The Labor of Capital: How Wealth is Created

The mistrust of the Catholic Church towards free-enterprise is a very old phenomenon. The time has come to leave behind the concept of an ‘antagonism between Labor and Capital’.

Cardinal Josef Höffner of Cologne (d. 1987), in his book “Christian Social Doctrine”, lamented the fact that socio-economic debates in Germany were characterized by a misunderstanding of the role of the entrepreneur.  Alongside other factors, he saw this as rooted in the influence of the Marxist idea of an antagonistic dualism between Capital and Labor.  Even Catholic social teaching rarely concerned itself with the typical phenomena of free-enterprise: as Höffner put it, “When free-enterprise came up for discussion, it was frequently mentioned with an open mistrust”.  But a change has occurred, and it was expressly announced by the Second Vatican Council.

Ecclesiastical Mistrust of Free-enterprise

And yet even this was limited: the Second Vatican Council praises entrepreneurial activity, to be sure (Gaudium et spes, no. 64), but only conditionally: the purpose of such production must not be “the mere increase of products nor profit or control, but rather the service of man”. Clearly, the traditional “open mistrust” still resounds in this formulation. Moralizing approaches such as this were already present years earlier in Quadragesimo anno (1931): “Expending larger incomes so that opportunity for gainful work may be abundant” is characterized as “an outstanding exemplification of the virtue of munificence and one particularly suited to the needs of the times” (no. 51). In his 1932 commentary on the Encyclical, co-author Oswald von Nell-Breuning spoke of the “virtue of the capitalist investor”.  But the function of the investor, in any case, really has nothing to do with virtue, since this is an economic function, and that is what Höffner had in mind.

An adequate evaluation of this economic function first occurs four years after Höffner’s death in the Encyclical Centesimus annus by John Paul II (1991). Here, capitalism is defined as an economic system “which recognizes the fundamental and positive role of business, the market, private property and the resulting responsibility for the means of production, as well as free human creativity in the economic sector” (no. 42). As long as this economic system is “circumscribed within a strong judicial framework”, it is to be considered something positive, and, according to John Paul II, should really be called a “business economy” or a “market economy” or simply a “free economy”.  Here the argument is functional-economic in nature: the entrepreneur’s profit is recognized for its foundation-laying function, as is likewise (no. 32) the intellectual achievement of the entrepreneur as organizer and creative innovator.  Already in Sollicitudo rei socialis (1987) John Paul II had emphasized the importance of entrepreneurial activity for the conquest of poverty, and was critical of how “in today’s world, among other rights, the right of economic initiative is often suppressed” (no. 15). Mistaken demands for “equality” have led to “passivity, dependence and submission to the bureaucratic apparatus . . . in place of creative initiative”.  This point of view has not only overcome an economically naïve, moralistic treatment of the business world; it also reflects the institutional and especially the legal presuppositions of any successful capitalistic undertaking.  And yet soon afterwards, Caritas in veritate (2009) revealed the beginning of a reversal:  the “common good” and an economy of “gratuitousness” are set against “commercial logic” (no. 36); the free market, it is claimed, is “not, in and of itself . . . the place where the strong subdue the weak” – certainly, only in so far as it is “structured and governed in an ethical manner.”

In Laudato si’ (nos. 128 – 129) Pope Francis refers very appropriately to business as a “noble vocation, directed to producing wealth and improving our world“, but at the same time he warns that ”the goal should not be that technological progress should increasingly replace work”, and maintains that technological progress that can lead to “laying off workers and replacing them with machines” is against humanity (no. 128). Business activity, for this reason, is fruitful for a region, “especially if it sees the creation of jobs as an essential part of its service to the common good” (no. 129).

The Profit Motive and the Common Good

Such texts perpetuate the traditional ecclesiastical mistrust and incomprehension toward the specifically entrepreneurial.  Successful businesspeople are not motivated by the intention to create employment positions, and certainly not at the cost of technological progress. Their goal, rather, is to bring products to the market which they can sell.  An entrepreneur must often eliminate positions in the interest of the viability or survival of the business.  Nor is the purpose of his action to promote the common good, although the common good is very well promoted, actually, through successful businessmen and entrepreneurially minded managers, often just because they open a path for technological progress.  Entrepreneurial action seeks to realize entrepreneurial visions, and purposely to earn money thereby.  Profitability is its law; its goal is absolutely to make a profit. But again, this is not personal profit, or personal enrichment, but rather the means to build the business, to invest in the future, and to become, or keep being, better and more innovative than the competition. And if someone is “at the top”, one of the best in the business, or even the only one in the market selling something, it is worthwhile for him to hold onto that position, and to defend it against rivals with undiminished efforts of innovation and optimization. Profit-seeking generates competition and innovation and fulfills a social function – as long as it takes place within the legal framework of a just state.  The presence of profit shows that there is strong correlation between production and consumer demand. In this way, profit that is rational, business-logic — not irrational, greed-logic – serves the common good, and high business profits, as a rule, are evidence that value is being created.

