The Case for Legalizing Capitalism by Kel Kelly

The Casefor

Legalizing Capitalism

The Case for Legalizing Capitalism

Kel Kelly

2010 by the Ludwig von Mises Institute and published under the Creative Commons Attribution License 3.0.

http://creativecommons.org/licenses/by/3.0/

Ludwig von Mises Institute518 West Magnolia AvenueAuburn, Alabama 36832mises.org

ISBN: 978-1-933550-62-6

The book is dedicated to the

handful of people in the world who

truly honor morality, principles,

and ethics, consistently, regardless

of personal agendas.

7Preface

I FIRST BEGAN to learn about economics in college and from reading and studying the topic subsequently on my own. As my studies progressed, I thought I was on the path to learn-ing how the world worked. But one day, while sitting at a caf in Paris (where I was doing graduate work), the book I was reading introduced me to the great economist Ludwig von Mises and the so-called Austrian school, which Ilike most peoplehad previ-ously never heard of. 1

After studying free-market economics, I began to under-stand how the world really worked, and learned that all other explanations of economics could easily be proven incorrect. I soon began to understand how our nations economic policies in fact actually harm us. I learned that the economic concepts that I, like everyone else, had always thought straightforward and obvious, were completely opposite from what we all simply took on faith. I thought that price controls, wealth redistribution, and government regulation helped and protected people. I had no idea that these things actually harmed those it was intended to help. I further assumed that economic progress was a natural phenomenon: I didnt understand that for over the tens of thou-sands of centuries that man had existed, improving standards of living had occurred only during a handful of those, and not at all consecutively. Moreover, I didnt know that it was possible for us to cease progressing, at any time, and actually to lose all of the economic gains we have achieved.

As I began to learn true economic cause and effect, I real-ized that almost everything our government does works against us, and that people unknowingly vote for policies that make

1 The book was Trader Vic II: Principles of Professional Speculation, by Victor Sperandeo.

them worse off, not better off, because they, too, falsely assumed that they had a grasp on basic economic concepts. I realized that although the new information I was learning was well doc-umented in academic form in the truly free-market circles, for the most part it was not being disseminated to everyday people. This book has been written in order to try and make the public at large aware that most of what they think is good for their lives, in terms of economic policies, is usually not.

The economic insights that I apply here to our many eco-nomic and political problems did not originate with me, but are the culmination of centuries of work performed by great economic and philosophical thinkers. I am simply organizing numerous economic analyses originated by others into a single volume, with the hope of addressing most of the political issues that voters are concerned with. I earnestly try to assign credit to the appropriate sources. Any original thoughts or analysis cre-ated by others that I use and fail to acknowledge is purely acci-dental and I deeply regret the omission.

I would also like to defend my tendency of disproportion-ately using only a handful of sources for the bulk of the eco-nomic concepts I present here. Most of my sources in this book are associated with the Ludwig von Mises Institute because it is the world center of the only true free-market school of eco-nomics that exists, namely, Austrian Economics (which includes classical economics to a very large degree). The Mises institute, with its support of Austrian economics is therefore, the premier source of research on, and advocacy of, real capitalism. All other schools of economic thought other than this school of Free-Mar-ket economics endorse various forms of government control of the economy and of individuals.

Additionally, I feel no need to pretend to have an unbiased presentation and thus to balance capitalistic arguments with anti-capitalistic ones. I do, however, present many anti-capital-istic arguments, and I do so as accurately as possible, but this is

8 The Case for Legalizing Capitalism

for the sole purpose of refuting them, as that is my objective in writing this book. My ultimate goal is not to present all assertions from all competing schools of thought equally, but simply to pro-mote the ones that I have discoveredafter years of comparing all argumentsto be correct.

Besides, the public hears the anti-capitalist arguments daily from popular sources, which themselves are very biased, and which also make no attempt to present correct capitalistic arguments to offset the anti-capitalist assertions they are mak-ing. What is needed are counter arguments to these commonly espoused views, not a dispassionate, inconclusive, politically cor-rect comparison. In terms of using limited sources, it is a fact that most economists, journalists, publishers, etc. rely on limited sources, indeed mostly on a single source! A dramatically dis-proportionate amount all of the economic information relayed today comes from one book published in 1936 by John Maynard Keynes; thus the famous saying Were all Keynesians now. Similarly to how most economists and journalists use this sin-gle source as an argument for their economics, I am using 10-15 primary sources from a different school of thought, and one of those sources, Professor George Reisman, is cited more than oth-ers (though his views incorporate much of the others).

It should be kept in mind that while most economic schools of thought have political agendas involving the seeking of gov-ernment power, the Austrian school, as I came to learn, is as close to unbiased as possible. Their only agenda, like mine, is complete social and economic freedom for all, not political or ideological domination (and I dont regard the goal of free-dom as an ideology, but a natural right2). Austrians/Capitalists

2 Ideology is defined as 1) the body of doctrine, myth, belief, etc., that guides an indi-vidual, social movement, institution, class, or large group, 2) such a body of doctrine, myth, etc., with reference to some political and social plan, as that of fascism, along with the devices for putting it into operation. The state of utter freedom is a natural, originating state that exists prior to its being altered or eradicated through physical

The Case for Legalizing Capitalism 9

cheer only those supporting true freedom, and are against all who oppose it; they do not promote political parties per se. It is precisely because they choose these principles and this morality rather than political power and control over other groups that they dont in fact achieve power, influence or recognition, and are thus little known and have little influence. But just because they are unpopular does not mean that they are not economically, and morally, in the right.

I ask all readers to approach the material in this book with an open mind, emotional detachment, and honesty with them-selves. After all, most of us, no matter the political persuasion, have the same ultimate goal: to make the world a better place for everyone, and to help those who are truly in need. What I try to show here is that we can achieve these goals without competing for political power and without harming one group in order to benefit another. And as it turns out, it is in fact precisely the free-dom that I am defending (proposing) that brings prosperity and better lives to everyone.

I would like to thank several groups of people for assisting me in this effort. Christine Perkell greatly supported me not only by discussing and debating the public perception of many topics in the book, and the merits of addressing the topics from differ-ent angles, but by reviewing and editing the entire book. Infelici-ties that remain are due to my own choices.

I would like to thank as well my high school English teacher and close friend Libby Atwell for reviewing and editing several chapters. Additionally, my mother, Pat Kelly, Dennis Campay, and Brian Pinneo kindly read individual chapters and offered valuable feedback, for which I thank them sincerely.

I finally offer thanks to Jeffrey Tucker and Doug French of the Mises Institute for finding my work valuable enough to

force by an ideological group. Absent socialism, Marxism, warfare states, and the like, freedom, or, capitalism, would naturally exist.

10 The Case for Legalizing Capitalism

publish . I thank him for his editing. Thanks also to Paul Wood-ward for creating the graphics and performing proofing and typesetting.

In another category altogether are the thanks I owe my mother and father, my best friends, for supporting me uncon-ditionally and believing in me wholeheartedly, no matter what. Without their love and support throughout my whole life, this book would not have been written.

