of consumers’ goods is fixed and is equal to a sum of total profits and total wages. In this context, every change in the amount of profits is necessarily accompanied by an equivalent opposite change in the amount of wages. At the same time changes in the amount of profits produce changes in the average rate of profit. As a result of this, when total wages rise and total profits and the average rate of profit fall, the effect is to raise the price of some commodities and lower the price of other commodities, even though there has been no change in the quantity of labor required to produce any of them. In Ricardo’s words: “Every rise of wages, therefore, or, which is the same thing, every fall of profits, would lower the relative value of those commodities which were produced with a capital of a durable nature, and would proportionally elevate those which were produced with capital more perishable. A fall of wages would have precisely the contrary effect.” 109

To understand this point, let us imagine an economic system with a fixed quantity of money and a fixed total volume of spending for consumers’ goods of 1,000 units of money per year. Let us further imagine that initially total wages are 800 units of money per year and total profits are 200 units of money per year. The wages on average are paid one year in advance of the sale of the consumers’ goods the wage earners help to produce. We can assume that total capital in the economic system is the 800 units of money expended in paying wages, and thus that the average rate of profit in the economic system is 25 percent (the 200 amount of profit divided by the 800 amount of wages, which represents the capital employed). Now wages rise to 900 and profits fall to 100. The rate of profit accordingly falls to approximately 11 percent ( 100 ⁄ 900 ).

Ricardo’s conclusion becomes apparent if we consider the effect on the prices of goods in which the outlay of wages takes place less than one year in advance of the sale of the resulting product and the effect in cases in which the outlay of wages takes place more than one year in advance of the sale of the resulting product. Thus, imagine a good which initially requires an outlay of 8 of wages and which is sold six months later at a price of 9, which will be the case when the annual rate of profit is 25 percent and thus the semiannual rate of profit is 12.5 percent. The wage outlay for this good now rises to 9. Since the annual rate of profit has fallen to 1 ⁄ 9 , the semiannual rate of profit is 1 ⁄ 18 . The price of this good therefore rises from 9 to 9.5, for it now equals a wage outlay of 9 plus a profit of 1 ⁄ 18 x 9. But at the same time, the price of a good in whose production the wages must be paid two years in advance of the sale of the good, will actually fall. Here the fall in the rate of profit will outweigh the rise in wages. For example, when the rate of profit was 25 percent, a good requiring an outlay of 8 of wages and selling two years later, would have to sell for 12.5. Now the outlay of wages is 9, but the good only sells for a little over 11, or to be precise, 9 x (10 ⁄ 9)2 .

Thus, as noted, Ricardo is aware of the fact that a change in the rate of profit results in a change in relative prices, with no change in the relative quantities of labor required to produce the various goods. The rate of profit, along with the relative periods of time that must elapse between outlays of capital and the sale of the resulting products, is a determinant of the relative value and prices of commodities, according to Ricardo.

In my judgment, Ricardo’s development of the influence of time and the rate of profit on the relative value and prices of commodities is in some respects more insightful even than Böhm-Bawerk’s. Certainly, after reading Sections 4–6 of his chapter “On Value,” there is every reason to believe that he would have been fully in accord with all of the essential points of Böhm-Bawerk’s critique of the exploitation theory, especially as presented in Karl Marx and the Close of His System. 110 For the substance of Böhm-Bawerk’s critique in that essay is merely that the fact that the value of commodities varies with the period of time for which profits compound on capital makes it impossible that they should vary exclusively in accordance with the quantity of labor expended to produce them.

iv. Differences in Wage Rates Between Countries and

Occupations as Still Further Factors

In the case of foreign trade, Ricardo departs even

490 CAPITALISM further from a view of the relative quantity of labor as the only determinant of relative value. He says, flatly: “The same rule which regulates the relative value of commodities in one country does not regulate the relative value the commodities exchanged between two or more countries.” 111

The kind of problem that emerges for a strict labor theory of value in connection with foreign trade is that, with due allowance for costs of transportation, the same commodity tends, as we have seen, to have the same price throughout the world. 112 This is so, irrespective of the quantity of labor that must be employed to produce the commodity in different countries. For example, the price of a bushel of wheat is, let us say, three dollars. This is the price both to farmers in India and to farmers in the United States, even though the relatively backward methods of production in India may mean that it takes fifty or a hundred times the labor to produce a bushel of wheat in India than it does in the United States.

This case suggests yet another element entering into the determination of relative prices—namely, relative wage rates. The cost of production of wheat in India and the United States can be equal despite the fifty-or hundred-to-one difference in the quantity of labor required to produce wheat in the two countries, if wage rates in the United States are that much higher than in India. 113 Furthermore, the inequality of wage rates for different grades of labor, such as skilled versus unskilled labor, leads products produced with the same quantity of labor in the same country to have different costs of production and thus different prices. For example, the watches produced with a thousand hours of skilled watchmakers’ labor are far more costly than the quantity of cotton or wheat produced with a thousand hours of the labor of farm hands.

Ricardo himself did not recognize the role of relative wage rates in determining relative costs and relative prices within a given country. But his disciple John Stuart Mill clearly did. The latter wrote:

. . . if wages are higher in one employment than another, or if they rise and [sic] fall permanently in one employment without doing so in others, these inequalities do really operate upon values. . . . When the wages of an employment permanently exceed the average rate, the value of the thing produced will, in the same degree, exceed the standard determined by mere quantity of labour. Things, for example, which are made by skilled labour, exchange for the produce of a much greater quantity of unskilled labour;

for no reason but because the labour is more highly paid. 114

It should be realized, of course, that differences in wage rates are not a fundamental explanation of differences in the value of products, for they themselves ultimately rest on the comparative valuations made by the consumers of the various products produced with the different kinds of labor. 115

Furthermore, it should also be realized that just as there are differences in the quantity of labor required to produce the same good among different countries, so there are also differences in the quantity of labor required to produce the same good within any given country. This is the case insofar as economic progress takes place in a country. The effect of economic progress is that the portions of the supply of a commodity produced with the more recently adopted methods of production tend to be produced with less labor per unit than the portions of the supply that are produced with older methods of production. In such conditions, the competition of the newer, more efficient methods of production tends to reduce the price of the commodity to a point where it corresponds to less than the quantity of labor required to produce it under the older methods. At the same time, because the newer methods are as yet only partially adopted, the price of the product tends to correspond to more than the quantity of labor required to produce it under the newer methods. In such cases, the price of the commodity can be described as gravitating downward, toward correspondence with the quantity of labor required to produce it under the newest, most efficient method of production, as the use of that method becomes more and more widespread. But under conditions of continuous economic progress, the price will never actually reach that point, because before any one method of production can be fully adopted, still more efficient methods of production come to be adopted.

