The three faces of capitalism

There are three activities that a capitalist firm does. Every firm engages in all three at different times, but the balance and the timing bring about radically different outcomes: Financially, in immediate human welfare, for development, and morally. I therefore call these the three faces of capitalism.

  • Capital formation:In capital formation the firm consumes financial assets (usually cash) and builds real assets that it will later use for production or extraction. Capital formation thus takes two forms:
    • Productive capital formation, such as technical innovation, the building of customer relationships and goodwill, channels to market, facilities or machinery, organizational and human capital.
    • Extractive capital formation, such as the acquisition of monopoly licenses or exclusivities, financial muscle, commodity stocks, control over suppliers or distributors, land, and all IP assets.
  • Production: Production is what an industrial, agricultural, or service firm does. Resources come in, labor and and devices are applied, and goods or services come out. The goal of production is to sell the goods or services at a profit, while minimising the share paid to suppliers and labor, and the running cost of devices.
  • Extraction: Extraction is what a landlord, bank, media company, utility, mining company, or retailer does. These firms have a productive function, but their dominant mode of business is to extract rents from assets that they own, while rationing those assets so as to command the maximum price.

The companies that people admire, Google, Apple, the great electrical and electronic firms, the venerable auto and aviation firms, the computer companies, the large and small software houses, big infrastructure, big science, universities, and medicine are all admired because of their productive capital formation: R&D, innovation, bright ideas, making what previously didn’t exist or wasn’t possible. Productive capital is seen as a beacon of hope and progress for humanity, and great store is set by it wittingly or unwittingly.

All the good jobs in capitalism are in productive capital formation too – at least all the ones that carry a clear conscience. I have such a job, like most geeks. Believe me, we’re pampered. So important is the creation of productive capital that we’re largely insulated from the vagaries of production. We’re also afforded great autonomy, so we’re able to see the whole edifice of the economy free of distortion, and even to criticize it as I do here. Our daily experience and relationship to work is in every way different from that of factory workers. Capitalism looks good from the inside, if you’re in productive capital formation.

Extractive capital formation is the dark side. Some of it is de-facto, through asymmetric relationships. A monopoly is an unequal relationship of a firm with its competitors. We lack an equally damning name for the vastly unequal relationship of some industries with their customers, but that difference in size and economic power alone is what allows a bank or a large retailer to milk their customers – even if the industries are not monopolistic as such.

De-jure extractive capital is any form of property or other legal rights of exclusivity or imposition. Throughout history land ownership, rent, and taxation have been the dominant forms. Since the 18th century, propertification has exploded with new forms of extractive capital such as assigned monopolies, copyrights, patents, and monetary rights. An old example of an assigned monopoly is the East India Company. Modern examples are oil companies in Iraq, or mobile (cell) operators who bid for limited spectrum licenses. We’ll return to monetary rights shortly.

All the obscene money is made in extractive capital formation and yet, correctly, nobody respects it. Business has a love-hate relationship with extractive capital. On the one hand, some form of extractive right is seen as essential for investment protection. How much? None, say the Open Source people, but their output is for the most part disappointing. Total ownership, say biotech, and their argument for value creation is equally unconvincing. Everyone professes love of openness and competition, but seeks extractive rights and market distortion.

Artists, films and theater, and musicians are admired as creators of productive capital. How is a movie or a song or a computer game productive capital? You can play it, in some way, and generate enjoyment. As such it’s part of the world’s richness in the same way as technology or education. Yet, recently, “content” is seen entirely though the prism of extractive capital. The once-respected firms that funded the creation of culture have turned themselves into landlords, attacking anyone whom they perceive as inimical to their rentier business model.

As for production, it’s boring. It’s no fun to be in industrial production, or in the service industries. Marxist schools of thought have yielded an excellent analysis of production, almost 200 years ago. Human labor is alienated and subjugated to competitively-driven cost minimization. The root cause is the separation of personal, inner productive capital from labor as the artisan economy gave way to the industrial. Their solution has been to re-apportion the means of production to the people. But here’s the problem: Production is boring. Everyone feels for the proletariat, but no-one wants to be the proletariat.

Communist attempts to regulate the relations of production, despite good intentions, have been on the whole backward – denying or fighting the separation of production from productive capital, the reduced need for and correspondingly fading status of labor, and the creative destruction needed to move to more modern forms of economy better fitting the aspirations and wishes of people as both consumers and professionals. Trade unions are a case in point. A union holds an extractive right, a quasi-formal monopoly over a specific domain of production. As such, it conflicts with efficiency. A more productive and forward-looking strategy of the left, in my view, would be to fight for a partnership, taking a share on the capitalist ownership of the firm.

Extraction is the bane of the economy. Where extraction dominates, economies and societies fail. Feudal and colonial economies have been the apotheosis of extraction, and the pits of human misery. Communism, with its focus on production, was a great improvement over the extractive feudal economy that it replaced in czarist Russia (and I didn’t make this up – I was told in person by J. K. Galbraith). Today, the predominance of extractive institutions is the prime reason why nations fail, as brilliantly documented here: But even in our “successful” economies, extraction take three dangerous forms.

Most of the world’s production takes place in Asia, mostly China. The reason this is not Chinese production but it’s nominally American production of goods such as Macs and iPhones, is entirely because of IP rights. Copyrights, design and branding rights, and to a much lesser extent patents keep IP-poor Asian firms beholden to the Western owners of these rights (patents are mostly used in fights between IP-rich firms). This is unstable. Wars have been fought over much lesser exploitation rights, such as for trade routes or oil reserves. At some point not too far into the future China will assert its freedom from the impositions of IP as an foreign extractive mechanism.

Land has been the basis of extraction for centuries, but in an economy without growth this hasn’t mattered. Historically rents have been static class-based current account imbalances from peasants to landlords. In a growth economy, since every economic activity has to be housed, land is able to extract not just current rents but also capital appreciation parasitic to the appreciation of the productive economy. Without improving its capacity or productivity, real estate appreciates. It also keeps its value, like a monetary asset, rather than depreciating as productive capital does. Those factors give real estate a parasitic and de-stabilizing role.

Lastly, we need to talk about the monetary rights of banks. Contrary to conventional wisdom, money is not created by the state, nor are banks mainly intermediaries between savers and entrepreneurs. The main function of banks is to create and rent out most of the money in circulation. The right to create money has been quietly privatized, from around 1970 onward. Banks have a legal right to create effectively unlimited capital, paying 0.0% – 0.5% interest to the state for the privilege (assuming a 10% reserve requirements at a very conservative 5%). They then rent that capital to the economy, at anything from 3% to 20% depending on the type of loan. Banks do offer real services in managing and screening loans, and up to a point to control risks. But the value of these services is small. The exorbitant privilege of banks to issue and rent out money in the modern economy, backed by the implicit insurance of the state, is the most rapacious and hidden extractive institution in the world today.

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