The Case for Legalizing Capitalism 11

13

Contents

Preface 7

Introduction 23

Part 1: The FoundaTions oF our economy

Chapter 1: Labor: Workers Of the World Unite and Shoot Yourselves In the Foot 35

What is an Economy and How Does it Work? 36

How We Progress as an Economy 39

Real Wealth 44

Profits Dont Really Exist 47

Capitalist Exploitation of Workers: The Myth 51

Capital Structure as the Driving Force of Rising Wages 53

How Wealth Redistribution Harms the Poor 55

How Government Creates Unemployment with Minimum Wage Laws 58

How Government Creates Unemployment by Sponsoring Union Coercion 62

How Other Government Regulations Create Lower Wages and Unemployment 68

Why Sweatshops, Child Labor, and Dollar-a-Day Wages Should Be Embraced 69

The Notion of Inequality: Our Achilless Heel 74

Chapter 2: trade: What It Is and How It Works 79The Basics of Trade 80

Domestic/Local Trade (Domestic/Local Specialization) 81

Dont Buy AmericanBuy Whats Best 83

We Dont Need Energy Independence 85

The Economic Threat from China 85

Trade Deficits Dont Persist in Free Markets 86

Who is We and Who is Us? 88

The Misconceived Notion that Trade Surpluses are Ideal 89

Does Trade Harm Poor Countries? 92

Restrictions on Trade 95

Globalization 97

Economic Arguments Against Globalization 101

Outsource Everything Possible 103

What About the Lost Jobs? 105

Free Trade is Good 109

Part 2: reGuLaTion

Chapter 3: Inflation: the Printing Of Money Is the root Of Most Evil 113

The History of Banking 114

Central Banks: Creators of Money Out of Thin Air 117

How New Money Causes Inflation 120

How Printing Money Constitutes Theft and Forced Wealth Redistribution 124

The Inflation Rate: Lies, Damn Lies, and Statistics 126

14 the Case for Legalizing Capitalism

Bet You Didnt Know That This Was Inflation! 129

Alternative Excuses Offered for Rising Prices 137

How the Governments Central Bank Creates Recessions and Financial Crises 141

The Creation of Recessions 141

A Monetary Perspective of Recessions 144

A Recessions Aftermath 146

The Creation of Financial Crises 148

Consequences of a Financial Implosion 151

International Financial Crises 154

The Crazed Desire for Price Stability 156

Stop the Insanity! 157

Chapter 4: regulation: the Helping Hand that Harms 161

How Anti-Trust Regulation Brings About Monopolies 167

Trust-Busting 167

What is a Monopoly? 169

Why Harmful Monopolies Cant Exist 171

Predatory Pricing 173

The Only Real MonopoliesGovernment Monopolies 176

Regulation of the Financial Industry 179

Regulation of the Shrimp Industry 181

Government Price Controls 184

In Praise of Price Gouging 184

The Worldwide Food Shortage 185

The Gasoline Crisis of the 1970s 188

A Personal Example 189

the Case for Legalizing Capitalism 15

Rent Controls 190

Pay Day Loans 191

Regulation of the Healthcare Industry 192

The AMA Monopoly 192

Do We Need To Be Protected? 194

Healthcare Insurance 196

The Quality and Cost of Our Regulated Healthcare 198

Socialized Medicine 199

Only Free Markets Can Solve the Healthcare Crisis 201

Regulation of Local Government Services 203

Regulation of the Airline Industry 204

Regulation of the Oil Industry 206

Hurricane Katrina 209

Abolish All Regulation 210

Part 3: GoVernmenT conTroL Versus Free marKeTs

Chapter 5: the Evil Corporation 215Capitalisms Good Deeds 216

Do Businesses Gain At Our Expense? 218

Are Profits Bad? 220

Profits Benefit Buyers and Regulate Companies 221

Should Profits Be Shared? 222

More Capitalism Means Lower Profits 225

Do Some Gain at the Expense of Others? 227

Are Businesspeople Evil? 228

Big Businesses Start Small 232


Corporate Social Responsibility: A Sham 233

Businesses are the Hands That Feed Us 236

Walmart: The Quintessential Evil Corporation 237

Destroying the Mom and Pops 238

Walmarts Receiving of Government Subsidies 239

Walmart Anti-Unionism 241

Low Wages 241

Executive Pay far Exceeds Worker Pay 244

Walmart Sells Cheap Products from Red China 245

Walmarts Lacking Healthcare Coverage 246

Walmart Is Too Big and Powerful 246

Survival of the Fittest or Unfittest? 248

Chapter 6: When Capitalism Is taken away 251The Great Depression: Governments Creation 252

What Created the Onset of the Depression? 252

The Economy Under Hoover 253

The Economy Under Roosevelt 258

The Roman Empire: From Economic Triumph to Economic Disintegration 265

Communism: Equality at Its Finest 271

Socialists Cant Calculate 272

Communism Results in Suffering 274

Social and Economic Restrictions Under Socialism 277

Rule by Terror 279

The Audacity of Defending Communism 281

Economic Freedom in Various Countries 285


Part 4: sPeciaL ToPics and consideraTions

Chapter 7: the Morality Of Capitalism 295Do Socialists Really Care About Others First? 296

Capitalists Are Not Greedy, You Are 297

Materialism and Money 299

The Immorality of Democratic Voting 301

The Delusion That There is Need for Wealth Redistribution 307

The Flawed Notion of Giving Back to Society 309

How Anti-Inequality and Anti-Poverty Policies Cause Inequality 311

The Poor 313

Who Are The Poor? 313

More on the Minimum Wage 316

The Failure of Anti-Poverty and Wealth Redistribution Schemes 318

Real Solutions to Poverty 320

Living on an Income Lower than that of a Living Wage 324

Helping the Real Poor 326

Its Never Enough 328

An Unsustainable Economy 329

Chapter 8: War and Patriotism 333The Civil War 337

Is Secession A Bad Thing? 339

Respecting the Borders of Other Countries 341

World War I 344


The Politicians Need for War 345

The Economic Need for War 347

World War II 349

Americas World Dominance 351

The Middle East Today 356

How to Start a War 358

The Need for War and the Terrorist Threat 360

Why Not Stop Our Part of the Terrorism? 362

Patriotism 364

The Ills of Democracy and Political Parties 369

The Patriotism of Politicians 370

A Proposal to Divide Up a Nation 373

Chapter 9: Environmentalismat any Cost 377The Problem of Disinformation 378

The Politics of the Environmental Movement 382

Environmental Issues and What to Do About Them 385

Forests 386

Air Pollution 388

Natural Resources and Sustainability 390

Water 394

Population Growth 396

Recycling 397

A Category of its Own: Global Warming 398

What Should Be Done About Global Warming? 404

There Are Better Ways to Fight Global Warming 408

Most Environmental Problems Can Be Solved With Property Rights 411


Environmental Degradation Worst in Places with Weakest Property Rights 413

Choose Life, Not Environmentalism 416

Part 5: PuTTinG iT aLL ToGeTher

Chapter 10: Socialist / Government Economic Policies 421

Planning Our Economy 422

The Meaninglessness of GDP as an Economic Indicator 423

The Keynesian Multiplier 427

The Supposed Failure of Lower Wage Rates to Create Full Employment 431

The Keynesian Explanation for Why There Cannot Be Full Employment 433

Liquidity Preference 435

Profits Rise, Not Fall, With More Investment 436

Keynesian Self-Contradiction on Profits 437

The Accusation that Savings is Destructive 438

Government Spending of our Savings 439

Why Recessions Remain Recessions 439

Printing Our Way Out of Recessions 441

Why are Keynesianism and other Socialist Policies So Popular? 443

Free Market Fantasy 446

Only YOU Can Prevent Socialism and Economic Regression 447


Chapter 11: Political Quotes and News Blurbs 451Amazon pays $1,500 in daily fines 451

Bush: US is Not Headed Into Recession 452

Bill Gates Issues Call For Kinder Capitalism 452

Some Chavez Allies Slow to Shed Luxuries 452

Obama: China is Rising and Its Not Going Away 453

Perus Fujimori Gets 25 years Prison For Massacres 453

German City Wonders How Green Is Too Green 454

Many Doctors Plan to Quit or Cut Back 455

Putting Money in the Hands of Unemployed 455

FDIC Warns US Bank Fund May Tank 456

Fed Plans New Rules to Protect Homebuyers 457

How Feds Invited the Mortgage Mess 458

Giuliani Offers Health Care Plan 461

Edwards to Crack Down on Wealthy Who Skirt Paying Their Share of Taxes 462

N Koreas Kim Jong Il Makes Rare Election Pitch 463

I stand with the writers 464

France Brings Line Dancing Under State Control 464

South Koreas Prophet of Doom Indicted 465

Bibliography 467

Index 473


Workers of the World Unite 23

Introduction

The financial system is collapsing, the stock market is crashing, and retirement funds are evaporating. the auto industry verges on extinction. Home prices have spiraled downwards. gas prices recently were the high-est they have ever been. Jobs are being lost rapidly and unemployment is shooting up. Healthcare costs are reducing some to bankruptcy and even death. Wages are not keeping up with inflation, which until recently has been increasing rapidly. there is fear of a sec-ond great Depression. What in the world is happening?

