"Capital" As Seen By An Austrian Economist

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In recent weeks the concept of capital has been thoroughly, and incorrectly, deconstructed by Marxists and Keynesians alike now that, suddenly, the world caught up with what we said would be the crux issue back in 2011: record wealth inequality (who could have possibly foreseen it following $10 trillion in central bank balance sheet expansion in the last decade), and finding "fair" ways of confiscating the wealth of the rich to - at least on paper - help the poor even if in reality all it would do is simply lead to more government theft, embezzling, corruption, and capital misallocation. It is now time to get an Austrian perspective and courtesy of unrepentant "Austrian" Sean Corrigan we just got one.

Warning: not for the faint of run on sentences and subordinate clauses.

From Sean Corrigan of Diapason Commodities Management

One of the most overused and therefore confused terms in political economy is that of ‘capital’. For all the customary richness of the English language, one word here is made to serve for several not entirely consistent purposes at once and it is usually left to the listener, not the speaker, to determine which is under consideration in any given context.

Commonly, 'capital' can be taken to mean an entry in a balance sheet or the sums of money loosely pertaining thereto, entities which can somewhat more precisely be referred to as capital means. The word can, conversely, be used as a synonym for that assemblage of longer lasting, slowly-amortizing means of production – those 'fixed' capital goods - through whose use we greatly extend our feeble human possibilities in the repeated shaping of the (often more ephemeral) things we feel we require and with which a capricious Nature does not effortlessly endow us. Yet again, the term can often refer to that motley  collection of inputs, unfinished, or fully-processed goods variously cluttering up the storerooms of our business or simply awaiting final payment by those to whom we have already delivered them: working capital or, to use an even more venerable phrase, circulating capital is what we have in mind here. No less than John Hicks once referred to these two contrasting views as being those of the 'fundist' and the 'materialist', respectively.

No matter what might pass in everyday parlance, it is crucial to avoid an obsession with capital only as a physically-embodied quantum, much less one imbued with any degree of 'permanence' or - horror of horrors! - of homogeneity. Long ago, the Chicago School – under the aegis of Frank Knight – tried to insist on such a bulk measure and even thereby to imply that societal 'capital' was a self-generating resource, indeed an 'inherently perpetual' one, for whose upkeep nobody in particular need overly trouble themselves. The response from the likes of Hayek and Machlup at the time was uncompromising in its rejection of what the former once referred to as a 'noxious mythology'.

Among the many objections these two and others raised was the decisive one that, to the limited extent it is at all admissible to conflate 'capital' with such tangible means, it should never be overlooked that not only are the vast majority of the goods which comprise it highly functionally specific and therefore not at all versatile in their immediate employment but that even that primary degree of particularity is furthermore contingent upon their compatibility with others means and methods which comprise the overall structure of production.

We Austrians like to make much of the role of a whole complex of complementary flows of goods and services in validating the utility of any other good or constellation of goods. We also tend to talk of 'plan coherence' – of the need for the entrepreneur to map out a pathway through time which will intermesh with those taken by his peers in a manner which will offer him a reasonable prospect of delivering a remunerative product to his future customers. This helps remind us that, yes, the successful entrepreneur will compete vigorously for those customers' dollars – in part by trying to secure first call on some of the same inputs or workers of which others think they, too, could make profitable use in fashioning what may seem to be decidedly non-competitive offerings - but also that co-operation with others' undertakings – however unwitting it may sometimes appear – plays an arguably more important part in the commercial ecosystem.

To see this, just ask who could have hoped to make money launching a social network or offering cloud computing before the advent of cheap, mobile devices and near-universal connectivity? Who would then have been able to launch a high-tech reboot of the Georgian coffee shop as a centre of gossip, a hub of information exchange, and even a locus of the discharge of serious business, before the advent of the Twitters, streaming news feeds, and virtual office systems one can now access there?

All of this should make it plain that 'capital' is inherently dependent upon the context in which one seeks to deploy it and that, far from being permanent, it is in a state of unremitting, Heraclitean flux. Indeed, this condition is likely to hold all the more strongly for the more potent forms of novel capital combinations, since their operation is all the more liable to wreak profound changes in that very tangle of productive streams within which they must themselves work. Not only are such combinations at constant threat of emulation, super-session, or even outright redundancy, as others seek to reap the same rich harvest they promise to deliver, but they may fall victim to their own success in less obvious ways by disrupting the income schedules or, more generally, changing the preference scales  not only of their intended buyers but of their buyers' buyers’ buyers to the nth remove.

