The Definition of Capitalism – Need for an Accurate Account

Today Ben Chu got slightly annoyed with Paul Mason and so produces a slightly annoying article in the independent

if you don’t first clarify definitions, all else is liable to break down. Clear language is the foundation of clear thinking and coherent action…. But what is this capitalism? What does the word stand for? It’s not a question that is asked enough. The journalist Paul Mason has published a book with the title “Post-capitalism” which, rather irritatingly, lacks any substantive discussion of what capitalism actually is…. During the first phase of the industrial revolution, when people spoke of “capital” they were generally talking about physical assets such as textile factories, water mills, steel foundries and railway lines. The owners of these “means of production” were the capitalist class. But the relative economic importance of physical assets has collapsed as the economies of the rich world have become more sophisticated…. “Capitalism” doesn’t really exist. There are various modes of market-based economic, social and legal organisation in rich countries, some of which work well in some respects, and some of which don’t.

Yes, clear language is necessary and capitalism has evolved, but that doesn’t mean it has evolved out of existence or will disappear through simple semiotic slight of hand. Ben assumes the definition of capitalism is associated with the ownership of fixed capital.   However that was never an essential component in its definition. Capitalism’ was a word was not used by either Adam Smith or Ricardo, or even the youthful Marx.  Capitalism was a late 19th-century term. The Oxford English Dictionary (Vol II, p 863) locates its first usage in English in 1854 by William Makepeace Thackeray in his novel, The Newcomes.

The shares were at a premium, and gave a good dividend. The Prince de Moncontour took his place with great gravity at the Paris board, whither Barnes made frequent flying visits. The sense of capitalism sobered and dignified Paul de Florac

Of course in the 1860s the term was greatly popularised by Marx.  The sense in which Thackery used it – and for the classical economists in their use of the term ‘capital’ was ownership as a monetary relation in a system of production.  The distinction between ‘fixed’ capital and variable, and between different forms of ownership in terms of financial assets were secondary. Definitions are essential but defining capitalism as a system of production, without being defining the essential as opposed to the contingent components of that system has not helped social theory in general or economics in particular.  Each generation defines capitalism by its own obsessions and when it transforms somehow magically we are in a post-industrial/modern/capitalist Nirvana, yet the structures of rentier unearned income are untouched. Perhaps the best definition of Capitalism was given by Walter Sombert (Sombart W. Der moderne Kapitalismus. Munchen, Leipzig: Duncker and Humbolt, 1916)

“It could be said that before double entry bookkeeping, the concept of capital was inexistent, and that without DEB it would not have come into being. We could even go so far as to define capital as the capacity for accumulation as assessed through double entry bookkeeping” (p. 24). The same applies to “the concepts of fixed and circulating capital”, “rotating capital”, “production cost”, etc. (p. 25). “The conceptual artillery of the private economy and the political economy being applied to the capitalistic economy is largely (and people are often unaware of this) derived from the arsenal of DEB. (…) To the extent DEB engenders the notion of capital, it simultaneously engenders the notion of the capitalist enterprise as an organisation designed to increase the value of a given capital. This reveals the creative contribution of DEB to the arrival of the capitalist enterprise.” (p. 25).

Double entry book keeping allows for a proper accounting of credits and debits and a separation of production and ownership, as well as of course depreciation of fixed capital so its profitability can be calculated.  Such are not factors which lead tp an evolution beyond capitalism but the logical and inevitable extension of a system of accounting of ownership which gives the appearance of money being used to create more money. Indeed as I have written about on this blog their are hints in the classical record of DEB existing in Rome and perhaps earlier in Athens so that Banking and proto capitalism arose together – before being lost in the fall of Rome and arriving back through Venice from Byzantine and the Arab World.

Tying accounting into economic and social theory is not just however a historical empirical exercise, it helps to excise bad economic theory.

For example Henry George was critical of definitions of ‘capital’ that included financial assets – stocks, bonds, mortgages, promissory notes, or other certificates for transferring wealth is not really capital, because

“Their economic value merely represents the power of one class to appropriate the earnings of another.” and “their increase or decrease does not affect the sum of wealth in the community”.

Hence a form of ownership does not dictate the creation of wealth – its is contingent on the structure of ownership.

Also as financial assets are not created by labour – their value is not subject to Says Law – it can be subject to speculative fluctuations and be subject to excess demand.  An insight of Gessell picked up by Keynes and forming his precuationary demand for money.

Indeed the neglect of clear definitions and theory based on double entry is central to almost every mistake in neo-classical economists, such as assuming that debts=credits so they cancel out and debt doesn’t matter, without fully understanding the implications of the debt creation and credit repayment occuring at different points in time.

I have argued here before that we should not let past any economic theory which is not rigorously defined in terms of the accounting constraint of capitalism i.e. assets = liabilities + owners equity (capital).  Known as the fundamental equation of accounting.

We can easily rearrange to the Fundamental Equation of Capitalism.

Capital=Assets-Liabilities

Its not difficult.  The capital of a firm can grow with sharebuy backs, but that is simply shareholders speculating on the rising future capital value of shares, its not steeping outside the rules of the capitalism game.

Similarly the rise of intangible value – brand value – holds not secret to an accounting based approach.  Brand value is simply the capitalisation of the profits a firm makes from it being a firm – including the markup from degree of monopoly from its own innovations and brand value.  In a perfect free market there would be no profits at all.

‘How can it be that we are wealthier today than people were 100 years ago?. . . This question is puzzling because, if you add up all the things we own, it is clear that the underlying quantity of raw materials has not changed over time,. … There’s only one explanation for this increase in wealth. We took this raw material that was available to us and rearranged it in ways that made it more valuable. We took stuff that was not very valuable and made it much more valuable. … What lies underneath this process of rearrangement are instructions, formulas, recipes, methods of doing things – the things accountants classify as intangible assets if they recognize them at all. They tell us how to take something that is not very valuable and rearrange it into a new configuration that is more valuable.’ (Evans 1998)

Sadly Ben Chu’s article only deals with the level of appearances on not in terms of economic value, power relations and distribution.  Capitalism is defined away by virtue of changing ephenomenon.  The nature of how wealth is made and who benefits and who loses out is lost.

One thought on “The Definition of Capitalism – Need for an Accurate Account

  1. Capitalism is the social system that places capital above the individual, and Socialism is the social system that places government above the individual. Distributism is the system that considers the individual and his/her freedom first and places them above but within a system of profit.

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