the answer is simple: Our government is sabotaging the econ-omy. these, and most other economic maladies, are human-made. Specifically, in its attempts to help us, the government has man-aged and regulated the economy and passed laws that sounded con-structive, but in fact hurt the economy and us. Political economic reality is replete with the law of unintended consequences. Our eco-nomic problems, in sum, are the natural result of political forces, not the natural result of (supposedly evil) market forces. We have voted our current problems into existence by having chosen politicians who promised to help us by means of economic intervention and regulation.

for example, we want the government to raise the minimum wage to help the poor, but that only makes the poor too expensive to hire and puts them out of work. We want the government to guarantee competent healthcare and therefore license only a subset of all would-be doctors. further, we want the government, employ-ers, and insurance companies to pay for most of our healthcare costs.

23

24 the Case for Legalizing Capitalism | Kelly

the result is reduced supply and increased demand for healthcare, thus raising prices and making healthcare less affordable year by year. Another example: We want the government to regulate the banking system to prevent depressions like the one in the 1930s. the result, however, is that the governments central bank creates too much money, causes economic booms and busts, financial and real estate market booms and busts, and puts many companies out of business and people out of homes. Similarly, regulations promoted as prevent-ing monopolies in fact prevent competition, allowing some companies to benefit at the expense of others and the general public. the exam-ples go on and on.

Our leaders are supposed to uphold laws that protect our prop-erty and insure our freedom; but the regrettable reality is that they do the opposite. the actual activity of politicians is to interfere with or outright appropriate the property of one group in order to ben-efit other groups. this, after all, is how they get elected! further, even if politicians had the sincere desire to help everyone, they could not. first, regardless of whatever expertise they claim, they have little or no accurate understanding of the workings of money and credit, capital investment, production processes, productivity improvements, wages and prices. they are no better informed on these matters than the pro-verbial man-in-the-street. Second, it is inherently impossible for a finite group of bureaucrats to direct and constructively shape outcomes of entire economiesthe actions of millions of people and millions of tools, machines, and factoriesas their regulations and controls are intended to do. No supercomputer has yet been invented that can make decisions and calculate optimal outcomes more accurately than can the combined effort of millions of individuals working together, who coordinate their interactions by using market prices that reflect the needs of buyers, the amount sellers should therefore produce, and the price that should be charged. In truth, its outright arrogant for politicians (or even economists!) to think, and to have us believe, that they can somehow so much as lend a helping or guiding hand to the national economy. the only genuinely helpful thing politicians can do is to undo their previous policies, the ones that have restricted rapid economic growth, distorted market outcomes, and caused thereby a destruction of wealth. As this book will demonstrate, real economic growth and prosperity can come only from free markets.

Introduction 25

But perhaps you thought we had free markets? We have no such thing! this is true regardless of the fact that politicians of all stripes claim that we do. the government has its hand in every company and every industry in the nation. there are tens and even hundreds of thousands of pages of government regulations that dictate what can and cannot be produced, how things should be produced, what prices can or cannot be charged, what workers should be hired and at what prices, and what requirements, approvals, licensing, and reporting must be undertaken or performed for each type of busi-ness, product line, or transaction. there are subsidies, tariffs, quotas, tax incentives and disincentives, implied threats, and actual threats that severely alter the actions both companies and individuals would otherwise take. On top of these things, both federal and local gov-ernments confiscate portions of the earnings of companies and citi-zens directly through income taxes, as well as through license taxes, annual tag fees, passport fees, other fees, property taxes, import tar-iffs, inheritance taxes, capital gains taxes, environmental-affecting taxes, consumption taxes, excise taxes, tolls, retirement taxes, hotel occupancy taxes, payroll taxes, transfer taxes, airport taxes, security taxes, value added taxes, surcharges, commercial rent taxes, etc., as well as by the taxes the government takes by printing money at our expense (the inflation tax). By contrast, a free market is one where anyone is free to live and to do business as they wishboth socially and economicallyas long as they do not initiate force upon others or their property. free markets are not an imaginary utopiathey would exist today if they were not being prevented by law.

though it may shock you, since you no doubt perceive yourself to largely support democratic capitalism, these types of intervention in the marketplace, which we desire and which are performed pre-sumably on behalf of society for the purpose of protecting society and helping to reduce inequality between various social groups, are in fact socialism. Full socialism is defined as the control by the state of the means of production (companies, and individual producers, and their tools). Partial state control of the means of production (as described above) therefore constitutes not free markets but partial socialism! Additionally, any forceful taking of money by one group (taxes) for the purpose of spreading it around to others constitutes the essence of socialism. thus, since most people believe that the state needs to


intervene in the economy to achieve a better outcome, most people in America promote some degree of socialism, and that is what we implicitly demand of our politicians (see footnote1 below for my defi-nition of socialism).

this constant helping of society through attempting to man-age it has resulted in a constant decline in our ability to produce real wealth and improve our standards of living. As it is now, we are seeing a consistent increase in the wealth of the rich, a moderate improve-ment in the wealth of the middle class, and stagnation in the living standards of the poor. But there is indeed a better way, a way that has seldom been taken in world history, but, when it has, has succeeded in improving the lives of all involvedrich, poor, black, white, man, or woman. It is called capitalism. Only capitalism, with its true free markets and true freedom for individuals can solve our problems and bring prosperity. (Note: I will henceforth use capitalism and free markets interchangeably.)

Understand that by capitalism I dont mean the right-wing, crony capitalism, corporate welfare economy, or the anti-rich, wealth-redistribution social welfare economy that we have today. In a truly capitalist society businesses never receive money or special privileges

1this book uses the term socialist and socialism very loosely, yet economically accurately. I call those who do not advocate at least 95 percent capitalism as socialists, because if they do not support this level of capitalism, they are supporting substantial government intervention. the intervention might be in the form of government owner-ship and operation of companies or industries, or in the form of laws imposing regula-tions, restrictions, taxes, subsidies, etc., each of which serves to benefit one group at the expense of another. the usual aim of government intervention is to benefit most of society at the expense of the few (usually the rich). Hence, even the United States and Switzerland, since they engage widely in such government intervention, can be called socialist, although most citizens would refuse to accept such a reality and label. Similarly, anyone who proposes government intervention of any kind, which includes republicans as well as Democrats, and even many Libertarians, is thus labeled socialist in this book. It should be kept in mind, however, that when I apply the term socialist, I am usually referring to those with a more intense desire for government control and wealth redistribution.

Ideally, we should all seek 100 percent capitalism, but such a proposal, which includes such notions as private ownership and control of things like roads and schools, is hard for most to swallow. thus, I am happy proposing and settling for 95 percent capitalism, which, in my definition, would consist of government providing such basic services as law enforcement, road-building, etc., but having absolutely no influence whatever on the way in which individuals and companies operate, providing that they cause no physical harm to others or their property or person.

Introduction 27

from government: they succeed if they please consumers in offering them what they want, and they fail if they do not. Analogously, in a truly capitalist society, individuals never receive special privileges or transfer payments. Instead, they have an abundance of jobs and of wages commensurate with the value of peoples work (more than a living wage). Under free market capitalism, it is virtually impossi-ble for things like inflation, shortages, booms and busts, recessions, unemployment, starvation, and unaffordable healthcare to exist. Why? Because competition and the threat of competition serve as iron-clad shackles on companies, preventing them from underpaying, overcharging, or under-supplying and guaranteeing the safest, lowest-priced, highest-quality products that can possibly be produced at any particular state of technology and development.

