How capitalism works – and doesn’t work

by Philip Ferguson

According to economics.about.com, “In every economic system, entrepreneurs and managers bring together natural resources, labor, and technology to produce and distribute goods and services.” They do qualify this by claiming, “But the way these different elements are organized and used also reflects a nation’s political ideals and its culture.” (They also note Marx’s description of a capitalist economy as one in which a small group of people who control wealth make the key economic decisions.)

It’s important to understand that the idea that every economic system has, or requires, “entrepreneurs and managers” in order to operate is factually wrong. For most of the time that human beings have existed we lived in collective societies, without entrepreneurs and managers. Different social classes only arose about 10,000 years ago and it’s only in the past few hundred years that capitalism has been the dominant global system. Facts, however, have never been allowed to get in the way of capitalist ideology – that is, the set of ideas which seek to justify the present system and usually do so by making it appear that capitalism is ‘natural’ and eternal.

Capitalism, however, is neither. It arose at a particular point in time, due to particular circumstances. Ultimately, it was a product of human action and can be abolished by human action too.

Origins of class society

Around 10,000 years ago settled communities and agriculture began to develop in the Middle East. These communities still mainly produced things as use-values and the products were consumed by the producers themselves. The development of agriculture, however, led to the production of a surplus. The surplus took the form of agricultural produce – ie humans could now produce more than they needed to eat, to clothe themselves and so on.

The production of a surplus meant that, for the first time, some people could be freed from manual labour. It also meant there was now a struggle for control of the surplus and society became divided into classes.

At the top was a small class of kings, pharaohs and other rulers and an aristocracy, who dominated control of the surplus. They could also finance standing armies, separate from the rest of society, for the first time. Priests and other specialists could also live off the surplus.

A state apparatus emerged for the first time to maintain the division of the surplus in the interests of the new ruling elites and to ensure that society did not disintegrate as different sections struggled over the division of the surplus. Before there was a surplus, a state was neither necessary nor possible.

This early stage of settled human society and the production of an agricultural surplus was based on slavery. In this kind of society it was very clear who did the work and created the wealth of society – primarily the slaves. Exploitation in this society was very transparent. The slaves worked for nothing and were forced to work. They created their own subsistence plus a surplus, which was taken by their owners.

Other parts of the surplus were created in a few areas by small farmers. Part of their product was confiscated by local overlords and also by kings, emperors etc in the form of tax. In a few places, such as ancient Greece and Rome, there was also a small class of wage-workers.

These societies reached their peak in Asia Minor (now Turkey), Mesopotamia (now Iraq), Egypt, ancient Greece and the Roman empires, China and the civilisations of Central America and Peru at different points in time.

There is some disagreement about the nature of pre-contact Maori society in New Zealand. However, private property was minimal, slavery existed but was not hereditary and the surplus was very small. Social organisation was generally collectivist.

Feudalism

The next stage in human society developed firstly in Europe, after the Roman Empire collapsed. This stage is called feudalism. In feudalism, most of what was produced was produced by peasants and they consumed it directly, ie as use-values. The surplus was produced also primarily by peasants. Again, the way the production of the surplus was based on exploitation was transparent. For instance, peasants would work a certain number of days of the year for themselves, creating their own subsistence, and a certain number of days on the land of their feudal lord in which they creatied extra produce which belonged to the lord. In addition, peasants, on their own land, could often produce a little more than they needed, but this – and even part of their subsistence – tended to be confiscated by local lords and kings in the form of a range of taxes. Where the peasant had any small surplus left they could trade it at markets.

In both the slave societies of antiquity and feudal society, production was mainly for consumption. Even the surplus was largely consumed directly by those who expropriated it. For example, kings used the surplus product to feed and cloth servants, soldiers, and other retainers. Religions took part of the surplus to feed and cloth bishops, priests and so on. Only a small amount of what was produced was sold on the market. Market days were big events, because the market was peripheral to society on a day-to-day basis.

Another important characteristic of feudalism (and the slave societies of antiquity) is that the economic and political aspects of society were generally fused. For instance, the baron for whom you performed surplus labour was also your political master. If you revolted against the baron, or the king, the revolt was both economic and social-political. As we will see, this is different from modern society (capitalism) where the economic and political become separated into different spheres.