In cases of the kind just described, the effect is inequalities in the rate of profit among different producers of the same product. Those who produce with the more recent methods of production earn above-average rates of profit, while those who produce with the older methods of production earn below-average rates of profit or suffer outright losses. However, it is also a common occurrence for products to be produced with different quantities of labor in the same country because of differences in the degree of skill among wage earners within the same occupation. For example, in many occupations there are some workers who are capable of producing twice as much as other workers even though both work with the same kind of machinery and tools. In cases of this kind, the departure of the price of the product from the quantity of labor required to produce it will be compensated for by inequalities in wage rates. Just as in the case of inequalities in the productivity of labor between countries, the workers who are twice as efficient in a given occupation in a given country will tend to be paid double the wage rates of the less efficient workers. As in the case of foreign trade, the price of the product will correspond to labor cost, but not to labor quantity.

THE DIVISION OF LABOR AND PRODUCTIVE ACTIVITY 491

The Actual Significance of Quantity of Labor in Classical Economics

Thus, in the hands of the classical economists, the labor theory of value was a theory which held that the relative quantity of labor required in the production of goods was usually, but not always, the major determinant of their relative prices. A variety of other factors was recognized as operating alongside of relative quantity of labor as determinants of relative prices. And in some circumstances the relative quantity of labor was held not to be a determinant at all. When the classical economists’ ideas on the determination of prices are all put together, it works out that in order for the quantity of labor required in production to be the sole determinant of the prices in whose formation it plays a role, a whole series of very special assumptions would have to be realized.

First, the tendency toward a uniform rate of profit on capital invested, which was discussed earlier in this book, would not only have to realize itself in the achievement of an actual uniform rate of profit in all branches of production, but also it would have to operate in conditions in which every branch of industry had the same ratio of capital invested to sales revenues, i.e., the same capital turnover ratio. 116 On these two assumptions, the uniformity-of-profit principle would imply uniform profit margins. That is, there would not only be a uniform rate of profit on capital invested, but also a uniform ratio of profit to sales revenues in every branch of production. This is because if capital invested were everywhere in the same ratio to sales revenues, then profits would have to be a uniform percentage of sales revenues in order to be a uniform percentage of capital invested. Uniform profit margins, in turn, would imply a uniform relationship between prices and costs of production everywhere. Everywhere prices would stand in the same ratio to costs of production—for example, if the uniform profit margin were 10 percent, then everywhere prices would stand in the ratio of 100 to 90 in relation to costs of production.

If the further special assumption were realized that in every branch of production the costs of production broke down in the same proportion between labor costs and costs on account of materials and machinery (and any other items purchased from other business firms), then a uniform relationship between prices and costs of production would imply a uniform relationship between prices and a series of prior wage payments. For example, if everywhere half the cost were for wages and half for materials and machinery, etc., then a price of 100 for a consumers’ good would correspond to 45 of wage payments in the direct production of the consumers’ good, plus an additional 20.25 of wage payments in the production of the 45 worth of capital goods used in the production of the consumers’ good, plus a further 9.1125 of wage payments in the production of the 20.25 worth of capital goods used to produce those capital goods, and so on. (Forty-five is half of 90 percent of the 100 value of the consumers’ good; 20.25 is half of 90 percent of 45; 9.1125 is half of 90 percent of 20.25.) The price of every good, in other words, would correspond to a uniformly diminishing series of prior wage payments. It would equal the sum of those prior wage payments each multiplied by the rate of profit, stated as a percentage of cost, compounded for the number of years by which the particular stage was removed from the sale of the ultimate consumers’ good.

If, finally, the still further assumption were realized that there is only one uniform grade of labor in terms of skill and efficiency, with one uniform wage rate, then it would follow that product prices would everywhere tend to be proportional to the quantity of labor required to produce the various goods. For then, wage costs would always be in the same proportion to the quantity of labor purchased. With a uniform wage rate, a wage payment of 10, for example, represents the purchase of twice the quantity of labor as a wage payment of 5. In these circumstances, prices would be proportional to costs, to wage costs specifically, and to the quantities of labor purchased by the wage payments that underlie the wage costs.

Any deviation from any of these assumptions upsets any strict correspondence between price and quantity of labor, even in the cases in which quantity of labor does play an actual role in price determination. And this, I believe, is the real nature of the relationship between prices and the quantity of labor developed by the classical economists.

5. The “Iron Law of Wages” of Classical Economics

The shortcoming of the classical economists’ theory of value was not their recognition of the very important role played by the quantity of labor required in production. It was, to a great extent, their failure to understand the role of marginal utility and consumer demand in determining the relative wage rates of different grades of labor and the relative prices of various other factors of production whose supply cannot be varied in immediate response to changes in demand. 117

Much more serious, by far, was their failure clearly to understand that in a free and rational society wage rates have absolutely no tendency to conform to the cost of “subsistence” or to the quantity of labor required to produce “subsistence.” This alleged connection—the socalled “iron law of wages”—was believed by the classical economists to exist mainly on the basis of a combination of the law of diminishing returns and the ideas they accepted from Malthus on population growth.

492 CAPITALISM

Diminishing Returns and the Malthusian Influence

As already explained in the discussion of the Ricardian theory of land rent, the classical economists often expressed the belief that if wages rose above the subsistence level, the effect would be an increase in population and thus the need to resort to land of inferior quality and to cultivate land already under cultivation more intensively, in order to provide food for the additional population. 118 The consequence of this would be a diminution in the size of the product attributable to the performance of additional labor, or, as most contemporary economists would describe it, a fall in the marginal productivity of labor. This, in turn, would raise the cost of necessities to the workers and ultimately make it impossible for them to purchase anything but the bare minimum of necessities. At that point, population would stop growing because of the sheer economic inability of the average pair of parents to raise more than two children to adulthood.

In this way, subsistence was seen as marking the equilibrium level of real wages. When real wages were above subsistence, population grew, and then diminishing returns reduced real wages toward the subsistence level. If real wages fell below the subsistence level, people died of starvation, population fell, the poorest lands were thrown out of cultivation, and the remaining lands were cultivated less intensively. The result was that returns to labor increased, the price of necessities fell, and real wages moved up toward the subsistence level. In the words of Ricardo:

The natural [viz., equilibrium] price of labour is that price which is necessary to enable the labourers, one with another, to subsist and to perpetuate their race, without either increase or diminution. 119

The market price of labour is the price which is really paid for it, from the natural proportion of the supply to the demand; labour is dear when it is scarce and cheap when it

is plentiful. However much the market price of labour may deviate from its natural price, it has, like commodities, a tendency to conform to it.