Decade after decade our politicians, both republicans and Dem-ocrats, have continuously implemented more of the same policies that have increasingly slowed our economic progress. Both ancient greece in the fourth century B.C., as well as the roman empire of the sec-ond century A.D., through relatively free markets, reached a state of development that brought them close to an industrial revolution simi-lar to that which ultimately occurred in Britain in the late 1600s. But ever-encroaching socialism (i.e., military warfare, class warfare, crush-ing taxation, inflation, and regulations) ate away at and economically reversed these advanced societies; rome dwindled into nothingness, into absolute poverty, where most people produced and consumed, if lucky, the minimal necessities of a day-to-day subsistence. It was more than a thousand years before civilization again reached a state of improving standards of living. Similarly, the Western world today is on the verge not only of no longer progressing but even of retrogressing. the policies we have voted for have had the unintended consequence of increasingly restricting our ability to accumulate, and keep capi-talsavings that become factories, machines, tools, computers, etc.the sole means by which we can produce and create wealth. Without essential changesand soonwe will begin (or continue, as the case might be) sinking slowly into an economic abyss. the decline will not be noticeable, as it will be gradual, since things that change subtly and slowly are not noticed day by day or even decade by decade.


Consider this remarkable irony: we citizens put our faith in gov-ernmentthe entity that steals from us, causes wars, imprisons and starves innocent citizens, and is an absolute monopolyto provide for us and keep us safe. At the same time, we see businesseswhich have eradicated diseases and starvation,2 engaged in peaceful exchanges instead of war, are fully restrained by hungry competitors (in free markets), produce virtually everything we currently own and enjoy, and pay us our wages and provide capital for us to improve our pro-ductivityas our enemies from whom we need protection. these commonly held but irrational prejudices form the very foundation of the political arguments espoused by professional anti-capitalist thinkers.

Most economists, especially those associated in any capacity with government, subscribe to one or the other variations of non-free-market economics3despite the economic ills, including the great Depression, caused by these policies over the last hundred years. their economics, primarily Marxist and Keynesian and, to a lesser degree, supply-side economics, and even Milton friedmans monetarist school, are in many cases, despite their differences, fundamentally flawed in their shared belief that markets can be profitably managed by the gov-ernment. they fail to grasp that the success of markets is a function of their freedom. therefore they promote theories to fix things, assuming that the current economic problems were caused by insuf-ficient, instead of too much, outside intervention. Since these main-stream economists devise government intervention, or benefit from it in other ways, I will hereafter call them mainstream or govern-ment economists.

2Contrary to popular notions, most diseases were not eradicated by government. for evidence of this, see: timothy terrell, A Pox on government Vaccines!, The Free Mar-ket (April 2001). Additionally, even where disease eradication was performed by gov-ernment-funded scientists, the funding unambiguously originated with for-profit, wealth-producing entities. Had these entities not first created the wealth that the govern-ment then confiscated, it would not have had funding with which to perform research and pay researchers.3this includes economists at think tanks, banks and investment firms, the World Bank, the IMf, the treasury Department, the federal reserve Bank, and virtually every econ-omist in Washington, D.C., because they are all tightly linked with, or constitute, the government.

Introduction 29

It may seem outrageous for me to propose that numerous Ph.D.-certified, Nobel Prize-winning university professors do not understand correctly how economies progress and produce in a synchronized manner, but this is in fact the case. I dont intend to be pompous, for these economists are very intelligent people. Its just that they have learned incorrect explanations of economic cause and effect, even if their schools of thought are the most common and popular world-wide. Likewise, the scores of journalists and authors who claim that we currently have capitalism and that it has failed us are outright igno-rant of what capitalism actually is.

the most prominent of the early incorrect theories came from Karl Marx,4 who most proposed that workers were exploited and forced by capitalists to a subsistence level of existence,5 the remedy being state ownership of the means of production. then, during the great Depression, John Maynard Keynes incorrectly identified the cri-ses as stemming from animal spirits and from a failure of markets to work properly, when in fact it was brought on by previous govern-ment intervention. He thus channeled his personal socialist feelings into thinking up, on the spot, his theories of how markets fail and of how government can fix them.6 Since his theories seemed to make sense, and since they gave government the green light to intervene in the economy, the theories caught on like wildfire. today we have multiple variations of these two dominant theories, along with plenty of new ones. But none of these economic schools, unlike the free market school, explain how an unhampered economy can progress effectively. they only explain (incorrectly) how things can go wrong and how markets can be manipulated for the better so as to protect

4 Based on flaws in Adam Smith, The Wealth of Nations, edwin Cannan, ed. (London: Methuen, 1776).5though he later, for all practical purposes, indirectly admitted his wrong thinking in the third edition of his work. Karl Marx, Das Kapital (Hamburg: Verlag von Otto Meissner, 1867).6 John Maynard Keynes, The General Theory of Employment, Interest and Money (Lon-don: Macmillan, 1936). His previously concocted theories from several years earlier were promptly refuted by Austrian economist friedrich Hayek. the second time around Hayek decided it was not worth the trouble because he knew that once he spent the time and energy refuting Keynes again, Keynes wouldas Keynes admitted he had a tendency to dosimply change his mind and come up with a new theory.


citizens . But it is precisely markets free of interference that actually do protect citizens.

When our current government-managed economy experiences problems, there is huge pressure on government to do something. It is a difficult-to-accept truth, however, that the best action is no actioni.e., to allow the market to self-correct. But politicians pur-sue the easy and popular course of intervention, instead of the correct course of being hands offas there used to be in the 1800s (and even in 1921) when recessions were thus fleeting. In the face of any current crisis, they feel compelled to implement new policies, which neces-sarily become the seeds of the next crisis about which they will soon have to once again do something. It is understandably difficult to accept the notion that nothing should be done when millions are suf-fering during economic downturns. But the quickest road to recovery is not to interfere with the corrective processes markets undertake. Better yet, we should abolish the policies that cause financial crises and recessions.

the economic achievements of todays society came from capi-talism, while the recessions, inflations, unemployment, and lack of increasing real wages came from anti-capitalistic interventions in the market. this book aims to prove these assertions by explaining the relationship among human action, labor and the production of goods, and money in accessible terms that require no previous study of eco-nomics. An economic whistleblower for the many, I will disabuse readers of false notions about the causes of economic prosperity, and provide them instead with an understanding of markets sufficient to enable them to vote themselves into increasing standards of living.

In this undertaking, I am indebted primarily to the works of David ricardo, John Stuart Mill, and Jean-Baptiste Say (generally asso-ciated with the British Classical School of economics), and even more so to the works of eugen von Bhm-Bawerk, Carl Menger, Ludwig von Mises, friedrich Hayek, and Murray rothbard, among others, who represent the Austrian School of economics. economist george reisman, who represents both schools, has had the most influence on my economic understanding. It is these economists fundamental insights into the nature of the economic common good that underlie the material and arguments of this book.

Introduction 31

By giving readers an easily understood presentation of these various brilliant economists combined insights, this book seeks to change the general publics view of the pervasive incorrect assump-tions about the sources and causes of economic well-being and to do so by addressing the social and economic issues most relevant to the average voter in our world today.7 I do this by explaining cause and effect through logic and deductive reasoning; for the most part I leave aside statistics, since they can complicate the story and confuse read-ers, and because they can be easily manipulated to tell whatever story one wants them to. My hope is that if people understand the logic of how free markets bring prosperity and benefits to all of us, they will vote for politicians who will allow markets to be free, or else demand it of them.

7 I make little attempt to speak to the die-hard socialist because their views will not be altered no matter what logic, reason, and facts are presented to them; their views are driven by emotions, not economic reality.