In feudal society small producers – peasants and artisans – also owned their own means of production. Peasants held land and some tools, artisans owned workshops and tools.

Origins of capitalism

In the late stages of feudalism, however, a number of important changes took place, eventually leading to the rise of a new form of human society – capitalism. These changes included the removal of large numbers of peasants from the land, as it became converted into the private property of aristocrats and turned into sheep and cattle farming, the arrival of Europeans in the Americas and the transfer of vast amounts of plundered wealth from there to Western Europe, the slave trade in which Africans were sold like commodities to enrich the emerging capitalist class and dynamic trade with parts of Asia. There was a scientific revolution beginning in the late 1400s, a philosophical revolution in the 1600s and 1700s (the Enlightenment) and in the late 1700s/early 1800s, the industrial revolution.

The dispossession of peasants in Western Europe meant that there was now a large class of people who had no control over any means of production for creating their own necessities of life. The only way they could now feed and clothe themselves was by selling the one thing they still owned: their ability to work. At first there was simply nowhere for them to work and many starved, were enslaved, or became parts of a big underclass in expanding urban centres, or rural outlaws. Plunder and trade meanwhile was concentrating large amounts of money in the hands of the emerging capitalist class. An important factor in the creation of modern capitalism was the slave trade. As Marx noted, “The discovery of gold and silver in America, the extirpation, enslavement and entombment in mines of the aboriginal population, the beginning of the conquest and looting of the East Indies, the turning of Africa into a warren for the commercial hunting of black-skins, signalised the rosy dawn of the era of capitalist production.”

With the dispossession of peasants in Europe and their conversion into wage-labourers and with the wealth garnered through the slave trade and plunder, the new capitalist class could establish factories and hire workers.

As capitalism developed, the dispossessed class largely became absorbed in the growing new workplaces, especially the big factories, or became wage-workers or tenants on big landholdings which had once been in the hands of their extended families, clans and other collective groups. (In New Zealand, this process was very visible in the second half of the 1800s, as Maori were dispossessed of land and had no alternative but to become workers for wages. It was also very visible in the way that land prices were established that meant no workers who came here from Britain could afford to buy land, but would also have to work for wages.)

Characteristics of capitalism

Because under capitalism the mass of people could no longer produce their own necessities, they were also forced to buy them. Moreover, in general under capitalism, production was now for the market, rather than for direct consumption by the producers. Production for the market in a capitalist society also meant production for profit. Goods produced to be sold on the market for a profit are called commodities.

So we can see a couple of the main characteristics of capitalism:

● Commodity production – the production of goods to be sold on the market for a profit – becomes the dominant form of production in society and expands rapidly

● The producers no longer own or control their own means of production; they have been dispossessed of these; the only way they can survive is by selling on the market the one thing they have left – their ability to work (their labour-power)

Under capitalism, we have the continuation of use-value production, but use-values are produced as commodities; the exchange-value aspect is more important than the use-value. We can therefore identify capitalism as involving two intertwined processes, one of which is universal (done by all types of society) and one which is specifically capitalist:

● Labour process (universal), production of use-values

● Valorisation process (specific to capitalism) – production of exchange value/value

The capitalists’ economic power was matched by their seizure of political power, as they overthrew (and executed) feudal monarchs in revolutions in Britain (1640s), France (1789) and, later, in other countries. In France, a large chunk of the old ruling class (the aristocracy) was beheaded.

Under capitalism, with the development of more and more technology, production becomes more efficient, the social surplus grows massively. However it becomes less immediately clear than it was under slavery and feudalism who produces the surplus and how it is the product of exploitation.

For instance, whereas under feudalism, the obvious physical division of the peasants’ working time between producing their own necessities on their own land and producing a surplus on the local baron or lord’s land, makes it equally obvious who produces the surplus and that they are being exploited, under capitalism things appear differently.

In a capitalist society it appears that workers sell their labour-power on the market for a wage. They go to work for 40 hours – or, these days, often more! – and get paid for those hours. So it appears that no exploitation takes place.

But where, then, does the surplus come from?

Exploitation

The surplus can’t come from simple sales – for instance, buying cheap and selling dear – because everyone would do this and the total transactions involving cheap and dear products would cancel each other out.

This is where we need to understand the way that production of the surplus and exploitation of the producers – transparent in slave and feudal societies – become opaque or invisible in capitalism.