It is when the market price of labour exceeds its natural price, that the condition of the labourer is flourishing and happy, that he has it in his power to command a greater proportion of the necessaries and enjoyments of life, and therefore to rear a healthy and numerous family. When, however, by the encouragement which high wages give to the increase of population, the number of labourers is increased, wages again fall to their natural price, and indeed from a reaction sometimes fall below it.

When the market price of labour is below its natural price, the condition of the labourers is most wretched: then poverty deprives them of those comforts which custom renders absolute necessaries. It is only after their privations have reduced their number, or the demand for labour has increased, that the market price of labour will rise to its natural price, and that the labourer will have the moderate comforts which the natural rate of wages will afford. 120

For the most part, Ricardo’s statements in these passages are actually unobjectionable, given the conditions of a precapitalist society. In such primitive conditions, the connection he makes between wages and minimum subsistence is entirely consistent with the laws of supply and demand.

What is objectionable is such statements as: “With the progress of society . . . one of the principal commodities [food] . . . has a tendency to become dearer from the greater difficulty of producing it.” 121 If true, it would mean that food could be produced most easily by our caveman ancestors and has been becoming progressively more difficult to produce ever since. Obviously, the opposite is true.

Ricardo’s Reservations

Although he clearly endorses the principle that wages have a tendency to conform to their “natural” rate, it is equally clear that Ricardo had some serious reservations. For just a few paragraphs later, he writes:

Notwithstanding the tendency of wages to conform to their natural rate, their market rate may, in an improving society, for an indefinite period, be constantly above it; for no sooner may the impulse which an increased capital gives to a new demand for labour be obeyed, than another increase of capital may produce the same effect; and thus, if the increase of capital be gradual and constant, the demand for labour may give a continued stimulus to an increase of people. 122

Furthermore, it turns out that subsistence, in Ricardo’s view, does not really mean subsistence at all. It means rather that level of real wages above which the average working family is willing to bring up more than two children, and below which it is willing to bring up less than two children. “Subsistence,” in other words, turns out to mean whatever level of real wages results in an equilibrium working population and thus in no tendency of real wages to fall because of population increase or rise because of population decrease. In Ricardo’s words:

It is not to be understood that the natural price of labour, estimated even in food and necessaries, is absolutely fixed and constant. It varies at different times in the same country, and very materially differs in different countries. It essentially depends on the habits and customs of the people. An

English labourer would consider his wages under their natural rate, and too scanty to support a family, if they enabled him to purchase no other food than potatoes, and to live in no better habitation than a mud cabin; yet these moderate demands of nature are often deemed sufficient in countries where “man’s life is cheap” and his wants easily satisfied. Many of the conveniences now enjoyed in an

English cottage would have been thought luxuries at an earlier period of our history. 123

THE DIVISION OF LABOR AND PRODUCTIVE ACTIVITY 493

And, further, along the same lines:

The friends of humanity cannot but wish that in all countries the labouring classes should have a taste for comforts and enjoyments, and that they should be stimulated by all legal means in their exertions to procure them. There cannot be a better security against a superabundant population. 124

In these two passages Ricardo’s usage of the concept of “subsistence” is actually compatible even with describing the standard of living of the average worker in the present-day United States as subsistence. This would be the case if, with a fall in real wage rates below the present level, the average present-day American working family would decide to reduce the number of children it had to a point below the level necessary to keep up the present number of workers.

It should be realized that the observation of economic history from the perspective of the late eighteenth and early nineteenth centuries strongly supported the belief that the equilibrium level of real wages is subsistence— subsistence in the full-bodied sense of extreme poverty characterized by chronic hunger and malnutrition. This was because, again and again, the operation of the law of diminishing returns, coupled with population growth, had in fact brought wages down to actual minimum subsistence whenever, for a brief time, they had gotten above it. Prior to the nineteenth century, history had not yet provided any actual examples of the standard of living of the great mass of workers rising very far above the level of minimum physical subsistence and remaining there for very long. The Industrial Revolution was as yet too young. It was simply too soon for observers such as Ricardo to realize that the progress they were observing around them represented a radical break with all of previous human history. 125

Adam Smith’s Mistaken Belief in the Arbitrary

Power of Employers Over Wage Rates

A further element in the writings of the classical economists, on the basis of which they propounded the “iron law of wages,” was their belief that employers possess arbitrary power over wage rates. Adam Smith believed that wages are the outcome of an unequal struggle between wage earners and employers, in which employers possess the allegedly decisive advantage of being able to hold out for a longer period of time. He writes:

What are the common wages of labour, depends every where upon the contract usually made between those two parties, whose interests are by no means the same. The workmen desire to get as much, the masters to give as little as possible. The former are disposed to combine in order to raise, the latter in order to lower the wages of labour.

It is not, however, difficult to foresee which of the two parties must, upon all ordinary occasions, have the advantage in the dispute, and force the other into a compliance with their terms. The masters, being fewer in number, can combine much more easily; and the law, besides, authorises, or at least does not prohibit their combinations, while it prohibits those of the workmen. We have no acts of parliament against combining to lower the price of work; but many against combining to raise it. In all such disputes the masters can hold out much longer. A landlord, a farmer, a master manufacturer, or merchant, though they did not employ a single workman, could generally live a year or two upon the stocks which they have already acquired. Many workmen could not subsist a week, few could subsist a month, and scarce any a year without employment. In the longrun the workman may be as necessary to his master as his master is to him, but the necessity is not so immediate. 126

The apparent result of this alleged state of affairs, according to Smith, is that employers are in a position arbitrarily to drive wages as low as they like short of the point of depriving themselves of a supply of workers— i.e., to the level of minimum physical subsistence. In Smith’s words:

But though in disputes with their workmen, masters must generally have the advantage, there is however a certain rate below which it seems impossible to reduce, for any considerable time, the ordinary wages even of the lowest species of labor.

A man must always live by his work, and his wages must at least be sufficient to maintain him. They must even upon most occasions be somewhat more; otherwise it would be impossible for him to bring up a family, and the race of such workmen could not last beyond the first generation. 127

In fairness to Adam Smith, it should be pointed out that on the very next page of The Wealth of Nations, he comes close to grasping the actual principle on which wages are determined in a free market—namely, the competition of employers for labor that is always inherently scarce—but he regards the case as atypical.

There are certain circumstances, however, which sometimes give the labourers an advantage, and enable them to raise their wages considerably above this rate [subsistence]; evidently the lowest which is consistent with common humanity.