P A r t O N e

The Foundations

of Our Economy

33

34 the Case for Legalizing Capitalism | Kelly34 the Case for Legalizing Capitalism


Chapter 1

Labor: Workers of the World Unite And Shoot Yourselves in the Foot

Blaming greedy companies for exploiting workersits all the rage these days, and actually has been for several hun-dred years. Popular as well are politicians promising to resolve workers woes. Presidential candidates on the cam-paign trail in 2008 were trying to win votes by telling us how they planned to create jobs for us, and help us receive higher wages by boosting the economy. they promised to raise minimum wages and strengthen our unions. Democratic primary contenders, Barack Obama and Hillary Clinton both supported higher taxes on the wealthy with which to pay for lower taxes on the middle class, as republican candidate John McCain had also once proposed. Most of our politicians support government taxpayer spending on programs that they believe will create jobs. But can the government really create jobs? Can it really help workers bring in higher wages? How does it all work?

You might think that a discussion of how workers earn wages must necessarily be dry and boring. this chapter will delve into some technical detail in the first half, but only enough to provide a frame-work for the following, decidedly less technical material in most of the other chapters in this book (and the book becomes more dynamic as it progresses). But understanding clearly how jobs and wages come about is crucial for comprehending how workers, economies, and

35


standards of living improve. that process forms the very foundation of this book and of economics as a whole. Comprehending the eco-nomics of labor is important because most Marxist and Commu-nist countries, and most left-wing ideologies in general, exist largely because of the very belief that workers are exploited by evil and greedy capitalistic companies.

this ambitious goal of the chapterto prove that nothing could be further from the truthwill show that companies tend not only to pay workers the maximum amount they can bear, but that they are the creators of most jobs, provide the capital to improve productivity and raise real salaries, increase the quantity and quality of consumer goods, and bestow upon us a permanently higher stan-dard of living, all while paying us in the process. At the same time, companies gains, though very large initially, are not as permanent as the workers gains. further, this chapter will demonstrate why such a phenomenon as unemployment would never exist in a completely free market, and is in fact caused by the policies of the politicians who purport to help us workers.

What is an economy and how does it Work?

to understand how workers get paid, you need a basic know-ledge of how an economy works. We hear a lot about the economy: that its strong, or its slowing, or that we need to improve it. We see it as a thing that we must somehow manage and grow as though its a wild animal. But the economy is not a thing: it is simply us and our lives. the economy embodies each of us working, producing things we all need for our lives, and exchanging these things with others who are doing the same. Whether as individuals producing, or as thou-sands of people grouped into a company and producing together, we all make stuff that businesses and individuals need, and we get com-pensated for the stuff we produce (and producing includes any of the activities that individuals and employees engage in that contribute towards creating a final product). We then exchange our stuff or our salaries for different stuff made by others. thats an economyits as simple as that.


Imagine that you are stuck on a desert island. to survive, you catch fish by hand in the ocean. Since they are fast and slippery, its a difficult job, taking you 12 hours to catch two fish; 6 hours per fish. You can therefore catch only two fish per day. But then you get smart: you decide to make a net. Yet making a fishing net by hand takes time, too, as it involves many steps: searching the island for raw materials like grasses and vines; finding something to serve as the handle; twin-ing and bending strong but pliable vines or twigs into a rim to support the netting; and finally braiding and weaving vines into netting and tying it to the frame to form a sieve-like scoop. With no tools avail-able, this process will take you five days by hand. to take five days off of fishing without going hungry, you must save some of your caught fish for a couple of days by eating only one fish per day instead of two. the saved fish will sustain you for the five days it takes to build the net, and once the net is complete, you can catch 50 fish per day.

this example introduces some basic components of an econ-omy. You have savings (the fish you set aside to eat over the course of several days) that sustained you while you produced a capital good (the net). the capital good, which, in this case, was also a new technol-ogy, allowed you to improve your productivity (the number of fish you produced per day). Now that you have plenty of food to keep you from starving, you have more free time and labor available. You can use this to improve your standard of living by building a hut, a bed, clothes, and maybe even a boat. In addition to time and labor, though, you will need tools (more capital goods) with which to build these things. that means that it will take a lot of time, savings, and produc-tion of capital goods to improve your standard of living.

Now, suppose that several other people also landed on the desert island. With a division of labor, each person can focus on making the things they are best at (given what needs to be made), which increases the total amount that all islanders can produce, and each person can trade most of what they produce for the goods made by the others. Obviously, the more capital goods (e.g., knives, hammers, nails, shov-els, nets, axes) that get produced, the more consumer goods (e.g., bowls, fish, beds, huts, hammocks, clothes) that can be produced in a given amount of time. With this division of labor among the castaways resulting in increased productivity, and with the existence of a capital


structure, which consists of an organized collection of tools and technolo-gies used to make things, there will be more goods produced overall in the island economy, which means higher standards of living. Obviously, part of the success of this process involves each person producing what others want or need; making something just for the sake of making it will not necessarily satisfy the needs of others in the community. this concept will be discussed in more detail throughout the book.

In this division of labor society, what each person produces becomes that individuals purchasing power. the things people make that they dont directly consume they can trade for other goods they need or want. In this hypothetical deserted island economy, the cast-aways amount of consumption is based on their amount of produc-tion: the value of what they produce becomes the value of the amount they can consume; and to the degree that their production adds to the supply of goods in the economy, prices (barter exchange ratios) fall in proportion, increasing their purchasing power. this notion that sup-ply (things produced) creates its own demand (the means with which to consume) is known as Says Law.8

Notice specifically that what people on the island gain from pro-ducing and exchanging becomes their profit, not their wages. In this example, individual producers do not pay themselves or each other wages when they produce for themselves or when they trade for other goods. If the islands cloth maker sells a shirt, or if the berry picker sells some berries, they are traded (they are paid) other goods in exchange for the full amount of their production.9

Now, back to the real world. todays complex, modern economy still contains the same basic functionality. In our modern, advanced economy, most of us produce a single thinghair cutting, electri-cian services, sales or marketing services, etc.and we then exchange our salary for everything else we want. We still have many individual

8 Jean-Baptiste Say, , Trait dconomie politique, ou simple exposition de la manire dont se forment, se distribuent, et se composent les richesses (1803); english translation A Treatise on Political Economy, C.r. Prinsep, trans. and Clement C. Biddle, ed. (Philadelphia: Lippin-cott, grambo, 1855).9george reisman, Capitalism: A Treatise on Economics (Ottawa, Ill.: Jameson Books, 1996). the fact that a single producer/sole proprietor earns a profit, and not a wage, is a truism, but is not a commonly accepted notion.


producers such as hot dog vendors, farmers, painters, lawyers, and, of course, economists. But most production takes place in companies. the primary difference here is that in addition to profits, wages are also present. In contrast to individual production where all income con-sists of profit, wages appear once there is combined production (groups of people working together in companies) and individual producers within the group are paid in advance for producing an input, or an intermediate product, by businesspeople/employers/managersthat is, someone in charge of orchestrating the production of individual inter-mediate products to combine them into a final product. the final pro-duct is partly composed of each individual workers contribution; their contribution is only an intermediate step towards completion of the product (except for the product of those few workers who are involved in the very last stages of production). In combined production entities, workers have freely chosen to work for someone else in exchange for wages, instead of producing on their own for profit. they would only choose to do this if they felt they could make more income by accept-ing wages than in producing by themselves and earning profits.10

how We Progress as an economyMost of our rising standards of living can be attributed not to

us single workers, but to entrepreneurs, capitalists (e.g., stock hold-ers, bond holders, venture capitalists, individual wealthy investors) and businesspeople who create, finance, and run these companies.11 Inno-vative entrepreneurs seeking profits think up ingenious ideas for ways to make our lives more enjoyable or to produce things we currently produce more efficiently: mattresses, ovens, picture frames, comput-ers, cell phones, and video games (consumer goods), or conveyer belts, nail guns, adhesive materials, and building cranes (capital goods). Indi-viduals or other companies will buy these innovative products for the

10 Based purely on money incomes, which is without question the biggest factor in choosing between various employment opportunities. there are, of course, other fac-tors such as commute distance, type of work, perks, career benefits, camaraderie with coworkers, etc.11these three entities may or may not be the same person, or any two of them could be the same person. Were they the same person, the one who is running the business also had the idea and vision to create the companys product, and also wholly or partly financed the business and its production.


right price if they believe they will benefit from having or using them. A good idea can easily be made into a product because if the idea is poten-tially profitablethat is, if consumers will pay more for something than it costs to produce itpeople with money to lend (capitalists) will do so in order to earn more money. Innovators/entrepreneurs will use this money to start businesses producing these products, or use part of the loaned funds to hire others who know how to do it for them.

to design, produce, market, and distribute the products, the busi-nesspeople (once entrepreneurs begin producing they become busi-nesspeople) hire laborers. they direct and manage the laborers, likely with the help of other managers reporting to them, who each oversee particular areas of production. When the final products are complete, the businesspeople will (hopefully) sell the products for more than the costs of production (including labor) and earn a profit.