What happens in capitalism is that while workers may, and certainly in the First World often do, sell their labour-power at its value – which is basically the cost of reproducing themselves in a fit state to work each day and being able to produce the next generation of workers – something else goes on in the production process. We can take the example of a worker the value of whose labour-power is $500 a week and whose wage is $500. It appears that this worker is getting a “fair day’s pay for a fair day’s work”. And, indeed, there is a genuine formal equality in the transaction on the market – the worker sells his/her labour-power at its value and the employer pays that value in the form of a wage.

However, when the worker is put to work in a factory or other workplace producing goods or services for the market, they will be using machinery and working in a group. Collectively, then, workers produce a mass of goods whose value is greater than what they are paid. Say they are producing cars. In a week, in a car plant, a worker might produce $1,000 in value in the form of a car or part/s of a car. So, just like the feudal peasant, the worker’s working time consists of two parts – one in which they produce a value in the form of car production of $500, which is the same as the value of their own labour-power (or the amount they need to live on each week) and which we can call necessary labour or necessary labour-time and another part in which they produce an additional $500 of value, again in the form of car production, which is the surplus and is produced through surplus labour in surplus labour-time.

Because both necessary and surplus labour in capitalist society are performed in the same workplace as part of the same working week and the same physical product, it is not immediately obvious, as under feudalism, that the worker is being exploited through working extra hours and creating a surplus.

It would, however, become obvious if a group of workers said after 20 hours of a workweek, “OK, we’ve been paid $500 and we’ve produced $500 of value, now we’re going home for the rest of the week! The boss would not say, “Fair enough, see you next week.”

Because the capitalist owns the means of production and therefore the worker has no way of surviving without selling their labour-power, economic compulsion (and legal compulsion in the form of work contracts) ensures the worker will work the surplus labour-time. And, of course, few workers are even aware they are performing surplus-labour because of the way it is not obvious as it was under feudalism and slavery.

(In feudalism, as we noted above, the surplus is a direct product, separate from the product the peasant creates for their own direct consumption. The surplus in feudalism is therefore best described as surplus product. In capitalism the surplus is a value embodied in the product, just like the necessary work-time is, and is therefore best referred to as surplus-value. The surplus-value is realised when the product is sold. Then it is converted into actual profit.)

The creation of surplus-value, which occurs through the exploitation of workers, is the key which makes capitalist society go round. Part of the surplus-value goes to the state, in the form of income and company taxes and finances government expenditure on a range of things from public health and education to the cops and courts and secret police; part of it goes to banks and other lending and investment institutions in the form of interest; part of it goes to those who own land and buildings in the form of rent paid by businesses; part of it is used to reinvest in new, expanded plant, machinery and research and development. And some of it is used personally by the capitalists to buy stuff like the $10 million home owned by prime minister John Key.

Division of surplus-value

As in ancient slave societies and feudalism, the surplus (or, more specifically, surplus-value) produced in capitalist society is divided up in various ways. The development of capitalism, for instance, leads to a massive development of the state – all these state services, managers and employees have to be paid out of the surplus. These include the costs of health and education, courts and prisons, standing military forces and so on. The thing about these goods and services is that they are not produced as commodities – they are not produced to be sold on the market to realise a profit. They are, or were in the past, free or cheap and therefore sell at much less than their value. So they have to be financed out of the overall social surplus.

The way this is organised is through the state taking part of the surplus-value in the form of tax. Generally, in a capitalist society, tax, including PAYE tax on workers, is deducted from the total surplus-value.

Some of the surplus-value also goes in rents paid by businesses to the capitalists who own the land and/or buildings and some goes in interest to other capitalists, like banks. Some of it goes into reinvestment (which could be called “productive consumption” because it leads to further production of wealth). Some of it goes into the luxurious personal lifestyles of the capitalists (which could be called “unproductive consumption” because it does not expand the total social wealth).

During economic boom periods – like the massive post-WW2 economic boom from the late 1940s until the early 1970s – there is such a huge mass of surplus-value that the growth of the state and state services present no problem to the economy. Similarly, during such times, workers in a few sectors may even increase their wages in a way which gives them a little bit of the surplus (although, generally, even in a boom, surplus-value and profit expands much more than wages).