Capital is therefore never something which is simply assembled, wound up, and left to run in a corner of the factory, churning out goods and gathering in revenue with no more ado than to see the odd squirt of oil injected into its finely-tuned mechanism. It is altogether a more subjective and conditional construct than that.

But if we draw back from the jaws of Scylla, we must not be caught up instead in the swirl of Charybdis. It is therefore also important not to confound ‘capital’ too intimately with any mere monetary measure, even if we inevitably attempt to compare the values of our respective endowments in terms of the dollars and cents which are so ubiquitous a yardstick in an exchange economy. Again, it is the use to which the money (or the goods it has bought) is put which counts. Money under the mattress, to take the most trivial example, may rightly be counted as part of our wealth, but it is not participating in a transformation of values from one form or a translation of goods from one location to a second state or place where a higher appraisal results and so it hardly qualifies as capital, per se.

Even when we attempt to give monetary expression to that portion of an enterprise over which we have secured some lasting charge (often by persuading others to dig under those very same mattresses we dismissed above) and whether our obligations to them are of long-deferred redemption (debt) or of none at all (equity), before long, such ‘capital’ comes to represent a semi-fictional mish-mash. Here we find nothing less than a fuzzily-estimated, partly-imputed, and often deliberately-obfuscated conflation of the residual worth of a whole miscellany of non-commutative belongings, both tangible and notional (such as
goodwill). And our lack of precision does not end there for the whole will further be subject to even more rule-of-thumb adjustment in the form of the depreciation applied to it.

Patently, none of this can ever be really definitive, no matter how honestly we do our sums. On our books, after all, this gallimaufry may be worth one thing; in the hands of another, something different; and rusting in the scrapyard, something else again. Without such differences, the corporate financier's furrow would be a thin one indeed to plough; there being little scope then for mergers, acquisitions, or buy-outs on the upside and no lower bound in the form of liquidation value on the down.

Going beyond this, we are, of course, all too well accustomed to talking of the ‘capital markets’ when we describe the institutional setting within which we issue, acquire, and transfer the record of our lien over, or our shared ownership in, such purposive legal bodies, with all their associated fixtures, chattels, contracted labourers, ideas, licences, and brand names - and, indeed, no less an eminence than Mises himself declared that the single best marker of a market economy was the existence of a stock exchange. But our very familiarity with this means we are prone to lose sight of some of the fundamentals when we move all the way from counting unique apples and individual oranges to reckoning in uniform dollars and cents. That is a caveat which applies all the more forcefully when we add our shoes and ships and sealing wax to your cabbages and kings, then yours and ours both to those belonging to everyone else, as we tend to do when we talk glibly about the ‘capitalisation’ of the entire market.

Capital, as we have tried to explain, is as much as a matter of function as form and we should therefore like to propose a definition – if still a tentative one – along such functional lines, as follows.

'Capital', we suggest, is best thought of as a negotiable property rights framework within which to exercise entrepreneurial skill in the transformation of energy and matter over time into a succession of more highly-valued, freely-exchangeable forms under conditions of risk and uncertainty.

Here we should also pause to point out that the stated material inputs can be spent simply in sustaining the human actors involved so that, over time, they can produce what may well be completely intangible goods (i.e., services) for offer; that, in this context, the ‘framework’ implies a legally defensible statement of ownership which will vary by time, place, and institution; and that ‘negotiable’ means that the rights themselves may be freely transferred, not just their product. By contrast, we would reserve the term 'capitalisation' for the estimate of the current money price of that capital which we make according to our best guess of the pattern of the revenue stream to which we hope its operation will give rise, that putative stream's quanta being discounted back through time to the present at the prevailing rate of interest.

Since we have introduced it to the discussion, perhaps we should also briefly digress to make it plain that this business of interest is not the reward of giving up some ill-defined quantity called 'liquidity', of an inducement we must be offered if we are not to 'hoard' the money that comes our way rather than putting whatever part of our income we do not immediately intend to consume towards the purchase of some other financial instrument and hence at the temporary disposal of a third party.

Money, under most normal circumstances, is only peripherally to be regarded as a portfolio asset for to do otherwise is to deny due recognition of its principal economic purpose, viz., that of helping us carry out the manifold, mutually beneficial transactions by which we harvest the innumerable riches offered by the division of labour.

Money is not, by and large, to be thought of in terms of a stock to hold but rather as a vital flow via whose medium pulses the infinitely rich traffic of everyday life. It is not after all the blood pooling in the spleen which is critical to an organism's physiology, but the coursing fluid by which is ensured the unceasing circulation of oxygen, nutrients, waste products, hormones, and the watchmen of the immune system to all the body's tissues.