When in any country the demand for those who live by wages; labourers, journeymen, servants of every kind, is continually increasing; when every year furnishes employment for a greater number than had been employed the year before, the workmen have no occasion to combine in order to raise their wages. The scarcity of hands occasions a competition among masters, who bid against one another, in order to get workmen, and thus voluntarily break through the natural combination of masters not to raise wages. 128

What Adam Smith says about the conditions of an increasing demand for labor applies in principle equally to conditions of a constant or even falling demand for labor. Even in the face of such a demand for labor, the quantity of labor demanded will exceed the supply of labor available if wage rates are sufficiently low. At that

494 CAPITALISM point the scarcity of labor is once again felt, and the result is a competition of employers for labor. Moreover, as will be shown in Chapter 13, any fall in wage rates necessary to achieve full employment, is the cause of lower costs and more production, both of which operate to reduce prices and thereby to prevent the fall in wage rates from entailing a fall in the average worker’s actual standard of living. 129

Ricardo’s Confusions Concerning the

“Iron Law of Wages”

In contrast to Adam Smith, who held that employers have arbitrary power over wages, Ricardo comes to the opposite mistaken conclusion, namely, that arbitrary power over wage rates resides with the wage earners. They allegedly have the ability to make employers grant wages above the level corresponding to the state of supply and demand for labor, and in so doing to reduce the rate of profit.

Consistent with this, nowhere does Ricardo present high profits as being made on the basis of subsistence wages. On the contrary, in Ricardo’s view, when wages reach subsistence, profits fall, as the consequence of an effort to offset the fall in the wage earner’s standard of living. What drives wages to subsistence, according to Ricardo, is not the arbitrary payment of low wages by employers, but, as we have seen, the rise in the price of food and other necessities caused by population growth and the operation of the law of diminishing returns. At that point, according to Ricardo, wages must be increased, to keep pace with the higher price of necessities, and this rise in wages reduces profits.

Ricardo claims that this rise in wages occurs apart from the operation of the supply and demand for labor:

Independently of the variations in the value of money, which necessarily affect money wages, but which we have here supposed to have no operation, as we have considered money to be uniformly of the same value, it appears then that wages are subject to a rise or fall from two causes:

1st. The supply and demand of labourers.

2dly. The price of the commodities on which the wages of labour are expended. 130

A few pages later, proceeding as though he has somehow established this alleged second cause, he reminds his readers that in addition to being regulated by supply and demand:

. . . we must not forget, that wages are also regulated by the prices of the commodities on which they are expended.

As population increases, these necessaries will be constantly rising in price, because more labour will be necessary to produce them. If, then, the money wages of labor should fall [as the result of rising population and thus a larger supply of labor], whilst every commodity on which the wages of labour were expended rose, the labourer would be doubly affected, and would be soon totally deprived of subsistence. Instead, therefore, of the money wages of labour falling, they would rise . . . . 131

The fact that the ultimate power over wage rates in Ricardo’s view rests with the wage earners becomes clear in the following passages, in which he attempts to defend his position that a rise in the price of necessities must result in a rise in wages:

It may be said that I have taken it for granted that money wages would rise with a rise in the price of raw produce, but that this is by no means a necessary consequence, as the labourer may be contented with fewer enjoyments. It is true that the wages of labour may previously have been at a high level, and that they may bear some reduction. If so, the fall of profits will be checked; but it is impossible to conceive that the money price of wages should fall or remain stationary with a gradually increasing price of necessaries; and therefore it may be taken for granted that, under ordinary circumstances, no permanent rise takes place in the price of necessaries without occasioning, or having been preceded by, a rise in wages.

The effects produced on profits would have been the same, or nearly the same, if there had been any rise in the price of those other necessaries, besides food, on which the wages of labour are expended. The necessity which the labourer would be under of paying an increased price for such necessaries would oblige him to demand more wages;

and whatever increases wages necessarily reduces profits. 132

Thus, in the last analysis, according to Ricardo, wages rise because the wage earners need higher wages in order to keep pace with the rise in the price of necessities.

Now this doctrine of wages rising to offset the alleged rise in the price of necessities is, of course, entirely wrong. It appears to be the result of nothing more than a desire on Ricardo’s part to soften the harshness of the fact that his analysis ties real wage rates to subsistence by way of the operation of population changes and the law of diminishing returns. 133 According to that analysis, the only way that wages can recover to subsistence when conditions drive them below it is “after their [the wage earners’] privations have reduced their number.” Only then, will “the market price of labour . . . rise to its natural price.” The mechanism would be the operation of the law of diminishing returns in reverse, as the population and thus the supply of labor diminished because of such horrible events as famines and plagues. Instead of accepting his own analysis, Ricardo postulates a rise in wage rates to alleviate the wage earners’ suffering without any reduction in the supply of labor.

Furthermore, it is actually inconceivable for any price (or wage) to rise without either the demand rising or the supply falling. 134 Inasmuch as Ricardo’s context here, is

THE DIVISION OF LABOR AND PRODUCTIVE ACTIVITY 495 an alleged rise in wages without a fall in the supply of labor, it is necessary to conclude that at least implicitly he assumes that when wages fall to the subsistence level, there will somehow be an increase in the demand for labor that will be responsible for raising wage rates in the face of higher prices of necessities.

Ricardo’s apparent belief in a kind of deus ex machina of a rising demand for labor to raise wage rates in the face of rising prices of necessities, is what leads him to the conclusion that there is a tendency toward a falling rate of profit, which, fortunately, is interrupted by improvements in the production of necessities.

The natural tendency of profits then is to fall; for, in the progress of society and wealth, the additional quantity of food required is obtained by the sacrifice of more and more labour. This tendency, this gravitation as it were of profits, is happily checked at repeated intervals by the improvements in machinery connected with the production of necessaries, as well as by discoveries in the science of agriculture, which enable us to relinquish a portion of labour before required, and therefore to lower the price of the prime necessary of the labourer. 135

Ricardo expresses essentially the same thought in connection with foreign trade, but with more obvious radical connotations:

It has been my endeavour to show throughout this work that the rate of profits can never be increased but by a fall in wages, and that there can be no permanent fall of wages but in consequence of a fall of the necessaries on which wages are expended. If, therefore, by the extension of foreign trade, or by improvements in machinery, the food and necessaries of the labourer can be brought to market at a reduced price, profits will rise. If, instead of growing our own corn, or manufacturing the clothing and other necessaries of the labourer, we discover a new market from which we can supply ourselves with these commodities at a cheaper price, wages will fall and profits rise; but if the commodities obtained at a cheaper rate, by the extension of foreign commerce, or by the improvement of machinery, be exclusively the commodities consumed by the rich, no alteration will take place in the rate of profits. The rate of wages would not be affected, although wine, velvets, silks, and other expensive commodities should fall 50 per cent., and consequently profits would continue unaltered. 136

This last paragraph appears to suggest the Marxian notion that improvements in production simply pass the wage earners by, because they are followed by a corresponding reduction in wages. It is possible to argue for this interpretation on the basis of other passages in Ricardo as well.