A large profit,12 one significantly higher than the average profit (in percentage terms), is possible when a product is new and differ-ent, and has no competitors (think of the first personal computer, hula hoop, automobile, etc.). If a profit is very large, it is because sales rev-enues far exceed the total costs of producing the product. Costs consist of workers wages plus the cost of all the capital goods and materi-als (e.g., tools, machinery, building, raw materials, supplies). this large profit generally makes the entrepreneurs and capitalists who provided the funding for the ventures very wealthy. If a businessman was hired to run the company by the entrepreneur, that person most likely received a salary, but could also have shared in some of the prof-its. these high profits should be celebrated and seen as a good thingafter all, they signify the creation of something that customers desired so much that they preferred to have the product than their moneybut in fact profits are generally frowned upon in our socialist-oriented society as evidence of greed and selfishness. But fret not, socialist friends, there is good news: these often-called obscene profits will not last long.

Large profits are fleeting because of the economys tendency to shift toward a uniform rate of profit throughout the economic system.

12 Profit is always discussed in percentage termsin terms of the dollar amount of profit as a percentage of the dollar amount of sales revenues.


the steps involved are simple and logical: (1) capitalists flock toward those products or industries where they see or anticipate the great-est percentage profits; (2) more capitalists in one product or industry means more money invested there; (3) increased investment creates a corresponding increase in demand for labor and the capital goods required for production; (4a) increased demand for labor and capital goods drives up the costs of labor and capital goods and simultane-ously (4b) increased production and supply drives down the selling price of the products; thus (5) higher costs and lower selling prices mean lower profits. the same process works in reverse: if profits are low, fewer capitalists invest, causing monetary capital (e.g., mone-tary savings cum financial investment) to flow elsewhere; the result-ing lower production means reduced supplies, which drives up selling prices, leading to increased profits. With money constantly shifting away from areas of low profits toward areas of high profits, rates of profit tend to equalize throughout the economy. there are many things that cause profits on companies income statements to vary widely in different industries, but the effective rate of return on mone-tary capital invested tends toward equality across industries.

With the understanding of the uniformity of profit principle, we can visualize what will happen to an entrepreneurs successful com-pany: others will notice the high profits from the entrepreneurs new product, and will rush to produce the same product or, even more likely, either a cheaper or an improved version of the product. We see new examples of this daily. for example, once Apple came out with its Newton hand-held device, Palm soon followed up with its Pilot, and then Nokia with the first smart phone, the 9000 Communica-tor. Soon after, there were hundreds of models of smart phones from many companies, each competing by offering additional attributes. this kind of competition leads to each new round of products deliv-ering versions that usually improve on the previous ones, and at lower costs.

As an example of profits being competed away, take the simple ballpoint pen. It first came to market in October 1945 at a selling price of $12.50 (over $50 in todays money), with production costs per pen


of 80a 94 percent profit!13 the following October, after several competitors entered the market, ballpoint pens sold for $3.85, and the production costs averaged 30 per pen. By December 1946just a few months laterthere were over 100 pen manufacturers competing, causing pen prices to fall to 99 by february 1947. In 1948, pens sold for 39, and cost 10 to produce. Average profits had fallen to 74 per-cent. Within several years, average ballpoint pen profits were reduced such that they were in line with profits in other industries, which was probably about 10 percent to 12 percent (before taxes). the fact that pens have been sold an average of 57 times per minute since 195014 reveals the dramatic increase in supply. today, Bic, perhaps the best known pen manufacturer, has average profits of just over 10 percent.15

Clearly, once competitors arrive, big profits disappear quickly. But even older, established companies still have some rate of profit; they still have revenues that exceed their total costs. this profit is the standard uniform economy-wide profit, and it is this remaining profit that is generally seen as the problem associated with exploita-tion, as famously argued by Karl Marx.16 the charge of exploitation will be addressed below.

there are only two ways for companies earning the normal rate of profit to possiblyand temporarilyachieve large or excess prof-its. they must either develop a new, innovative, and original product, or they must find ways to produce current products more efficiently and cheaply. the former will raise sales revenues above costs, and the latter will lower costs below sales revenues.

13 Joseph t. Salerno, Pricing of the factors of Production and the Labor Market (a lecture from Introduction to Austrian economic Analysis with Joseph Salerno, 2006); http://video.google.com/videoplay?docid=5503610910224878764#.14tim Hepher, Bic makes a point with 100th billion-ballpoint milestone, The San Diego Union-Tribune (September 9, 2005).15 Societe Bic (Bic) 2008 Income Statement, http://www.bicworld.com/inter_en/inves-tor/index.asp#.16Marx, Das Kapital (1867). Marxs argument is rooted in the idea that something is worth the amount of labor hours used to produce it, whereas in reality a thing is worth what one is willing to pay for it based on their subjective view of how much it would ben-efit them to have it. thus, by calculating the number of hours needed to produce some-thing, depending on how one calculates the cost per hour of labor (which is a separate issue up for debate), it could be calculated that workers are not paid for the total number of hours worked, and the money owed them is instead kept by capitalists as profit.


to be able to constantly create new products for us consumers, and to be able to continually produce them more efficiently, new and additional physical capital (i.e., capital goods), paid for by monetary capital, must be employed.17 It is this capitalwhich, as we saw in our deserted island economy, comes from savings (i.e., production which is not yet consumed)that sustains companies while they develop new and better ways to produce, and often, while they simultane-ously use their current resources to continue producing in the cur-rent fashion. for example, for general Motors to have the ability to build a newer, more advanced factory while still producing vehicles in the current factory, it must obtain additional funding, since its current money is tied up in producing this years cars (it cant use its profits as they are either paid out to owners or reinvested in production). the capital goods that are purchased with monetary capital, combined with new science and technologies, ultimately lead to increased pro-ductivity. these new capital goods and new technology allow each worker to produce more things during a given period.

think about, for example, our large factories of today with auto-mated equipment producing items en masse versus the small shops of years past where workers produced goods by hand. Or consider how much more efficiently 4,000-horsepower diesel-powered trains a half-mile long transport supplies versus the historical method of horse-drawn wagons. think also about the fact that todays car companies can produce an entire automobile in 18 hours mostly with automated means: machines. these machines, these capital goods, help humans produce many more things much more quickly. the capital goods do most of the work. People may run the machines, but the machines per-form most of the actual production. even office workers produce most of their work on machines: computers. to produce the same quantity of work by hand would take us hundreds or thousands of hours longer.

the following conclusion is one of the most important that could be understood in all of economics: The continually increasing rates

17 In a world where government did not create money to add to the economy, addi-tional savings per se would not be needed to fund economic progress, only the sufficient devotion of saving to capital goods production versus consumption. the need for actual savings results largely from the effects of inflation, since inflation destroys capital. See Chapter 3 for more insight.


of productivity enabled by tools and machines bought through savings and investment are what allow us to continually increase the amount of goods and services available. This increase in goods and services serves to reduce prices relative to our incomes, and thus increase our real wealth and standard of living. What counts is whether we are able to produce more wealth each year than we consume or that deteriorates.

real WealthMoney as we know it is not real wealth; money is only a medium

of exchange that shows us the relative prices of different things. We have money so that we can exchange it for real stuff. the more real stuff we havehouses, refrigerators, medicine, food, diapers, soap, televisions, etc.the richer we are and the fewer hours we have to work to maintain a particular standard of living. the more stuff we produce, the cheaper everything becomes relative to our incomesthat is, in real terms. that, in sum, is how an economy works.