However, the history of capitalism is the history of booms followed by busts. Booms have generally lasted 10-15 years, followed by busts. The post-WW2 boom was the great exception, lasting for around 25 years. Why do booms always lead to busts in capitalist society?

A crisis-ridden system

In a capitalist society, because it is based on the spontaneous operation of a thing – the market – rather than conscious human control and planning, all kinds of things can and do go wrong from time to time. There can be too much production in one particular sphere of the economy, for instance. However, the fundamental cause of deep-going recessions and depressions like the 1930s and much of the period since 1974 is the tendency of the rate of profit to fall. In the late 1970s, after several years of recession following the end of the postwar boom, the OECD did a study of profit rates in all the major capitalist economies and found that the rate of profit had been falling in all of them for some time, even at the height of the boom. The OECD study was not able to explain this and was somewhat mystified by it.

However, there is no big mystery about why the rate of profit falls once you understand the nature of capitalist economy and the way the surplus is created through exploitation. What happens is that as capitalism expands, more and more capital is invested in plant and machinery in proportion to the amount expended on labour-power. We can make an equation S/(C+V), where S represents the surplus-value and C and V represent the capitalists’ outlay: C is constant capital (spent on plant, machinery, technology, raw materials) and V is variable capital (spent on labour-power). C merely transfers its own value into the new product. V, however, creates additional value through surplus labour-time, as we have explained already.

As C rises more and more, in relation to V (the part which creates new, expanded value), the rate of profit therefore falls. The overall surplus-value may still be large and expanding, so at first there doesn’t appear to be a problem. However, after a period of years, capitalism is faced with re-equipping and modernising not only individual workplaces, but whole industrial sectors and even whole economies. It is at this point that the fall in the rate of profit becomes a problem, because they simply lack the necessary capital for the scale of modernisation required. Thus the first country in which the postwar boom ended and recession began was Britain, because it had the oldest industry.

For instance, take a point in time in which capitalists invest a billion dollars and gain a 10 percent rate of profit. That means $100 million profit. But as the rate of profit falls to five percent, they would have to invest $2 billion to make the same amount of profit.

When the rate of profit falls to a level where ordinary production cannot be sustained, let alone new investment to revitalise industries, economies go into major recessions. How do the employers respond to this situation?

Capitalists often resort to using what profits they do have to speculate in shares, property, foreign exchange and so on, so there is a massive growth of the artificial economy – the sector which produces no surplus-value but plunders overall social surplus-value. This happened on a massive scale in NZ in the mid-1980s, as in other capitalist countries. The unproductive sphere (the artificial economy) expanded massively, while the productive sphere (the real economy) stagnated, starved of investment. This resulted in the October 1987 crash when the real economy could no longer sustain the parasitic, artificial economy and brought it crashing down.

Their crisis, our suffering

In economic crises, especially protracted ones like that which has followed the end of the post-WW2 boom, capital is forced to do two other essential things.

One is attack workers’ wages and living conditions, in order to cheapen the price of labour-power.

The other is increase the share of surplus-value in the hands of capital by decreasing the amount that is spent, usually by the state, on producing and providing public goods and services below cost.

In New Zealand, these two processes have been at work since the early 1970s, but reached their most ferocious under the fourth Labour government (1984-90) and in the first term of the fourth National government (1990-93).

A recent prestigious Canadian foundation report found that real wages in NZ decreased 6 percent in the 20 years from the mid-1980s on. Many workers, of course, have suffered much greater decreases. Wages, conditions and workplace organisation has been rolled back on a massive scale, as employers have sought to cheapen the price of labour-power in order to boost profit rates. Most workers in NZ have direct experience of this. It reached its peak with the Employment Contracts Act of 1991 and the process has continued under Labour. In fact, the rate of inequality between the “average New Zealander” and the several hundred richest individuals and families in New Zealand expanded more rapidly under Labour than National. It has also become harder for workers to strike.

But the other process is something that people often find more confusing and that is privatisation and the other changes that have taken place in the old state sector. Often people can’t understand why, when these things weren’t broken, the fourth Labour government decided to ‘fix’ them and began selling off state assets and turning other parts of the state sector into SOEs (State-Owned Enterprises), Crown Enterprises and so on.