As even Keynes recognised, shortly after he had befuddled the issue in his General Theory, to talk unthinkingly of the 'demand' for money is to beg the question, demand in terms of what? It is in the answer to that deeper question that we find the roots of interest, for the demand with which we are really concerned is the one for money now – predominantly exercised so as to be able to relinquish it again in order to acquire real goods and services in the shortest of short orders – and that demand can only be expressed in terms of a credible promise to deliver a suitable sum of money tomorrow.

Far from being the price of money (as the liquidity preference crowd and the facile opportunity-cost stock advocates mistakenly consider to be the case), interest is therefore the price of time – namely, the time that must elapse between the surrender of a present good and the postponed recompense for that act in the form of a future good, the ratio between the price of the two being what incorporates the interest rate.

That this second sum is a naturally the greater of the two is a fundamental psychological - in many cases an undeniable biological – trait of Acting Man. Call it a consequence of our basic mortality or a symptom of our feckless morbidity, but we all value goods today more highly than goods tomorrow and are thus willing to offer a premium (interest) to have them served up to us early.

So powerful is this urge that people will often submit to truly exorbitant scales of interest in order to satisfy their craving for instant gratification – a proclivity which completely refutes the mainstream's risible angst that any likely, mild pace of generalized price declines will instantly freeze 'consumption' in its tracks as the improvident mass – ordinarily well accustomed to paying double- and even triple-digit rates to sate its appetites – will magically be transmogrified into a  horde of avaricious tightwads, each of its members stubbornly starving themselves to death while the price of bread inches lower by one or two percent a year.

In the context of our treatment of capital, it should be noted that this near axiomatic phenomenon of time preference helps ensure that the producer's goods which pass through the capital framework are acquired by its guiding entrepreneur at a money cost which is less than the sum of his presumed future net receipts. Though the inflationist zealots who populate the op-ed columns of the mainstream media may rage at the idea that people are in anyway entitled to a return on their forbearance, the truth is that the ensuing element of the entrepreneur’s gain – or that of the outsider who helps finance his endeavours - is no more than the price of time, rightly paid for his deferral of the enjoyment of his labours. This is a sacrifice he makes, as part of the routine conduct of his business, in favour of affording other actors in the chain of production (mainly his workers, those of his suppliers, and the workers of their suppliers, etc., etc.) the chance to enjoy their own fruits long ahead of their final ripening.

Seen this way, all monies spent by owner-managers on everything except their own end-consumption is effectively a form of capital outlay, of 'saving'. Since this accounts for between $30-35 trillion dollars annually in the US, versus just under $12 trillion of (imputation-boosted) personal consumption and approaching $6 trillion of total government outlays, we can see that the bulk of economic activity represents this very same act of future-oriented activity. Hardly a sin, you might think, however hard the One Percent of the intelligentsia might try to persuade us ordinary folk to the contrary.

Nor, alas, is it in anyway compulsory. Under the onslaught of that same elite’s invidious and counterproductive urgings, capital withdrawal, liquidation, or consumption is always a possibility, there being nothing automatic about its replenishment, nor any guarantees regarding its continuing increase or improvement. To reiterate, the maintenance of capital is not something which is compatible with a state of complete exhaustive consumption. Once eat your seed-corn, and while you may have a nice warm glow in your belly for that one sweet moment, you will also have ruined your chances of filling it – and filling it many times over, at that - in the course of the following season. Thus we arrive at the presumption that capital is not only first accumulated, but subsequently maintained, by the exercise of some measure of restraint - an act of providential abstinence we tend to refer to as ‘saving’.

Since even the most fervent singers of the Internationale would presumably be happy to accept that the Stakhanovite heroes of the local Soviet - to whom they implicitly and unfavourably compare us soft-fingered, bourgeois rentiers - can hew more coal per shift when not reduced to using their bare hands for the task, they must also concede that human endeavour is usually best augmented with some durable and pre-fabricated implements. They will therefore have to admit that someone had best desist from working the seam for long enough to fashion such tools for the greater glory of the Collective. Given, further, that the chosen tool-maker will both need to keep himself from perishing in the cold, Siberian winter and to heat the furnace in which he will forge the business end of the doughty miners’ pickaxes, NY Times columnists, too, will have to allow that a few choice slabs of carbon must be taken from each sinewy giant - according to the means of his chart-topping haul of coal - and given to our diligent craftsman - according to the needs of his glowing brazier. Thus, the formation of the equipment by which even the Dictatorship of the Proletariat will be more rapidly brought about must involve the tedious business of saving, even if it is a dreadful sin of unexpurgated class consciousness to state this truth so explicitly.