Nevertheless, while this interpretation is logically consistent with much of what Ricardo says, it is not his actual meaning. His actual meaning is that the fall in wages here should be understood as a limited one, eliminating an extraordinary increase in wages to compensate for the rise in the price of necessities beyond the point of minimum subsistence. Once this limited fall in wages takes place, the effect of further improvements in production is to raise real wages through the mechanism of falling prices unaccompanied by any further fall in money wages. His actual meaning is essentially the same as the doctrine developed in Chapter 14 of this book under the name “The Productivity Theory of Wages.” Support for this interpretation appears on the very next page following the passage last quoted. Here it is pointed out how improvements in production generally do not operate to raise the rate of profit, but to reduce prices and thereby to benefit all classes.

The remarks which have been made respecting foreign trade apply equally to home trade. The [economy-wide, average] rate of profits is never increased by a better distribution of labour, by the invention of machinery, by the establishment of roads and canals, or by any means of abridging labour either in the manufacture or in the conveyance of goods. These are causes which operate on price, and never fail to be highly beneficial to consumers; since they enable them, with the same labour, or with the value of the produce of the same labour, to obtain in exchange a greater quantity of the commodity to which the improvement is applied; but they have no effect whatever on profit.

On the other hand, every diminution in the wages of labour raises profits, but produces no effect on the [average] price

of commodities. One is advantageous to all classes, for all classes are consumers; the other is beneficial only to producers; they gain more, but everything remains at its former price.

In the first case they get the same as before; but everything on which their gains are expended is diminished in exchangeable value. 137

The Actual Meaning Ricardo Attached to

“A Fall in Wages”

Indeed, the kind of fall in wages and rise in profits Ricardo usually has in mind turns out not to mean a fall in the wage earner’s standard of living—in fact, it is fully compatible with a rise in the wage earner’s standard of living. The most formidable evidence for this view occurs in Section 7 of his chapter “On Value.” There he makes it clear that he is talking of changes in wages and profits in the conditions of a monetary unit of invariable “inner” value, that is, a monetary unit such that all variations in prices are the result of changes on the side of production and supply, not changes on the side of money and demand.

Ricardo’s theoretical standin for such a monetary unit is a fixed aggregate quantity of labor employed in the production of commodities. However, his conclusions can be understood just as well, and far more easily, on the assumption of a fixed aggregate monetary demand— viz., expenditure—for the output of the economic system. (A fixed volume of spending for output would

represent a monetary unit of invariable “inner” value, in that all changes in prices would reflect only changes on the side of output—that is, production and supply—not changes on the side of money and spending. This is because with the amount of monetary demand—spending—being the same, the only way that prices could rise would be by virtue of a fall in output, and the only way that prices could fall would be by virtue of a rise in output. All changes in prices would thus proceed from the side of output, not from the side of money. Money would be of invariable inner value in the sense that even though prices changed and thus the value of money changed, the changes took place from the side of output, not from the side of money. 138 ) He states:

It is not by the absolute quantity of produce obtained by either class, that we can correctly judge of the rate of profit, rent, and wages, but by the quantity of labour required to obtain that produce. By improvements in machinery and agriculture the whole produce may be doubled; but if wages, rent, and profit be also doubled, these three will bear the same proportions to one another as before, and neither could be said to have relatively varied. [To understand this point, imagine that the money value of the aggregate product of the economic system is constant at 1,000 monetary units, which is the total of the spending to buy it. Now imagine that production and the supply of goods sold double and thus that prices halve. If wages, rent, and profits all continue at the same respective monetary magnitudes as before, then, in Ricardo’s view none of them has changed, even though the buying power of each of them has doubled.] But if wages partook not of the whole of this increase; if they, instead of being doubled, were only increased one-half; if rent, instead of being doubled, were only increased three-fourths, and the remaining increase went to profit, it would, I apprehend, be correct for me to say that rent and wages had fallen while profits had risen; for if we had an invariable standard by which to measure the value of this produce we should find that a less value had fallen to the class of labourers and landlords, and a greater to the class of capitalists than had been given before. We might find, for example, that though the absolute quantity of commodities had been doubled, they were the produce of precisely the former quantity of labour. Of every hundred hats, coats, and quarters of corn produced, if

The labourers had before . . . . 25

The landlords . . . . . . . . . . . . . 25

And the capitalists . . . . . . . . . 50

100:

And if, after these commodities were double the quantity, of every 100

The labourers had only . . . . . .22

The landlords . . . . . . . . . . . . . 22

And the capitalists . . . . . . . . . 56

100:

In that case I should say that wages and rent had fallen and profits risen; though in consequence of the abundance of commodities the quantity paid to the labourer and landlord would have increased in the proportion of 25 to 44. Wages are to be estimated by their real value, viz., by the quantity of labour and capital employed in producing them, and not by their nominal value either in coats, hats, money, or corn.

Under the circumstances I have just supposed, commodities would have fallen to half their former value, and if money had not varied, to half their former price also. If then in this medium, which had not varied in value, the wages of the labourer should be found to have fallen, it will not the less be a real fall because they might furnish him with a greater quantity of cheap commodities than his former wages. 139

What Ricardo means to say in the passages just quoted is that production doubles and prices halve. With total money income constant at 1,000 units of money, aggregate wages and aggregate rents fall from 250 each to 220 each, while aggregate profits rise from 500 to 560. Even though the 220 each of wages and rent now buy as much as 440 would have bought initially, wages and rent still fall in terms of an invariable money. Their fall in terms of such a monetary unit will not be any the less an actual monetary fall because they enable the wage earner and landlord to buy a greater quantity of the less expensive commodities than did their former wages and rents.

What must be stressed is that while this is certainly a fall in wages in Ricardo’s meaning of the term, it has nothing whatever to do with an approach of wages to subsistence. What contemporary economists would call real wages sharply increase in this case. (What Ricardo means by real wages, in contrast, is total money wages in the conditions of an invariable money. And he regards the goods the wage earners can actually buy as merely being nominal wages.)

