The Ethics of Capitalism, Class 6

Feudalism continued: Inherited Wealth and the Return of the “Rentier”; Big Business and Labor Market
Domination.

4. Inherited Wealth and the Return of the “Rentier”

The old feudal inheritances were reduced in the early 20th century: world wars destroyed lots of private capital,
governments nationalized a good deal of the industrial capital while implementing increasingly progressive
taxation. After the world wars there was relatively low levels of economic inequality. People had incentives to
work hard in relatively specialized forms of employment, which increased the level of education. Wages rose
steadily so that people could “catch up” with those who still benefitted from inheritance and land ownership.
The decades after World War II were highly productive ones in countries whose citizens possessed economic
freedoms.

In the 1970s, this changes with stagnate wages and the growth of economic inequality.

Thomas Piketty: an economy will move toward inequality and stagnation unless it is prevented from doing so
either by significant government regulation or by more external “shocks,” like wars. Because the early and mid-
20th century contained some unusually dramatic shocks, which were followed by certain sorts of economic
governance, Piketty believes these periods are anomalous decades in the longer run of economic history.

Basically, there are two sources of income in an economy. These are labor and capital. Both of these generate
“returns” to the people who own them.

Returns to labor are salaries or wages. Returns to capital vary, depending on the capital in question (by
“capital,” here we just mean any tradeable asset that is not labor). Intellectual property might generate royalties,
land or buildings will generate rent, shares in a big company will pay regular dividends, and so on.

Large holdings of capital generate incomes big enough for owners to live comfortably, without having to save
much of their annual return and with no need for wages. These owners of capital become a class of “rentiers,”
doing little apart from collecting wealth from the wage earners who pay them to rent use of their assets.

Under these conditions, wealth is not produced, but extracted: the rise of inequality occurs when a small elite
suck wealth from the wider population, whereas inequality reduces only when things are arranged so that people
can gain a reward for being productive.

Unless young people can squeeze into one of the remaining professions that promise high salaries, they can look
forward to a life of renting a home, no matter how hard they work. And to whom do the mass of workers pay
their rent? To the wealthy or lucky who were able to buy up all the housing, of course—Piketty’s extractive
rentiers.

If Piketty is right, then capitalism may not be self-sustaining: if we want private property to stay dispersed and
for people to enjoy the opportunities associated with competition, then regulations will be needed to stop the
drift back toward this sort of quasi-feudal “patrimonial capitalism.”

Drawing this conclusion doesn’t show that capitalism is bad, only that it needs to make sure that a large group
of people have the opportunity to engage in production and ownership. Lesson? feudalism is clearly the less
just system compared to capitalism, but may yet be the more stable. After all, the feudal economies of Europe
lasted for over a thousand years and capitalist societies have only recently emerged.
5. Big Business and Labor Market Domination

This is because the nature of economic production, at least initially, lent itself to large rather than small firms.
Once the Industrial Revolution cranked into gear, it became clear that a nation of shopkeepers wasn’t the only
possibility. In the 19th century, countries became nations of mills, mines, and factories that employed
thousands, rather than tens, of workers. These were large operations in which masses of people were employed
and controlled by bosses. In the 20th century, many developed countries lost their factories, mills, and mines.
They now have employers like big-box retail stores, call centers, and accountancy firms. But one trend has
remained: the companies in question tend to be large, with dominant market shares and very large numbers of
employees.

Why do big firms exist?

Imagine that every part of a Toyota Camry was produced by a different person or group who each individually
contracted with the Toyota company to supply them with parts. Then Toyota contracts with a series of people
and suppliers for them to assemble this one car and then sells the car to a dealer. Each contract for parts or labor
would be a one-time contract and would specify exactly what was required from the supplier or the laborer.
Each supplier or laborer could be guaranteed to get their market rate and would not have to be managed by the
Toyota company beyond the current project (meaning Toyota wouldn’t have so many employees). This is a
radical version of what Smith might have had in mind when he thought about a “nation of shopkeepers.” Why
don’t all the different parts of the divided labor work separately, on their own terms, and contract directly with
each other to produce the final product?

Answer: Firms exist because production is more efficient when it is organized hierarchically.

Fundamental question for any firm: make it ourself or outsource?

Doing things within a firm can be more efficient than outsourcing for a variety of reasons that came to be called
“transaction costs.”

The explicit, detailed contracts that are necessary when a firm decides to buy rather than make are extremely
costly in terms of time, adjudication costs, and knowledge (Williamson 1983, 1985). When laborers are hired
into a firm as employees, rather than treated as independent contractors, their contracts can be open-ended and
less specific giving more discretion to managerial supervision.

While these open-ended or “indeterminate” employment contracts might be economically efficiently, they
create the need for a hierarchical structure in the firm. Workers need to be told what to do by managers,
precisely because the contract doesn’t settle everything. Once a firm’s structure is in place, it is relatively easy
for a firm to become larger, taking advantage of economies of scale and thereby selling its product at a lower
price.