Probably not one member of Congress (besides ron Paul) fully understands this concept or else the government would be doing everything in its power to help companies grow their capital to build more tools and machines. Or perhaps they merely fear that doing so would not get them votes since they assume the public doesnt understand the concept. they in fact do the opposite, as is chronicled throughout this book. If the government truly wanted to create eco-nomic progress, the best way would be to create capital. this is done by lowering tax rates, abstaining from printing money and inflating prices, undoing burdensome regulation, taking off price controls, etc. All of these forms of capital destruction will be discussed in detail.

the idea that goods get cheaper needs some explanation since we see prices around us rising, not falling. though inflation raises the money price of goods, the real pricethe price as a proportion of our incomefalls as production and supply increase. the average automo-bile, for example, used to cost more than five times the average persons income; now the average price of a new car sold in the United States is $28,40018 or a little less than three quarters of the average persons

18 federal trade Commission, FTC Facts For Consumers: Buying a New Car (April 2006).


income of $39,430.19 Looked at another way, the number of hours of labor it takes to purchase a certain item or the number of hours of labor it takes to achieve a particular standard of living constantly declines through time as our productivity rises. Figure1.1 shows that the aver-age worker today needs to spend only 11 hours per week to produce what took an average worker in 1950 a full 40 hours per week; european data is comparable.20

this reduction in labor hours can be even better understood by looking at individual products as in Figure1.2.

the prices of goods, and wages, rise because the government prints more money and adds it to the quantity already existing in the economythats what inflation is, and nothing else. When the amount of money in an economy increases at a faster rate than the amount of goods and services, prices rise. But in real terms, if produc-tivity is increasing, prices fall relative to wages, even if both are rising in outside, or nominal, prices (the increase in the quantity of money does not lower wages along with prices because the supply of workers does not increase along with goods and services).

19 the economist Intelligence Unit, Pocket World in Figures 2007 (pamphlet from the economist). 20this data, like most government data, is likely fudged or inaccurate due to methodol-ogy flaws, but it is directionally correct.

Figure 1.1: A comparison between the work hours required today versus those in 1950 to produce the same results.

40

35

30

25

20

15

10

5

01950 1960 1970 1980 1990 2000

Paul Woodward / Mises Institute

Source: Bureau of Labor Statistics

Hours W

orked


If there were a constant supply of money, if government did not increase the number of bills floating around, prices would necessar-ily fall because the same quantity of money in the economy would have to be spread across more and more goods.21 think of it this way: if we have 100 dollars in an economy to purchase 100 items, each item would cost on average $1 ($100/100 items = $1). If we increase pro-duction such that we have 200 items in the economy, the same $100 must now buy, or cover, twice the items. this means that each item would cost on average 50 cents ($100/200 items = 50). the

21Mark J. Perry, the Miracle of the Market, http://mjperry.blogspot.com/2009/03/miracle-of-market.html.

Figure 1.2: A comparison between the work hours required today versus those in 1950 to produce the same results

Cost in TimeHours worked at the average wage to purchase typical household goods

1950 2009

Sofa 57 7 22 0Sofa Bed 69 2 19 4Arm Chair 28 4 8 9Mattress 34 6 33 3Four-Drawer Chest 43 5 3 3Desk 150 0 33 3Vacuum Cleaner 34 6 5 6Dryer 127 0 20 0Freezer 244 2 23 3Refrigerator 153 7 21 7Toaster 10 0 1 9Gas Range 65 3 23 2AM-FM Radio 26 9 0 6Recliner Chair 38 4 6 732-piece Silverware Set 22 7 0 8Television 161 5 30 5

Total hours of Work 1,267.0 254.5Weeks of Work 31.7 6.4months of Work 7.9 1.6Source: mjperry blogspot com21


important point to remember is that in real terms (or, in a world of an unchanging supply of money), as we increase our production of goods, prices fall while our wages stay the same. this is how increased standards of living come about.

Since an economy is simply each of us producing things in the ways in which we decide is best for us, politicians can do nothing to improve our decision makingany intervention will necessarily reduce the opti-mization of the process and slow it down. Any policy the government promotes, unless it is one removing restrictions previously placed on cap-ital accumulation and production, will cause fewer jobs to be created and fewer goods to be produced, and thus lower our standards of living. Nei-ther the Democrats nor the republicans, or any political party, including one composed of free marketers, have the ability to create wealth for us. Nor can any economist, including myself, orchestrate a better outcome for millions of people than individuals can create for themselves using their labor, incomes, capital, and the price system.

Profits dont really existI mentioned above that it is this standard rate of profit that Marx-

ists and socialists (and most of society today) view as the means of worker exploitation. they argue that some or all of the profits should instead be paid to all the workers in a company instead of being kept by the capitalists. they suggest that workers are not being paid for the full value of what they produce. this is a grave misconception.

to see why we must understand what this standard rate of profit is and why it exists. the answer will tell us why workers dont receive this profit in the form of additional wages. In reality, this standard rate of profit is not a profit at allit is a mix of two different things. the first, inflation is in a class of its own. When the government creates new money and inserts it into the economy, the new money increases sales revenues of companies before it increases their costs; when sales revenues rise faster than costs, profit margins increase.


New money, which is created electronically by the government and loaned out through banks, is spent by borrowing companies.22 the expenditures show up as new and additional sales revenues for businesses. But much of the corresponding costs associated with the new revenues lag behind in time because of technical accounting pro-cedures such as the act of spreading asset costs across the useful life of the asset (depreciation) and not recognizing inventory costs until the product is sold (cost of goods sold). these practices delay the recogni-tion of costs on the profit and loss statements, or income statement.

Since costs are recognized on companys income statements months or years after they are actually incurred, their monetary value is diminished by inflation by the time they are recognized. for exam-ple, if a company recognizes $1 million in costs for equipment pur-chased in 1999, that $1 million would be worth less today than in 1999, but on the income statement the corresponding revenues recog-nized today are in todays purchasing power. there is an equivalently greater amount of revenues spent today for the same items than there were ten years ago (since it takes more money to buy the same good, due to the devaluation of the currency). Another way of looking at it is that with more money being created through time, the amount of revenues will always be greater than the amount of costs, since most costs were incurred when there was less money existing. thus, because of inflation, the total monetary value of business costs in a given time frame is smaller than the total monetary value of the cor-responding business revenues. Were there no inflation, costs would more closely equal revenues, even if their recognition were delayed. In summary, a majority of profits earned by businesses are actu-ally inflation effects; thus, government gives companies much of their paper profits.

Since business sales revenues increase before business costs, with every round of new money printed, business profit margins stay wid-ened; they also increase in line with an increased rate of inflation. this is one reason why countries with high rates of inflation have such

22Most funds are borrowed from banks for the purpose of business investment; only a small amount is borrowed for the purpose of consumption. even borrowing for long-term consumer consumption, such as for housing or automobiles, is a minority of total borrowing from banks.


high rates of profit.23 During bad economic times, when the govern-ment has quit printing money at a high rate, profits shrink, and during times of deflation sales revenues fall faster than do costs.