Hopefully, it is now clear that Ricardo does not in fact argue that the capitalists arbitrarily set wages at the level of minimum subsistence, and that, indeed, the core of his analysis is actually fully compatible with real wages steadily rising and doing so precisely on the basis of the activities of the capitalists, whose savings create the demand for labor and capital goods and who are responsible for the steady rise in the productivity of labor and thus for a steady fall in prices relative to wages. Hopefully, it is also clear that in the writings of Ricardo, if and when wages do fall to subsistence, not only is the cause held to be the combination of population growth and the operation of the law of diminishing returns rather than any greed on the part of employers for higher profits, but also the effect is held to be a reduction in the rate of profit, not an increase. 140 Profits, according to Ricardo, are definitely not the result of any arbitrary imposition of subsistence wages, which is what Marx alleges them to be. 141

THE DIVISION OF LABOR AND PRODUCTIVE ACTIVITY 497

Classical Economics’ Mistaken Denial of the

Ability to Tax Wage Earners

However inconsistently, insofar as the classical economists believed that the equilibrium level of real wages was minimum subsistence, they were led to the conclusion that wage earners cannot be made to pay a significant amount of taxes. After all, if wages are merely equal to subsistence, what is there to tax? Thus, for example, Ricardo writes: “Dr. [Adam] Smith uniformly, and I think justly, contends, that the labouring classes cannot materially contribute to the burdens of the State. A tax on necessaries, or on wages, will therefore be shifted from the poor to the rich . . .” 142

This view is entirely false. We saw in Chapter 9 that taxes on the “rich”—on businessmen and capitalists— are overwhelming borne by the wage earners in the form of a lower demand for labor and a lower productivity of labor, which latter is caused by a lower demand for capital goods relative to consumers’ goods and reduced incentives to improve production. 143 The truth is that wage earners always end up bearing the major burden of taxes; they bear the burden whether the taxes are levied on them directly or on businessmen and capitalists.

The truth of this proposition does not depend on real wages initially being above subsistence, as happens to be the case today, when they exceed subsistence many times over. If, as in most of history and in most countries even now, real wages are at the level of subsistence, an increase in taxes in any form operates to reduce them below subsistence. It does so either by directly reducing the wage earners’ spendable income, if it takes the form of an additional income tax they must pay, or the buying power of their incomes, if it is an additional sales tax they must pay. If it is an additional tax on the “rich,” it reduces the demand for labor and thus the wage earners’ pretax incomes; it also reduces the supply of goods produced and available for them to buy, and thus raises the prices they must pay. The wage earners simply cannot escape the burden of the tax.

If real wages are initially at the subsistence level, the effect of any tax increase is that wage earners are literally taxed to death. Wages then recover to the subsistence level from a point below the subsistence level insofar as a reduced population makes it possible to produce agricultural commodities and minerals under conditions of a higher productivity of labor. At that point, the higher productivity of labor resulting from the depopulation offsets the burden of the tax.

If a modern, division-of-labor economy should ever be driven to the point of subsistence wages, and then taxes be further increased, real wages would not recover as the result of depopulation. The depopulation would further reduce the productivity of labor, by reducing the extent of the division of labor. A collapse of society would ensue.

6. Marxian Distortions of Classical Economics; The Final Demolition of the Exploitation Theory

In the last two sections of this chapter, I have shown the actual nature of classical economics insofar as it is alleged to underlie the Marxian exploitation theory. Indeed, precisely on the foundation of classical economics, I have demolished the conceptual framework of the exploitation theory. I have shown how the labor theory of value of classical economics—at least as developed by Ricardo, who was the leading theorist of the school— stands merely as a partial principle, alongside of a variety of other principles of price determination, and can actually be used to express the essential productive contribution of businessmen and capitalists to the rise in real wages by virtue of continuously raising the productivity of labor and thereby making goods more and more abundant relative to labor. I have shown that in the hands of Ricardo even the socalled iron law of wages of classical economics does not actually lend very much support to the exploitation theory. Thus, the notion that classical economics implies Marxism is at best highly superficial. In essentials, the opposite is true, as my critique of the conceptual framework of the exploitation theory on the basis of classical economics should make clear.

In Chapter 14, I will explain in detail Marx’s very different version of the labor theory of value and “iron law of wages.” A reading of that material, in the light of the account of the classical economists’ views that has been presented in this chapter, will make it obvious that Marx’s views represent gross distortions of the classical economists’ ideas on these subjects.

Chapter 14 will complete the vital work of refuting all remaining aspects of the exploitation theory. It will provide a systematic critique of the Marxian version of the iron law of wages—that is, the notion that employers have the power arbitrarily to set wage rates at minimum subsistence. It will hunt down the numerous manifestations of this doctrine in the prevailing political-economic ideology of the twentieth century and one by one subject them to a thoroughgoing critical analysis, from which they will be unable to recover in the mind of any rational reader who takes the trouble to study and understand the analysis.

Chapter 14 will follow an extensive explanation of the nature of aggregate demand, in chapters expounding the quantity theory of money, Say’s law of markets, and the cause and remedy for mass unemployment. Following this necessary preparatory work (which, of course, is enormously valuable in its own right), the critique of the

Marxian version of the iron law of wages will be provided primarily in the form of the presentation of a totally different, positive theory of wages—one that is fully compatible with the essential doctrines of classical economics. This theory of wages, I call, by the title of Chapter 14, The Productivity Theory of Wages.

Notes

1. The productive role of commodity speculation and the commodity markets has already been explained. See above, pp. 191–192.

2. Most of the material that explains these matters in the next three sections originally appeared in my article “Definitions Pertaining to Production and Consumption,” Il Politico 32, no. 1 (March 1967).

3. In today’s environment of blatant irrationalism and open hostility to science and technology, it must be stressed that proof of inherent destructiveness must be shown before an activity is to be disallowed the title of productive. There is no such proof to disqualify even alcohol, tobacco (in forms other than cigarettes), and gambling, when resorted to in moderation. Still less is there any reason to challenge the productivity of the manufacture and sale of such substances as coffee, saccharin, red meat, white flour, white bread, sugar, cow’s milk, table salt, and so on, the claims of assorted cultists and food faddists to the contrary notwithstanding.

4. Cf. James Mill, Commerce Defended (London, 1808); reprinted in Selected Economic Writings of James Mill, ed. Donald Winch (Chicago: University of Chicago Press, 1966) p. 128. 5. The meaning of the terms productive, unproductive, and reproductive consumption in the physical sense was explained above, on pp. 131–132.

6. These concepts appear in the writings of Adam Smith and his followers under the names “productive and unproductive labor.” Unfortunately, the classical economists were highly inconsistent in their use of these terms and frequently employed them to refer to a very different distinction, namely, the distinction between labor employed in the production of tangible, material goods and labor employed not in the production of tangible, material goods. (See below, the quotations from Adam Smith on p. 456.) Apart from this inconsistency, Adam Smith and James Mill can be acknowledged as the originators of the basic distinctions I have employed in this discussion. Cf. Adam Smith, The Wealth of Nations (London, 1776), bk. 2, chap. 3; reprint of Cannan ed. (Chicago: University of Chicago Press, 2 vols. in 1, 1976), 1:351–371. (Where appropriate, from now on, specific page references to the University of Chicago Press reprint will be supplied in brackets.) Cf. also James Mill, Commerce Defended, chaps. 5 and 6 (pp. 105–139) in Selected Economic Writings of James Mill.