The industrialized, wealthy “West” of today became prosperous through businessmen and investors who were focused on their businesses, improving thereby the living standards of everyone, and this they accomplished, to a greater degree than even the wealthiest people of past epochs would have dreamed possible.  If, in recent decades, hundred millions of people of the “Third World” have come out of poverty, if the number of those living in extreme poverty has been cut in half, and if the gap between the rich and poor in poor countries is constantly shrinking – then this is the consequence (even in countries with highly state-managed economies like China), of increasingly free enterprise and of a market economy with borders open to international trade.

Common Interests

Why are businessmen, investors, capitalists so important? In the section called “Capital and Labor” in Nell-Breuning’s commentary on Quadragesimo anno can be found an unexpected hint of an answer. To the Marxist thesis that capital (owners of capital, businessmen) is locked in an exploitative relationship to the value created by the labor of the workers, Nell-Breuning countered, “It is not only the work of hands that is productive, but just as much the work of brains.  If people want to rise in prosperity, one thing is irreplaceable: a strong effort of intellectual as well as physical labor, of managerial as well as functional labor” (53).  In fact: there is such a thing as the “labor of capital”  — or call it, if you like, the work of the entrepreneur, the investor, and of course the inventor, who is associated or even identical with the former, and who creates “at least as much” value.  This work of capital is an intellectual and spiritual organizational achievement, without which the productivity of the laborers would barely be just enough to survive – and in the nineteenth century it wasn’t enough for that. This insight makes the Marxist and the Trade-Unionist perspective obsolete, according to which the capitalists and the investors represent interests that are in structural opposition to the interests of the workers. To be sure, Nell-Breuning does not offer any economic analysis of the “work of capital” and its function – and that perhaps explains his later adoption of a Trade-Unionist position.  In a 1958 lecture entitled, “Is Ownership the Power of a Class?” he started to characterize workers as “people deprived of the means of production” who had become “victims of a class-monopoly” and a mere “appendage” to capital.  Götz Briefs, a Catholic economist and social ethicist who emigrated to the USA in 1934, took Nell-Breuning to task, in a letter posthumously published in 1976, for arguing on the basis of the premises of the Marxist theory of value. According to Götz Briefs, in reality, the employee is the real beneficiary of the “capitalist means of production”, because these means are what “support and multiply (…) his achievement”, and permit him, in the form of a rise in his wages, better working conditions and a rise in his social status, to share in the “economical and technical fruits” of those capitalist means.  This is the decisive point. Of course, the entrepreneur is dependent on his workers – that fact is obvious. Less obvious is something else: if there were no businessmen and investors, the people who are “deprived of the means of production” – no matter how hard they work — would perhaps be in a position where they could barely ensure their survival.  It is only through the enterprising idea, which anticipates consumer demand and marketability, and then through the implementation of that idea and the capital it brings, that there comes into being that increase of value which raises the productivity of the “means-of-production deprived” worker, and also his compensation, to the level which improves his living standard and leads to an ever-increasing and more widespread well-being.

