Then What Is Capital?
Yesterday we defined wealth. If you need to catch up, it’s here: Part I. Today, in Part II we’re going to define capital and capitalism. Tomorrow, in Part III, we’ll use those definitions to determine whether capitalism is an evil system of depriving the poor in order to enrich the already rich, as you may have been led to believe, or whether it’s a system of increasing productivity and thereby increasing wealth.
Let’s look at Crusoe on his island again. Crusoe has some good ideas about farming. He understands that, with some tools, he can greatly increase the productivity of his bare hands. The first thing to do, then, is to spend some time making a plow. It’s not easy. Without ore and a forge, he has to make do with supplies at hand. He makes a plow out of coconut shell and some sturdy bamboo, which he has lashed together with the fiber he also uses for fishnets. It’s pretty crude, but it’s a lot more effective than digging with his hands. He is able to accomplish more. The plow he has made is capital.
Capital comes from surplus work. In addition to the farming he was doing by hand to subsist, he took extra time to work on this capital project. It wasn’t easy, but it was worth it. Because with that capital (i.e., extra time/work/wealth invested), he is able to produce more with his garden.
With the surplus he is able to produce with his plow, he finds himself with more time above and beyond what it takes to subsist, and he can use this time for more capital investment. He spends many spare hours gathering large sections of bamboo, which he connects together in a rickety but effective pipeline from the spring. He has invested in an irrigation system. The capital comes from his extra work, the actual building of equipment—which will greatly save his labor in the future so he can produce more.
Capital is always a representation of surplus work that is invested to find ways to produce more wealth. A society of hard workers without capital may remain as third-world agrarian subsistors for thousands of years. But bring in some capital investment for invention, and quite suddenly you have the makings of an industrial revolution.
There are two ways to get capital. The original and best way is to work more than necessary while spending less than you’re making. That is what Crusoe does in the irrigation example.
Another way is by borrowing capital. Debt is, of course, spending money yet to be made on the assumption that it will be made. So debt means it’s going to take longer before those future earnings feel like wealth. But sometimes the expectation is that, with capital, so much more can be accomplished that the debt will be paid off and then some.
Suppose Friday wanted to do fishing from a boat, because he knows he would have access to more fish to catch out away from shore. But building a boat is a big capital investment. If he takes time out from his fishing to build a boat, he will be without food for maybe a month—not really an option. Or he could build the boat slowly, but in his spare time it would take him maybe a year to get it finished. But suppose another native already has a boat (he used it to try to leave the island once, but then decided he preferred the island as home, and the boat has sat unused since). The boat is capital for the other islander—his surplus.
Friday makes a deal with the boat owner: “You let me use the boat now, and I will make payments to you for the cost of the boat plus a percentage more, to compensate you for letting me use the boat before I could pay for it.” This deal is a loan, with the cost plus interest being returned. But it is also a use of the boat owner’s surplus. He is able to put his capital to work, to increase his own wealth, by investing in Friday’s plan. So loaning capital is one part of capitalism.
There is some risk. Friday might be wrong about there being more fish out away from shore, so he might have a hard time repaying with interest. Or he might crash, causing the loss of investment, which would mean taking a very long time to repay the loan plus interest (and maybe defaulting and never being able to repay).
Another way Friday might make the deal is like this: “You could become part owner in my business. I will do all the work and all the fishing, but because I use your boat, I will give you an agreed on percentage of my profits.” Friday makes the boat owner an investor in his business. This arrangement is a partnership, but there are various other arrangements for a person with capital to put his money to work in someone else’s business. The stock market is a complicated mechanism, but it’s really just about finding ways people can take their capital (their surplus wealth) and put it into projects that they believe will help them make more wealth, benefiting both the owner of the capital and the user of the capital.
In this system, there is never a time when someone gets something for nothing. The capital investor has worked beyond necessity to earn the capital, and he tries carefully to place this wealth where it can do more wealth creation (and wealth is created by work, remember, so he is facilitating productive work). The entrepreneur who uses the capital does not receive it for free; he must use it to make a business productive enough to provide wealth for himself as well as the investor.
In short, what is capital? The accumulation of work above and beyond what is essential followed by careful use of it toward a good idea intended to result in even more surplus.
And what is capitalism? A system for using accumulated wealth to invest it in more wealth creation.
Keep these definitions in mind tomorrow as we look at the morality of capitalism.