7. In case anyone wonders about the classification of government employees engaged in tax collections or employees of private charities who are engaged in fund raising, see below, pp. 454–455.

8. See above, p. 132.

9. See above, ibid.

10. See above, p. 40.

11. On occasion, I will include accumulated savings in the methods I offer for measuring the degree of capital intensiveness of the economic system. See below, for example, Chapter 14, n. 71.

12. John Kenneth Galbraith, The Affluent Society, 3d ed. (Boston: Houghton Mifflin, 1976), pp. 110–111.

13. It should go without saying that productive expenditures made for the purpose of reducing costs of production, such as many of those made by a company’s research and development department, are productive expenditures. They too are made for the purpose of bringing in sales revenues. Their only distinction is that they seek to do so with a greater profit than would otherwise be the case. All the expenditures made by business enterprises for business purposes are productive expenditures. 14. Subsequent discussion in the next section of this chapter, concerning the closely related doctrine of imputed income, will make still clearer the absurd results implied in the notion that a saving of expense is the equivalent of actually earning an income.

15. See above, p. 40.

16. Ibid.

17. See below, pp. 634–636.

18. Cf. Wealth of Nations, bk. 2, chap. 1 [1:298].

19. Ibid., bk. 2, chap. 3 [1:351]. Italics supplied.

20. Ibid., [1:352]. Italics supplied.

21. See above, 446–447.

22. Smith’s confusions here are noted by Cannan. See Wealth of Nations, bk. 2, chap. 3 [1:351].

23. See below, pp. 473–475.

24. See above, pp. 453–454.

25. I present my theory of aggregate profit and the average rate of profit, below, in Chapter 16, and many of the leading applications of the theory in Chapter 17.

26. Much of the material in this and the next section of this chapter originally appeared in my article “Cost and Revenue: An Economist’s Defense of the Accounting Concepts,” Il Politico 33, no. 4 (December 1968).

27. United States Department of Commerce, Office of Business Economics, National Income 1954 Edition (Washington, D. C.: U.S. Government Printing Office, 1954), p. 46.

28. Paul Samuelson and William Nordhaus, Economics, 13th ed. (New York: McGraw Hill Book Company, 1989), pp. 117–118.

29. See Glamour, March 1992, p. 114.

30. Samuelson and Nordhaus, Economics, p. 524.

31. Ibid., p. 525.

32. Ibid.

33. See above, pp. 162–165. See also above, p. 201 and pp. 206–209.

34. See 208–209.

35. Many of the essential points, together with their specific

THE DIVISION OF LABOR AND PRODUCTIVE ACTIVITY 499 formulations, that I make in this section and below, on pp. 475–485, previously appeared in my essay “Classical Economics Versus the Exploitation Theory” in Kurt Leube and Albert Zlabinger, eds., The Political Economy of Freedom Essays in Honor of F. A. Hayek (Munich and Vienna: Philosophia Verlag, 1985), pp. 207–225. They were originally presented in a lecture I delivered under the title “A Ricardian’s Critique of the Exploitation Theory” at the University Club of New York City, on January 26, 1965, before a group of members and friends of von Mises’s seminar.

36. For a discussion of how the tax laws have fostered uneconomic concentration, see above, p. 395.

37. Cf. above, pp. 140–141.

38. See below, pp. 477–480, 632–634, and 683–685 passim. 39. See below, pp. 478–480.

40. On this point, see above, p. 141.

41. Concerning all these points, see above, pp. 173–174. 42. On the nature of profit management and bureaucratic management, see above, pp. 304–305. For a thorough discussion of the subject, see Ludwig von Mises, Bureaucracy (1944; reprint ed., New Rochelle, N. Y., 1969).

43. See above, pp. 176–180.

44. See above, pp. 327–328.

45. See below, pp. 622–631 and 634–636.

46. On these points, see below, pp. 622–629 and 632–634. 47. See below, pp. 634–636.

48. Cf. Ludwig von Mises, Human Action, 3d ed. rev. (Chicago: Henry Regnery Co., 1966), p. 531.

49. On the vital role of exchange and money, see above, pp. 141–144.

50. See above, pp. 172–173.

51. Cf. George Leland Bach, Economics, 6th ed. (Englewood Cliffs, N. J.: Prentice-Hall, Inc., 1968), pp. 353–354. The antiadvertising example there serves as the prototype for the proadvertising example presented here. Bach expounds essentially the same hostility to advertising in his eleventh ed., 1987, but with less clarity and forcefulness.

52. Cf. ibid. for an exposition of this fallacy.

53. See Yale Brozen, “Is Advertising a Barrier to Entry?” in Yale Brozen, editor, Advertising and Society (New York: New York University Press, 1974), pp. 79–109.

54. Cf. von Mises, Human Action, p. 321.

55. Cf. ibid.

56. On the objective foundations of the value of wealth, see above, pp. 42–49. For further reading on the subject of advertising, see Jerry Kirkpatrick, In Defense of Advertising (Westport, Conn.: Quorum Books, 1994). This book constitutes a thoroughgoing philosophic analysis and defense of virtually all aspects of advertising.

57. See above, pp. 200–201, 414–417 and 441–456.

58. On this last point and the demolition of the whole of the specific substance of the exploitation theory, see below, pp. 618–663 and 664–666. See also above, p. 464.

59. In this instance, of course, the abandonment of an essential classical doctrine was also the result of the prosocialist sympathies of John Stuart Mill, as well as the mistaken ideas of the late nineteenth-century defenders of capitalism. See above, pp. 3, and below, pp. 664–666. For a defense of the wages-fund doctrine, see below, ibid. For a critique of the notion that consumers pay wages in buying products, see below, pp. 683–685.

60. See above, the quotations from Smith on p. 456.

61. In connection with his opposition to government borrowing, see his discussion of public debts, in Wealth of Nations, bk. 5, chap. 3 [2:441–486].

62. Wealth of Nations, bk. 1, chap. 5 [1:35].

63. Ibid., chap. 6 [1:54–55].

64. Ibid., chap. 8 [1:73–74].

65. On the productive activity of businessmen and capitalists, see above, pp. 462–464.

66. See above, especially p. 304 and pp. 310–317. See also above, pp. 27–31, 63–71, 135–139, and 303–304.

67. Wealth of Nations, chap. 6 [1:56].

68. See above, p. 304.

69. Cf. Karl Marx, Capital, trans. from 3d German ed. by Samuel Moore and Edward Aveling; Frederick Engels, ed.; rev. and amplified according to the 4th German ed. by Ernest Untermann (New York: 1906), vol. 1, pt. 2, chap. 4; (reprinted, New York: Random House, The Modern Library), pp. 163–173.