The main reason, as noted above, is because the state sector in capitalism, as in previous forms of society, is only made possible by – and lives on – the social surplus. In terms of how capitalism operates, the state sector is largely ‘non-productive’ – ie in the sense that it does not produce surplus-value but uses it up. Of course what is ‘unproductive’ for capital may be extremely productive/useful for society. However, private profit, not social usefulness, is the chief imperative in capitalist society.

When the rate of profit fell to such an extent that the postwar boom ended and a crisis began, an important way for capital to escape the crisis was to lessen drains on surplus-value. The less the deductions on surplus-value by the state, the more there was to convert into private profit.

Where the state had built up resources to a level where they could be profitably run as private businesses, capitalists were keen to get possession. So Labour sold a chunk of these to its wealthy backers and friends after 1984. The break up of the Post Office and the sale of the telecommunications part (now Telecom) is an example. The goods and services produced by these former state assets were now produced for sale at a profit on the market – ie became commodities – and so instead of being a drain on surplus-value they became contributors to surplus-value. This was good for profit rates, especially for those who got ownership of these enterprises at bargain prices, but not so good for the thousands of workers who were laid off by Telecom, NZ Rail and so on when they were privatised nor for workers more generally who now had to pay market rates (and more) for these services.

The other thing done by Labour and National from 1984-93 was creating SOEs and introducing market rates, or at least some form of such charges, for previously cheap or free services. Goods and services still in state hands therefore became commodified or partly commodified – ie, to varying degrees they too were now produced to be sold for either a profit or as close to cost as possible. This also required job shakeouts for workers in those areas, worse working conditions and pay for workers ‘lucky’ enough to keep their jobs and increased charges for all who use those services.

The other major reforms to reduce ‘non-productive’ deductions on surplus-value were to slash benefits (the 1991 “Mother of All Budgets”, maintained since by Labour) and to generally rein in spending on health, education and other ‘non-productive’ sectors.

After 1993, the crusading nature of these ‘new right’ reforms declined, mainly because while they did part of their job (driving down wages and living conditions, weakening effective workplace organisation, reducing ‘unproductive’ deductions from surplus-value), they did not succeed in bringing a new boom to the economy. The reforms have been bedded in both by Labour and National since 1993, with some of the roughest edges being smoothed down a bit.

Maintaining government budget surpluses, holding down spending on health, education and other ‘non-productive’ sectors, restricting wage rises and any kind of independent or militant workplace organisation, and continuing the process of commodification, albeit in a slower and more managed way, remain the core of economic policy of the two dominant political parties.

From the above we can see that struggle over wages and conditions and over how the social surplus should be divided and spent are in-built into capitalism.

Alienation

The other kind of conflict that is in-built is the struggle over aspects of how work and the workplace are organised. These are generally linked to employers’ attempts to weaken workplace organisation and impose practices which cut costs and boost profits – or, in the case of the state sector, cut costs to cut drains on surplus-value.

However, this form of conflict is also connected to another in-built feature of capitalism – namely, that workers no longer have any control over the means of producing their own subsistence, let alone any surplus. They have to sell their labour-power and turn up each day at a workplace owned by someone else – either a private employer or the state. This situation can be called alienation.

On the one hand, the worker has been alienated from their own means of production historically (ie dispossessed); on the other hand, the workplace is an alienated and alienating place because the worker has little or no control over it. Rules are imposed. The products workers create are not owned by the workers, but the employers. In factories, workers become mere “hands” on production lines. Offices have increasingly come to resemble factories in the way they operate. Newer industries, like the fast food sector, also have factory-line styles of production. And where workers might figure out more efficient ways to do things, they are reluctant to pass these on to management because greater efficiency is likely to lead to job losses. Even humanising the workplace in small ways is often hard.

It is difficult to see how any of these problems can be overcome without reorganising society as a whole. For instance, if workers collectively produce the basics of life, or the value thereof, in 20 hours, we could have a 20-hour basic workweek. We would likely decide that we wanted free health and education and also reinvestment in more and more sophisticated machinery and technology etc to make production even more efficient. Therefore we would want a surplus and we could work out how many extra hours we’d need to work to create this. In such a situation, because production would be based on meeting human or social needs, and be rationally planned, we could work 25 or 30 hours a week total, have plenty to live on, have plenty of spare time and a big surplus for health and education and other things society wanted. And we would have control of the workplace, so the hours we worked would be a great deal more pleasant and humanised than at present.

See also: How capitalist ideology works