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More words that matter: capital and labor – Part one

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From Peter Radford I was having a conversation this morning in which I argued the word “capitalism” has no meaning.  Or, perhaps, it has too many meanings.  It is a fraught one as well.  People get vexed in its presence.  I ought also have said the same thing about the word “labor”. Both words are relics of the early years of industrialization when they meant more to those throwing them around back then.  In our contemporary economy they mean rather less.  To me they reference things quite different from what they are in typical economic thinking, they are place-holder words for a power relationship that exists in a modern economy between employer and employee.  That relationship is better described in a corporate context, in which case the notorious “capitalist” slides from view to be

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from Peter Radford

I was having a conversation this morning in which I argued the word “capitalism” has no meaning.  Or, perhaps, it has too many meanings.  It is a fraught one as well.  People get vexed in its presence.  I ought also have said the same thing about the word “labor”. Both words are relics of the early years of industrialization when they meant more to those throwing them around back then.  In our contemporary economy they mean rather less.  To me they reference things quite different from what they are in typical economic thinking, they are place-holder words for a power relationship that exists in a modern economy between employer and employee.  That relationship is better described in a corporate context, in which case the notorious “capitalist” slides from view to be replaced by the sort of managers agency theory is purported to talk about, while the power lurks in the background.

That power relationship was massively asymmetrical in the decades before the emergence of modern democracy, but has been made more benign subsequently.  Note that I am not arguing all is well.  It has been made more benign, not perfect.  Far from it.  Democracy is the counterweight to the excesses erstwhile capitalists unleash on us all.  It is why plutocrats, as I prefer to call them, are constantly trying to pervert democracy.  It’s a power struggle that never ends.  So we ought expect the latest batch of plutocrats to seek to do evil to democracy: it dilutes their power and thus threatens their wealth.  There is nothing new in this power struggle, most societies have had a self-serving elite trying its damnedest to pillage the underclass.  Our modern economy is no different.

The slipperiness of both words, capital and labor, has done quite a bit of damage to economics.  They were inserted early on into that strange animal we call the production function.  They were regarded as inputs into the machinery of the economy and a great deal of time and effort has gone onto understanding their relationship.  It was only noticed later that their domination of the production function threw a chilling light on the lack of understanding economists had on a central issue of concern to them: growth.  Which, it turned out, was more caused by something called total factor productivity than it was by either capital or labor.  Clearly something was amiss.  Maybe capital and labor were far less important than we thought, or, maybe, they were the wrong things to be talking about in the first place.

And it wasn’t as if the problem was a small one that could be tucked under the rug.  For instance, when Abromovitz first checked his numbers, what he referred to as the residual in his equations accounted for approximately 80%-90% of growth.  Capital and labor were, indeed, of little importance.  Solow confirmed this a little later, although his version of the residual was a bit smaller, weighing in at around 60%-70%.  Clearly economics need a major revision.

Hear is Abromovitz’s description of what he took away from this conundrum:

So the Residual was really a grab-bag.

For this, there were several big reasons. One was that the measure of factor inputs was incomplete. The whole intangible side of total capital accumulation-education, on-the-job training, and research and development (R&D)-was neglected. And so were other categories of expenditure and forgone earnings by business, households, and govern- ment (for example, the costs of improving health) that have the effect, and often the purpose, of increasing future income. So also were the productivity gains attributable to better allocation of resources and to economies of scale. And all these missing elements were unmeasured and difficult to measure but still embedded in the Residual. It was clearly not a measure of the advance of applied knowledge alone.

With all that in mind, I called that big Residual “some sort of measure of ignorance”

A measure of ignorance is a mighty healthy way to describe the finding.  It is a valuable discovery to learn that your hitherto assumption, in this case that the key inputs are capital and labor, is incorrect.  Economics should be applauded for this discovery.

What it should be criticized for is its consequent continued inclusion of capital and labor as inputs, and for its adoption of total factor productivity as something to be studied rather than eliminated by further discovery of what, exactly, are the proper or more influential inputs.

This does not mean that economists ignore the problem.  We are constantly hearing from them that modern workers need to sharpen their skills if they are to remain relevant in our high technology economy.  There’s a clue in there somewhere: perhaps skills are an input?

As an employer I purchase access to those skills when I hire an employee.  As a worker I sell those skills to the highest bidder.  Or I try to.  In the context of our highly inter-connected economies skills are a key ingredient to getting stuff done.  If so, they ought to be an input.  Or some proxy ought to be.

But now we have another problem: we have disaggregated labor.  We have identified one part of it as being a skill.  What else is there?  Might I suggest energy?  As we all know work requires energy.  We transform our natural environment by applying energy to previously useless, or disordered, stuff and thus turn it into useful, or ordered stuff.  Our subsequent consumption of this ordered stuff then disorders it, but that’s a different discussion for later.  So energy seems to be important.  It needs to be an input.   This would be helpful in our conversations about the environment.  If energy was an explicit input in our production functions we would expose it to more analytical critique and, dare I suggest, make it easier to discuss ways to source it more efficiently.

So labor might better be viewed as a combination of skill and energy.  The word labor could then be banished to the realm of politics, or I would prefer to political economy, where it belongs.  People do work.  People apply their skills and their energy to a material or informational substrate to create order which they then consume to extract the energy, as in food, or other use, as in an iPhone.

What about capital?

I think Abromovitz gives us the answer, or he hints at it.  It is the accumulated consequence of prior advances in knowledge.  It is manifested in technology, not narrowly defined as machinery, but is more broadly defined as embedded knowledge within any process that allows skills and energy to be more efficiently deployed.  Which means that capital includes all sorts of things we typically disregard: it includes our ability to manage a process, our ability to discover new knowledge, and our ability to fund these along with the application of prior advances in knowledge.  Capital is, in short, an enabler that has a huge social component which is why it has always had a fraught aspect.  Who owns it also owns the enablement, even though skills and energy are more fundamental or basic.

More sophisticated capital, by which we mean simply that we have learned a lot along the way, means we can expand our ability to imprint our skills on a wider array or forms of substrate by coupling it with energy.  All to create order.  All, subsequently, to consume and destroy that order.

I realize that this is very crude, for which I apologize.  It began this morning in my rejection of the word capitalism, which is a distraction from our understanding of the creative process we apply to our environment to make the stuff we both like and need.  But I do see the economy as a cycle of creativity wherein our skills are enabled by what we learned in the past and the harnessing of energy, to fashion a substrate into an order we value in its destruction.

More on all this later.

Peter Radford
Peter Radford is publisher of The Radford Free Press, worked as an analyst for banks over fifteen years and has degrees from the London School of Economics and Harvard Business School.

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