70. John Stuart Mill, Principles of Political Economy, Ashley ed. (1909; reprint ed., Fairfield, N. J.: Augustus M. Kelley, 1976), pp. 79–88.

71. David Ricardo, Principles of Political Economy and Taxation, 3d ed. (London, 1821), chap. 6 passim; reprinted as vol. 1 of The Works and Correspondence of David Ricardo, ed. Piero Sraffa (Cambridge: Cambridge University Press, 1962), pp. 110–111, passim. (Where appropriate, from now on, specific page references to the Sraffa edition will be supplied in brackets.)

72. F. A. Hayek, Capitalism and the Historians (Chicago: University of Chicago Press, 1954), pp. 15, 16.

73. Smith, Wealth of Nations, bk. 1, chap. 11 [1:277].

74. Ibid., chap. 8 [1:77].

75. Ibid., bk. 1, chap. 11 [1:277–278].

76. On this point, see below, pp. 813–817.

77. See below, pp. 762–767 and 825–826.

78. Wealth of Nations, bk. 1, chap. 6 [1:58].

79. See above, pp. 462–464.

80. See above, pp. 459–462.

81. On the nature of time preference, see above, pp. 55–58. 82. See below, pp. 743–744.

83. Human Action, p. 142.

84. See the rebuttal of the alienation charge, above, pp. 129– 130.

85. It is important to realize that large salaries and bonuses for key executives can be justified even in conditions of recession or depression, insofar as they are earned for sharply cutting costs, including laying off large numbers of unnecessary employees. As illustration of this principle, one should consider how desirable it would be for the U.S. Postal Service to become privately owned and for the new key executives to earn tens of millions of dollars in salaries and bonuses by virtue of massive firings of unnecessary or unproductive employees that would result in annual savings of hundreds of millions of dollars. Fortunately, this kind of process is what does occur in private business when necessary. Thus, the current complaints about the injustice of executives earning high incomes in the midst of layoffs likely are fundamentally unfounded.

86. Cf. Eugen von Böhm-Bawerk, Capital and Interest, 3 vols., trans. George D. Huncke and Hans F. Sennholz (South Holland, Ill.: Libertarian Press, 1959), 1:263–271.

87. Ibid., 1:266.

88. Ibid., 1:269.

89. Cf. ibid., 1:241–307; see also “Karl Marx and the Close of His System” (New York, 1898); reprinted as “Unresolved Contradiction in the Marxian Economic System” in Shorter Classics of Eugen von Böhm-Bawerk (South Holland, Ill.: Libertarian Press, 1962), pp. 208–287.

90. See above, pp. 478–480.

91. See also above, pp. 462–464.

92. See above, pp. 313–316.

93. This relationship is elaborated in great detail below, pp. 618–622. For elaboration of the classical economists’ concepts of demand and supply, see above, pp. 152–155. 94. Adam Smith, Wealth of Nations, bk. 1, chap. 8 [1:72]. 95. For elaboration of the meaning of the wages-fund doctrine, see above, p. 474, and below, pp. 664–666.

96. Cf. Ricardo, Principles, chap. 20 [pp. 280–281]. 97. Cf. ibid., chap. 1, sec. 6 [pp. 43–51]. See also below, pp. 536–540.

98. Ricardo, Principles, chap. 1, sec. 1 [p. 12]. 99. See above, pp. 201–202.

100. See Ricardo, Principles, chap. 4 [pp. 88–92], which deals with the distinction between market price and natural price (viz., equilibrium price). See also chaps. 2 and 3 [pp. 67–87], which deal with land and land rent, including the rent of mines, and chap. 24 [pp. 201–204], concerning taxes on houses. 101. See below, pp. 494–495.

102. Ricardo, Principles of Political Economy and Taxation, chap. 1, sec. 1 [p. 12]. This description clearly seems to exclude human labor.

103. Ibid., [p. 30].

104. Ibid., [p. 37]. Italics supplied.

105. Ibid.

106. In fact, the machine would have to bring in a total of $1,650 to allow for the fact that a year goes by between the outlay of the $1,000 of wages and the beginning of the machine’s useful life.

107. Works and Correspondence of David Ricardo, 8:193. 108. Ibid., p. 194.

109. Ricardo, Principles, chap. 1, sec. 5 [pp. 39–49]. 110. See above the reference to Shorter Classics of Böhm-Bawerk, in which this essay is reprinted.

111. Ricardo, Principles, chap. 7, [p. 133].

112. See above, pp. 187–188.

113. We have, of course, already encountered this principle in connection with the operation of competition and the law of comparative advantage. See above, pp. 351–354. 114. John Stuart Mill, Principles of Political Economy, p. 460. 115. See above, pp. 201–202 and 208–209. 116. Concerning the tendency toward a uniform rate of profit, see above, pp. 172–173.

117. On these subjects, see above, pp. 201–212. 118. See above, pp. 311–312,

119. Ricardo, Principles, chap. 5 [p. 93]. 120. Ibid., [p. 94].

121. Ibid., [p. 93].

122. Ibid., [pp. 94–95].

123. Ibid., [pp. 96–97].

124. Ibid., [p. 100].

125. I made the same observation earlier, when first introducing Ricardo’s theory of land rent. See above, p. 312. See also above, p. 358.

126. Smith, Wealth of Nations, bk. 1, chap. 8 [1:74–75]. 127. Ibid., [1:76]. For a critique of the doctrine of alleged arbitrary power by employers and the inference that in the absence of government interference they will set wage rates at minimum subsistence, see below, pp. 613–618. 128. Wealth of Nations, bk. 1, chap. 8, [1:77]. 129. On this point, see below, pp. 584–585. 130. Ricardo, Principles, chap. 5 [p. 97]. 131. Ibid., [p. 101].

132. Ibid., chap. 6 [p. 118]. Italics supplied. 133. As I have pointed out, the alleged rise in the price of necessities as any kind of permanent, inescapable phenomenon is, of course, itself also entirely wrong. See above, p. 492. 134. See below, pp. 897–907, where this point is elaborated and applied to various alleged explanations of the rising prices caused by inflation.

135. Ricardo, Principles, chap. 6 [p. 120]. 136. Ibid., chap. 7 [p. 132].

137. Ibid., [p. 133]. Italics supplied.

138. For a discussion of the subject of invariable money, see below, pp. 536–540.

139. Ricardo, Principles, chap. 1, sec. 7 [pp. 49–50]. 140. A critique of Ricardo’s doctrine of the tendency toward a falling rate of profit appears below, pp. 799–801. 141. For an account of Marx’s theory of wages, see below, pp. 607–610.

142. Ricardo, Principles, chap. 16 [p. 235]. 143. See above, pp. 306–310. See also below, pp. 622–642.