The exorbitant privilege of capital

Why we need to rethink capital’s relationship with labor

The robber barons

Capital has an exorbitant privilege. With capital we are able to undertake productive investments and reap a potentially infinite amount of rewards. However, capital is not the only factor of production: for those investments to succeed, we also need labor. Unfortunately the rewards received by labor are infinitesimal and declining. In the majority of the industrialized world, the share of national income received by labor has been dropping over the past decades as a result of a myriad of factors like globalization, deregulation of labor markets, and the neutering of the power and influence of unions. The root of this privilege goes back to the origins of capital and its historic process of accumulation.

Where does capital come from? One source is from capital itself. Any increase in the value of an asset provides the owner with additional income which can then be reinvested into other capital assets. Similarly, some assets like stocks and bonds provide a regular stream of income in the form of interest payments or dividends.  Additionally, physical capital like robots or other types of automated equipment can also produce additional capital without human input. However, the main source of capital is labor. Your work, as an employee of any firm, contributes to the profits of the firm through which the firm is then able to accumulate further capital. No amount of capital will make a firm thrive in the absence of labor which is why the two are not perfect substitutes. But capital’s exorbitant privilege comes from the fact that, unlike labor, it can generate infinite returns. Let’s see how this process takes place in practice.

Betting on Bezos

For an illustrative example, one can look at Amazon’s humble origins. In 1994, Jeff Bezos was planning to quit his Wall Street job to start an online bookstore and was looking among his family and friends for a $1 million investment. A total of 22 of them agreed to invest $50,000 each in exchange for a 1% stake in the company. For all of them, that would be the single greatest investment they could possibly imagine. Assuming that they did not sell off any part of that stake, their initial investment has offered a return of 14 million *percent* and by now would have made them billionaires. This despite none of them ever putting them a second of their time and effort in the company. The story for Amazon’s warehouse workers, however, could not be more different. Despite the fact that the company cannot run without its gigantic distribution centers, their workers are treated to near slave-like work conditions at the minimum wage (since raised to $15 an hour due to pressure). Given that these wages are hardly decent enough to accumulate savings, it is fair to say that their effective return is zero even though they are actually contributing to the further capital accumulation of the firm unlike Amazon’s initial shareholders.

In a nutshell, the initial providers of capital reaped all of the rewards and put in none of the effort. The workers who are the continuous providers of labor reaped none of the rewards and have put in the entirety of the effort to make Amazon a success. This injustice cannot be taken in historic isolation. The accumulators of capital are able to reinvest that capital into other productive enterprises which makes them even richer. The workers, unable to save, will accumulate no capital. A recent US Federal Reserve study showed 40% of Americans would be unable to come up with $400 for an emergency which shows just how much of the workforce lives paycheck by paycheck. Going further back, this historic accumulation of capital by a small elite has also been seeped in injustice. Marx famously introduced the concept of “primitive accumulation“, whereby capital was accumulated in pre-capitalist times through activities like the enclosure of common land from the late medieval period onward, as well as colonialism: many early industrialists had made their initial fortune in the sugar trade which was built on the back of slave labor. With this in mind, it’s hard to make the case that any holder of capital that didn’t accumulate it through labor first has done it ethically, that is, without some form of exploitation.

The Piketty equation

It is now a well-known fact that the rate of return of capital tends to grow faster than the so-called “real economy”: for example, the stock market tends to outperform nominal GDP which in the long run leads to even greater concentration of capital among those who already hold it. This is the essence of Tomas Piketty’s famous equation r > g which is the central idea behind his bestselling book Capital in the Twenty-First Century. Piketty has argued that this is an intrinsic feature of capitalism rather than just a fluke and if anything, the post-crisis environment seems to confirm it. Standard economic theory would have it that in a near-zero interest rate environment, productive investment should skyrocket but in fact the opposite has occurred: net investment in the US is at historic lows. One could argue that even in the absence of domestic opportunities then globalization would make it easier for the investments to be focused abroad. And yet this also has failed to materialize, with most developing countries (mainly those outside of Asia) suffering from chronic under-investment. Instead we have witnessed the accumulation of trillions in low-tax jurisdictions and offshore tax havens, and many other trillions squandered in low-productivity but high-return sectors like housing. Under capitalism, capital flows to the sectors that offer the highest returns, whether they are socially useful or even economically efficient.

Economic inefficiency aside, it is the impact on income inequality that is the most destructive in the long run. The infinite return on capital is the starting point for a moral critique of the capitalist system of production: there is no reason why this exorbitant privilege should exist and why it is allowed to perpetuate itself across generations. The simple remedy is obvious. Ownership of the means of production by workers would allow them to be the recipients of these returns. For example, any new business could see part of its taxes being used to fund an employee ownership trust (EOT), say equivalent to 1-2% of the company’s value each year. This would turn the company into employee-owned in the space of 25-50 years while still allowing its initial investors to have a juicy profit. In fact, even if Amazon were employee-owned at the minimum level of ownership (51%), it would have cost Bezos and his cohorts nothing: it is estimated that Bezos’s share of Amazon is 16% which adding the hypothetical 22% of the other 22 investors means that this all falls within the remaining 49% of the firm. But the benefits from employees would be extraordinary. Not only could they probably vote for more humane working conditions and higher wages, but would be getting dividends from their participation in the EOT. Labor would be getting its just rewards for its contribution to profit.

Cap ’em

Beyond that, there’s also no reason why the infinite returns on capital shouldn’t be finite. In other words, capped. Just as we don’t allow successful politicians infinite time in office, there’s no reason why successful investments deserve infinite returns, especially considering that the reverse never happens: thanks to limited liability, an investor can only lose as much as he put into an investment and not a penny more, something that even many liberal economists of the 19th century believed it would lead to unscrupulous behavior. If anything, capping the returns of an investment to a certain multiple of the initial investment would force entrepreneurs to invest in other activities rather than sitting on their pot of gold. Critics will argue that the promise of infinite returns is what makes entrepreneurship even possible. But is it truly the case? The odds of hitting an Amazon-like return is so infinitesimal as to be unrealistic. Most businesses are started not because of the promise of being a millionaire but by being in control of your own labor and income rather than depend on a boss and a wage: in other words, starting a business is actually a pretty radical socialist endeavor! Just don’t tell most small business owners…

Until capital’s exorbitant privilege isn’t ended and a fairer balance relative to the returns on labor are achieved, it is highly unlikely that the excesses of capitalism can ever be tempered. By definition this is impossible under capitalism, which goes to show why we need to consider alternative modes of production if we are to achieve a more just society.

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