Bear in mind that these apparent profits are not real but a mone-tary illusion. Due to higher costs from inflation companies must at some point replace their plants, equipment, and inventories at much higher prices, which wipes out most of their paper profits, even though this can-not be seen on an income statement (companies often consume capital without even knowing it). Since businesses have their increased profits from inflation taxed, but have to replace inventory, plant, and equipment at higher costs than last time, the profits needed to replace the equip-ment at higher costs are diminished because a portion of them has been taxed away; companies thus have about the same, or likely, less real pur-chasing power with which to replace assets. In short, the increased pro fits that inflation provides companies do not constitute real increased wealth for these companies; at best, companies come out even.

Since the inflation effect is one derived solely by the governments increasing the amount of dollars circulating in the economy, lets look at what would constitute profit in the absence of the inflation effect. this second source of profits is the deduction of costs from sales reve-nues to compensate capitalists, whose money the companies are using to operate. In this way, the difference between revenues and total costs is not really profit, but a return on investment paid to those who really own the company: capitalists. More specifically, profit compensates the capitalists for waiting for a return on their investment, since the invest-ment is made long before the final production it generates. Stated another way, the companies themselves do not make profits on what they sell; the profits are paymentslike any other of the companys payments to suppliersto the suppliers of capital as a return on their investments. Without their investments, the company would not exist.

Income statements are set up in such a way that capitalists can see their returnsa view of the business as seen by the capitalists. the businesss view as seen by the company would theoretically include the

23the other main reason for this, if the country is poor, is the fact that there is a lack of capital: the more capital, the lower the rate of profit will be, and vice versa (though it can never go to zero).


capitalists required return as normal business cost alongside invento-ries, machines, or labor. though this is never done, if it were, profits would not generally be left over after subtracting all business costs.24

In most cases, massive outlays of money are invested before any product exists. It can easily be years or even decades between the start of a businesss operations and when the business gets paid for the prod-uct it makes. for example, consider the aircraft industry: the amount of time required to plan and design a large plane, properly build and tool the factory, and to actually produce the plane can add up to many years or decades. Similarly, a nuclear plant takes 5 to 7 years just to buildand that does not include the time spent putting in place the companys business and operations. though less time is needed for the development and production of many items (e.g., shoes, furniture, candy), the same concept of production taking time still applies.

It is the capitalist who pays for labor (and machines) in advance in anticipation of future production. Can you imagine how long employ-ees at the airplane factory would have to wait if they could not be paid until the product was sold? they would have to work for decades before receiving any income, and they would not be fully compen-sated until the very last plane was sold, many years after the first one. How would they purchase food, clothing, and housing? the capitalists take on the role of doing the waiting for the workers, by paying them in advance for their future production. this is why true cooperativesthose financed solely by the workersrarely exist. Since the capitalists have their money tied up for several years, they are not able to use it, and have to forego their own immediate consumption. In short, they are compensated for the time spent without that money at their dis-posal. for this, they receive interest, just as a bank receives interest for lending out money. they also receive a bad rap as greedy, money-hun-gry pigs because they do not give away their money for free.

In the end, real profits do not exist on an ongoing basis. the cost of wages, supplies, machinery, land, and the money used for operations (capital), are all subtracted from revenues. After the subtraction of

24 Interest payments on borrowed funds, which are listed as items on an income state-ment, are different than interest to stock holders. In general, I am referring to profits prior to interest, taxes, etc. Interest payments can only be made if there are profits.


these items, nothing is left, except in those instances discussed earlier where exceptional profits can be made temporarily from introducing a new product or a new efficient production method.

capitalist exploitation of Workers: The myth

to return to the original question, how can we be so sure that the total wages a company pays are as high as they can be? How do we really know that workers (and machines) arent destined to be ripped off by their employers? Consider all the aspects of profitabil-ity and costs of a companys income statement as shown in Figure1.3. this sample company has sales revenues of $1,000,000, total costs of $900,000 and a profit of $100,000, or 10 percent. After allowing for the 10 percent profit, and after payment for other physical capital, $365,000 is the amount available to pay for labor (in reality, capital and labor purchases are chosen simultaneously). How do we know that all company employees combined will receive a total of $365,000 in salaries?

We know workers will be paid the full $365,000, the most they can be paid without the company losing its profit, because of the com-petitive nature of a capitalist economy. Labor is the scarcest resource we have. thus, it will all be put to use (the existence of unemploy-ment will be discussed below) by businesses competing for its limited supply. Individual workers tend to be paid according to the amount

Figure 1.3: Simple income statement showing sales revenues, costs, and profits for a sample company

Revenues $1,000,000 100%

30%

OtherCapital

Product Input Costs $160,000 16%

Cost ofLabor Wages $365,000 37%

Cost ofCapital

Supplies & Administrative $80,000 8%

CapitalGoods

Plant / equipment / machinery / tools

$295,000

Prot $100,000 10%


of sales revenue they can bring in based on their productivity. there is a going market wage for each type of worker and each level of pro-ductivity. Workers use capital goods to create their products, and both they and the capital goods get compensated according to the value of what they produce.

If a worker with a particular skill set, knowledge base, and educa-tion can produce work that brings in $40,000 in revenues, tight com-petition in the labor market will cause that laborers wage to be bid up to $40,000 as well, minus the amount needed to achieve the going rate of profit. If one firm tried to underpay the worker with a salary of $35,000, (ignoring, for the moment, the discount needed to achieve the required rate of profit) that person would be an undervalued asset because their associated revenues will be higher than their com-pensation/cost. Another firm would be inclined to offer the worker $38,000, another $39,000, and so on until the workers wage is ulti-mately bid up to $40,000. But the price will not be bid higher because if a firm paid more than the $40,000 the worker is capable of produc-ing, it would lose money. Similarly, all workers together (along with supplies, machines, etc.) are paid the most that can be paid for them without losing a moderate profit margin. total costs for a company, on average, will be equal to the amount of money the company takes in, except for the amount discounted from costs that is equal to the aver-age, economy-wide rate of profit.25 Were there no waiting and no capi-tal involved, a companys costs would equal the amount of money it brought in.

What does all this led up to? Simply this: far from exploiting workers, companies do exactly the opposite. they (1) create jobs, (2) pay workers more than they would make on their own by being self-employed, and (3) provide the tools, technology, and machines to improve productivity and increase profits, thereby raising wages. All of this is thanks to entrepreneurs, business owners, and capitalists (who in some cases may be one and the same). While their big profits are short-lived, in the long run their actions result in permanent gains

25Again, except for those firms temporarily making high profits from introducing new products or cheaper production methods, and, except by firms making below average profits because of the fact that they are uncompetitive.


for the wage earners. that should make businesspeople the workers best friends, not their worst enemies.

given these truths, it is ironic if not indeed tragic that the exploi-tation of labor is at the heart of many arguments for why we need government protection from companies that would supposedly oth-erwise abuse workers and pay them unfair salaries. We can see now that, on average, this could not be the case. Businesses would certainly like to pay lower wages and to take advantage of the workers, and in fact most care nothing about the workers personally beyond making sure that they are happy enough to be productive and help bring in revenues for the company. But businesses are not able to underpay workers because of the market forces explained above. If companies pay too little, workers can instead choose to work for other employ-ers who will pay higher wages. the same principle applies to workers who want to earn more moneythough they would like to earn more, they cannot ask for more than they are worth in the market-place because their price will be uncompetitive: other workers with similar skills and abilities will sell their labor services for less money (i.e., the market wage). As with the prices of anything else in the economy, the price of labor is ultimately determined by supply and demand, not by individual greedy employers.

capital structure as the driving Force of rising Wages

It should be clear at this point that what helps workers, besides the ideas of entrepreneurs and the expertise of the business owners, is capital. the availability of capital derived from savings makes possible the transformation of an idea into real, physical goods and services, and the ability to produce these goods at faster rates, and with increas-ing salaries. Countries that experience a continually rising standard of living do so only because of a growing capital structure.

Since we now know that a capital structure is the collection of physical buildings, factories, machinery, and tools in place that mak

Documents

The Case for Legalizing Capitalism by Kel Kelly