The Economy of Giving

The economic value of a product does not correspond to the labor expended in its production (as Marx still believed), but to the demand generated by that product in the market. The demand depends on the subjective preferences of the consumers and determines – with a given supply or scarcity – the market-price.  The entrepreneur must discover the needs of consumers, correctly figure out their value, and – like Henry Ford or Steve Jobs – have a vision and put it into effect. This is why only the successful entrepreneurial vision creates the value of the work of the employees who make the product.  This is true even for high-level and highly-qualified staff – from IT or software specialists to highly trained academic specialists in research and development. Even the employee who contributes a great deal to the success of a business through his special talents needs an entrepreneurial project that endows his work with its “market value”.  In his 1981 book Poverty and Wealth, George Gilder called capitalism the economy of giving. In capitalism, wealth and private possessions are not used exclusively for one’s own consumption and occasionally for charity (that is, for the consumption of needy fellow humans), but rather are invested for the sake of an entrepreneurial idea. This is when private possession begins to “work” for the common good, because it creates work and generates the paying of wages – and note well, this happens before the entrepreneur and/or investor sees any return. Wages create monetary demands for goods, which makes further entrepreneurial action – investing and producing – profitable. Increasing accumulation of capital makes possible increasingly innovative methods of production, which in their turn create new forms of labor which raise the productivity of labor overall, and for the most part also the value of wages, which strengthens the demand for better products.  The steady increase of wages, the shortening of working hours, and the gradual disappearance of child labor did not come about simply through social legislation or union-driven labor conflicts.  Worker-protection laws along with the universal requirement of going to school were able to counteract the worst situations and certainly made pressure for innovations. Nevertheless, prosperity for the masses was ultimately founded on a steady increase in the productivity of labor.  Without this, laws could not have been passed, or once passed, would have remained without effect or have become obstacles to further development. This historical fact is valid for the future as well: only a growth in productivity makes possible the rise of living standards in society.

The capitalistic-market-economy process of creating prosperity presupposes the framework of a state with a functioning rule of law.  Since risk is an essential characteristic of entrepreneurial work, clear and universally applicable regulations and their state enforcement are essential, especially in the area of contract-law and the defense of private property rights. It is only on such a basis that successful enterprise can flourish, that markets can actualize their coordinating and allocative function, and competition, as a “discovery process” (Friedrich August von Hayek), creates innovation and prosperity.  That is still valid today and applies precisely –as the Peruvian economist Hernando de Soto has shown—to the countries where defective property rights and a corrupt state bureaucracy have trapped people in poverty.  It is impossible in those places for the “little guy” to escape from a subsistence-level economy through entrepreneurial action. And yet the fundamental role of private ownership and the protection and extension of ownership-rights as the generator of prosperity – at the same time, as the key to the solution of economic/environmental issues – leads only a shadowy existence in the social teaching of the Church.

It seems that in many people’s minds there still floats the evil image of a conflict of interest between “Capital” and “Labor”: the idea that in capitalism the only person who can get rich is someone who takes something away from other people, and that private ownership only fulfills a social function when it is taxed and redistributed. But the truth is the opposite. In contrast to socialism, in a capitalistic economy someone can only get rich who also makes others rich, who produces what people find useful, and that means useful according to their subjective preferences – the only meaningful criterion in a free society without paternalistic oppression. The terms “capitalism” and “free market economy” do not imply in any way “crony capitalism”, which really exists in the USA and in many other places and is the result of an intertwining of politics and business. It is based on using political power – democratically elected – to steer the movement of markets in a certain direction through laws and regulations. When this happens, large concerns, consortiums, and special interest-groups use the leverage of their great financing ability and efficient personal networks to lobby successfully, to get government regulators under their control (regulatory capture), so that smaller companies are left out. This is not the capitalism discussed by the proponents of the classical-liberal tradition such as Ludwig von Mises or Friedrich von Hayek, nor is it Joseph Schumpeter’s world of innovative and prosperity-producing “creative destruction”.  There has been capitalism like this and there still is; despite all its defects its prosperity-making power is still effective.  And yet its results have been hindered and adulterated by all kinds of government intervention.  As Alfred Müller-Armack wrote in 1946 about the unfortunate developments of the past (as the inventor of the idea of the “social market-economy” he would seem an unprejudiced source):  “It has been demonstrated by scientific research that the main  causes for the failure of the liberal market economy do not lie so much in itself as in the distortions it has had to undergo through interventions coming from the outside, and that have been increasing since the end of the last century.” We find ourselves again today in a new phase of market activity being manipulated and misguided by politics and central banks – and to deal with the consequences we have only put the fox in charge of the henhouse.