All the complications of the forgoing should alert the reader to the grave dangers of accepting glib academic pronouncements about the aggregate returns achievable by something called ‘Capital’ at face value, however irresistible it may seem to divide a given bucket of earnings by some epistemically doubtful gauge of total capital. He should be even more on his guard when any such attempt is gleefully harnessed to aid an assault on those garnering such returns, by means of the Trojan Horse appeal to ‘social justice’. This, a phrase Hayek which acidly referred to as a ‘semantic fraud’, is little more than a pretext under which our would-be philosopher-kings’ can give vent to their dismay that there can be men better rewarded than they - men who are impudent enough not to pay the pronouncements of these sages the slightest heed, into the bargain.

Contentions over what is to be included in the denominator in this overarching calculation abound (and has indeed already spawned a degree of polemic). But no matter what we chose to put in or leave out, we face the insurmountable stumbling block that capital can only be calculated here in terms of its historic cost. Yet to use this is to fall for the crudest of sunk cost fallacies (or perhaps for the more malign Labour Theory of Value). In truth, what was spent yesterday cannot now be unspent, so capital - like all other goods - must be revalued in both in the present moment and in each of the long succession of such moments to come. This, however, risks bringing us full circle, since the only basis which exists for such a valuation is to estimate the future stream of revenues we deem will accrue to our capital and to discount them back through time (perhaps also allowing for the incorporation of various subjective risk premia in the rate we choose) to the here and now. But if we do this, what does it then mean to talk of an independent reckoning of the return on capital, ‘r’ as the cause célèbre of the left-leaning salons is wont to do?

In light of all this, it is our belief that if we all held to some such expression of capital’s functional essentials as we have outlined above, not only would we be  better guarded against errors of understanding, but those of prescription, too. Certainly, a Rive Gauche Nomenklaturchik such as M. Piketty could not have undeservedly managed to seduce such a mass audience into marvelling at his crude, zerosum, neo-Marxist politics of confiscation if we had. In the first instance, it is largely beyond dispute that it is the condition of the property rights framework which is the prime determinant of both the productivity and the plenitude of capitalistic endeavour - even of the willingness with which it is attempted in the first place. It should be clear from the sorry contemporary example of his own homeland that Piketty’s desired Apparat would corrupt this framework beyond redemption and that it would do so to the detriment of the Many as well as to the frustration of the Few.

Secondly, entrepreneurs must display a rare skill not given to the rest of us ‘routineists’ (to use a trenchant Misesian phrase) – and hence they will fully merit their rewards when they do so. Furthermore, the courage to set one’s possessions at hazard and to expend one’s strength in a test of both (theoretically calculable) Risk and (intractably Rumsfeldian) Uncertainty is also what distinguishes those subjecting themselves to such vicissitudes from us, their prospective happy customers. This again plays a significant part in delivering the unequal – but hardly disproportionate - rewards enjoyed by the successful as opposed to those earned by both their less adventurous and their less competent peers. For all his undoubted human failings, can we really deny that a Bill Gates has merited a good part of his present fortunate estate and that it will serve little purpose for the envious state retroactively to lop the head off such an egregiously over-tall poppy ?

The fundamental truth is that, under the operation of a genuinely free-market capitalism, outsized economic rewards only accrue to those who do manage to add a great deal of value (we here pass swiftly over the parasitic levies exacted through the kind of political machinations of which our esteemed bien pensant  implicitly approves, as we also disregard those only made possible from an exploitation of the many flaws to be found in our inherently faulty monetary-financial architecture).

Under a proper free market capitalism – not the crony-ridden, inflationary Corporativisimo which governs our world thanks in part to the Trahison of such Clercs as our new Wunderkind - such a relatively enlarged recompense can only be enjoyed by those few who affect to offer a multiplicity of their fellow humans a net gain of individual satisfaction. The fact that they do leave us with a surplus of fulfilment after the sacrifice of all the necessary inputs (including that of the goods to which they could otherwise have given rise) is deducted, is justification enough for their elevation above the norm. Do not forget, moreover, that as every new day dawns in the unsentimental milieu of the free market, they must effectively start all over again if they are to sustain, much less increase, their advantage and that the smartest and the best are thus incentivized to keep finding ways to improve the common lot.

Surely, even the most determinedly paternalist utilitarian would find it hard not to support the notion that all is well and good if one man gains one hundred units of reward in return for adding one unit of betterment to the lives of one hundred and one of his fellows? Such are the considerations that utterly vitiate the truncated, ‘Progressive’ calculus that all the ills of the world derive from the dubious empirical contention that some ill-conceived, aggregate statistical artefact ‘r’ seems to be consistently greater than an equally smeared-out and uninformative facsimile of growth, ‘g’.