Capitalism and a market-based economy are not the same thing

Capitalism and a free market economy are not the same thing. While this may seem evident to many, there seems to be a general confusion that leads to all sorts of challenging discussions. If you aim to change or improve a system, it is first critical to properly understand it. To understand a complex system such as a modern economy you should probably start with some of the core organizing principles. How do we allocate resources among citizens? How free are citizens? How much control does a central authority have? etc. It is clear that we cannot address all of this in a blog post, but I wanted to point out one critical issue that keeps coming up in discussions – capitalism is a method of distributing resources in a society. In contrast, a market based system of exchange of goods and services is a mechanism to force organizations to improve their performance and the value they deliver. While there are strong linkages between the two concepts, they are not the same thing.

When discussing politics, the common refrain is that capitalism and our current form of democracy are the best systems we have and we should be content to keep plodding along. I will put aside the democracy issue for now, as that merits another post. There is a common social acceptance that capitalism was the driving force behind the insane economic growth of the last 300 years. From the industrial revolution to the latest AI startup, we tend to chalk up progress to the existence of capitalism. However, I would argue that we have a strong tendency to conflate capitalism and a market based economy. It is not simply a chicken and egg question (though it partially is). What came first, capital or innovation? Capital over the past millennia was generally stable and then exploded in the industrial revolution. What changed? We still had kings, aristocracy, the church and other organizing forces. Innovation allowed organizations to offer greater value in the form of cheaper goods – kicking off competition, which is a self reinforcing flywheel that has kept accelerating ever since.

Capitalism

Capitalism is commonly defined as “an economic and political system in which a country’s trade and industry are controlled by private owners for profit, rather than by the state.” This definition seems fairly clear, but I would argue that it conflates ownership with trade. Capital is a representation of the accumulation of something of value. You can have political capital, you can have social capital, you can have a variety of capital. It is not necessarily monetary, but it is something of value.

Capitalism is a form of social organization that is based on people and institutions with capital making decisions. You could contrast this to Socialism, where it is a society that collectively makes decisions or with Aristocracy where it is the king that makes decisions based on divine right. Some would say that we cannot simplify capital to be a generalized concept of counting “value” as that would be too simplistic and too vague, but let me continue on this tangent. A critical error in the definition above is to limit capitalism to the ownership by private interests. Many countries have state run companies, meaning they are owned by the state. The current Chinese political and economic system is often referred to as state run capitalism because the Chinese government is so active in the economy via the companies it owns and controls. So, capitalism should be better defined as a system where those who own the capital make the decisions – be they state, private or other.

Money

Despite using money on a daily basis, many of us and I did not know that money really is. In most school textbooks, we are taught that money is a tool for exchange – it allows me to buy something from you without trading directly in what I have (chickens for example). However, this concept of the origin of money is utterly false and lacks any substantial anthropological evidence. To learn more, simply consult David Graeber’s essay on debt.

So, what is Money? Money is a quantification of value. Money is a representation of assets (value) and debt. In fact, money was invented by the ancient Sumerian temples who were trying to quantify their assets – cows, grain, wine,… and track who owned what to whom. Money, ultimately, is a score-keeping system. It is, an accounting mechanism. Anyone who has run a business or done complex tax returns will know that the “score-keeping system” we use for managing money is far more complex than a simple point system.

In contrast to scoring goals in a game, money is not created in the same way. Money is issued (today at least) by a central bank. In reality money is not issued so much as created by the issuance of credit. The central bank issues credit, not money. When you hold a $20 bill in your hand, it is a note of credit from the government to you. You do not actually have $20, you have credit and in counterpart the central bank has a debt. However, if we start to look at all of money as an accounting system – which it is – then we can begin to realize that the game is rigged.

There used to be a social movement called the Social Credit (notice the use of “Credit” in the name). Without going into detail, this movement identified how the current accounting system used by businesses and by owners of capital was rigged against wage workers. In short, the way we account costs and revenues is not reflective of the actual costs of production and it is unsurprisingly skewed towards the owners of capital. To take a simple concrete example we can look at the depreciation of equipment. The depreciation rates that businesses can apply to their equipment is usually in excess of the actual depreciation of the equipment. That is, you can reduce the value of the equipment in your accounting of profits and losses faster than the value of the machine objectively decreases. You may depreciate the value of a computer in two years, but it actually has a useful life of five years. By doing this, you capture that difference (3 years) and you can use that hidden value to drive more business and therefore profit from it. Social credit is far more complex than this and I encourage everyone to look into it. But the long and short of it is that money is a representation of assets and credit and that the math we use for accounting is rigged against workers and for the owners of capital.

Free Market Economy

A free market economy is defined as “The free market is an economic system based on supply and demand with little or no government control.” Another way of stating this would be to say that a free market is a competitive market where different actors – private or public – can freely compete for resources and customers. When the aristocratic system fell apart during the industrial revolution (and after), it was largely because the industrialists competed and beat the aristocrats in creating greater value to citizens. They offered work to peasants and produced much more value than the traditional agricultural based system controlled by the aristocrats. My own French family came from an aristocratic family in France that saw their relative wealth evaporate as they stayed centred around agriculture and ownership of land, while new industrialists build factories. Eventually, may family sold their Chateau to the family of are large grocery chain. What has driven the vast majority of the innovation and wealth we see today is not capitalism itself, but rather competition.

Forcing people, companies and governments to compete with each other in order to create as much value as possible is the principal source of our wealth. As with any competition, we must have clear rules and that is where rule of law comes in and it remains a primary function of governments to establish and enforce the rules we use to compete. Different rules will lead to different outcomes and it is therefore critical to select the right rules for the right situation. Capitalism is a series of rules about the ownership of capital – despite being an important rule, it is only one rule among many. However, I wish to highlight that it is the competition among actors that drives our wealth – not simply ownership of capital.

Conclusion

The current political and economic elites have successfully conflated the concepts of capitalism (the private ownership of capital) and competition, telling us that their version of Capitalism is the best system for society. The truth is that the rules we are currently using are not fair to workers or the unlucky. The game is rigged, the house will always win. In Thomas Piketty’s seminal book, “Capital in the 21st Century”, he outlines how owners of capital can generate returns on their capital that is superior to the growth in wages of workers without increasing the value they create. The classic example is the owner of an apartment building or land that generates returns greater than inflation. An apartment building does not create much value, and yet an owner of an apartment building can earn more money than workers. In consequence, the capitalist class (the private owners of capital) can grow its wealth faster than the working class and the gap between the two continuously increases until you have social unrest, war, revolution or some other large event that destroys capital and resets the balance. Social Creditists said as much and proposed interesting solutions, but we did not implement them. In short, there is a fundamental problem at the root of the current capitalist system that needs to be addressed for the good of human society.

If we want to generate more value in society, we need to look for ways to increase competition. We need to look for rules that will enable people and organizations to compete to their full potential and not be handicapped by poverty, disease or bad luck. We need to identify rules that will allow small businesses to scale and grow. Rules need to be found and implemented that ensure international commerce is fair and equitable. We need to improve our accounting rules so that the true costs of environmental pollution, labour, resource consumption and other externalities are included in the costs of production and the cost of goods sold.

In short, our accounting system is broken and it needs an overhaul. There are a number of options and the ones I have advocated for include basic income, affordable housing and free education. Capitalism left uncontrolled will eat itself. It is the role of society and government to constantly update the rules of the game to ensure that society is driven to increase the sustainable value it creates for future generations.