The Faulty Leadership of Politics and Unions

The capitalistic process we have been describing corresponds to the often misunderstood “trickle-down-effect” – an unchangeable law – but is nevertheless often seriously hindered by politics, and even guided down false roads.  By means of enormously high government fees and taxes, massive redistributions and public debt, through the false stimulation of transfer payments, protectionism and subventions of all kinds, and as a result of financial crises like that of 2007/8  which were caused by  political influence, legislation and improper regulation, the real value of wage-increases melts away.  Central banks, with their monetary politics, use the poison that helped cause the crisis (cheap money, and now even “negative” interest) as if it were the medicine needed to heal it, but thereby only worsen the deficit problem and put off indefinitely, in many countries, the painful structural reforms that are needed for growth, innovation and the creation of jobs.  Instead of that, they produce new bubbles, contribute to the life-support of unprofitable businesses and failing banks, and make the rich richer. All of which – and this includes the creation of the unfortunate Euro, defended “at any cost” – has nothing whatever to do with a market-economy and capitalism, but a lot to do with politics. This state-interventionism is something the history books of the future will treat with dazed incomprehension, just as we of today must deal with the many political errors made by our predecessors.

Pressure from trade-unions often plays a destructive role in this process – here, too, the state and politics have their hand in the game.  There is a basic right to form coalitions, and the unions that flow from this right can contribute to the improvement of working conditions, can raise wages to an  adequate level in the case of stingy employers, and thereby improve the general working climate and productivity. But this will only happen to the extent that economic pre-conditions have first been secured. If these are not in place, the labor disputes waged by trade-unions produce the opposite of a rise in prosperity. Forced, industry-wide wage increases lead in the end to higher unemployment in other sectors of the economy.  They eliminate jobs even in their own industries by making it more profitable to use machines instead of employees, and they increase inflationary pressure, which has the effect of reducing or eliminating any increase in the value of wages.

The Public-Choice School has shown that not only politicians, but also trade-union officials act, as a rule, in their own interest, i.e., in the interest of their own subordinates and the people employed in their own industries, to the expense of everyone else and the common good. Misguided regulatory legislation, as well as the interest of politicians in stirring up conflicts that contribute to the expansion of their voter base, also provide a strong stimulus.  Under the US President Franklin D. Roosevelt, the economically-hostile regulatory legislation that gave unions the right to use force and the power of monopoly in the labor-market was one of the main reasons for the failure of the New Deal: as a result of the stagnant wages (some of which were rising in face-value only), the massive unemployment in the USA would never be mastered until the American entrance into the World War (in January 1939 unemployment was still at 17.4%). Roosevelt’s political program, which is widely believed to have been socially beneficial, did secure his re-election.  Politics and the US trade unions share the responsibility for turning the depression that resulted from the market crash of 1929 into the long-lasting Great Depression, just as in the recent Great Recession, in many European countries, regulation of the labor-market along with other seemingly socially beneficial “advances”, in combination with union pressures, were, and partly still are, co-responsible for long-lasting unemployment, over-indebtedness and slowness of growth.

The Problem is Mass Poverty, not Inequality

Perhaps the awareness of all this has not yet become common knowledge among social scientists. It would help to explain the widespread mistrust of investors and capitalists, especially the most innovative and successful, the greatest of whom have usually brought, and are still bringing, enormous improvements in productivity and prosperity.  And perhaps this lack of awareness is also why people keeping putting more trust in regulation and government intervention. We are justified in asking, whether, without the restraining of capitalism by industry-specific and now universal minimum wages, without tariff-contracts and excessive labor-law regulations that have come into being through the pressure of trade-unions, prosperity could not, in fact, be much more widely and better distributed, so that less-qualified workers and immigrants could have a better chance of becoming integrated into the labor-market. After all, it is really the poorest who profit the most from capitalism.  They are the ones who first make use of innovation, growth and entrepreneurial success. The fact that re-distribution by the social-state and by unions have played a central role in the history of today’s prosperous society, and in Germany particularly, does not prove that they were the forces that actually created that mass-prosperity.  In any case, it is certain that we in Europe are in danger of gambling away our material well-being – to keep it for ourselves in a stingy and egoistic way, and only at the expense of the next generations – through an interventionist, regulation-obsessed, social-state-redistributive, growth-hostile policy that often goes by the name of “social justice”.  The collective whimpering, cultivated by the media, about apparently growing social inequality and “relative poverty” does not help us much.  Whoever is only concerned about that will find it difficult to acquire any insight into the real nature of the situation.

And even from the Christian perspective, the struggle against inequality can never be the primary goal.  If we want to assist Pope Francis in his movement of renewal, the real goal must be the overcoming of mass-poverty as well as the injustices that hold people trapped in it.  One of the greatest of these injustices is keeping people – rich or poor – from becoming entrepreneurial, and in that way become rich themselves and make others rich as well.

 

English translation by Gerald Malsbary.

Original article in German

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