Friday, October 28, 2005

About capital

A post (originally sent to the MoQ list) about the nature of capitalism, setting out my views. A good website for Hernando de Soto is here.

A few book references first; if you read these you'll get most of the background to my understanding. Most important: Hernando de Soto's "The Mystery of Capital", which I think is simply essential to any informed debate on this topic, and which I'll be drawing on explicitly below. Second, David Landes' "The Wealth and Poverty of Nations". Thirdly, Bjorn Lomborg's 'The Skeptical Environmentalist", especially Part 2 on Human Welfare. There are others, but they are the ones I rely on most.

I'd like to use De Soto to sketch out a framework for looking at the Quality of Capitalism. De Soto employs an analogy early on in his book: think of a lake. It could be looked at by a naturalist, and the beauty appreciated. It could be looked at by a sportsman, and the possibilities for recreation considered. If it is looked at by an engineer or a physicist, however, then the potential for installing a dam might be examined. That is, in the body of water that is the lake there is a _potential_ for energy which is currently being ignored. By the application of certain technology and machinery (e.g. a dam with turbines etc) that potential energy can be turned into something usable, and various possibilities flow from that. The potential energy is 'fixed' into a certain form, e.g. electric current, and then activities can be developed which derive from that fixed form. De Soto's point is that capitalism is the equivalent of the dam. In other words, capitalism is that application of human ingenuity which releases the potential that would otherwise be locked up, and which generates new fixed forms of energy which can be used in other ways.

So what is 'capital'? De Soto argues that although it is often confused with money (cash), this is a mistake. He writes, "What I take from [Adam Smith] is that capital is not the accumulated stock of assets but the potential it holds to deploy new production". In other words, to refer to the earlier image, capital is not the water, it is the possibility of electricity. Money is the facilitator of transactions, but "is not itself the progenitor of additional production". So money, or, more widely, any form of wealth or asset (land, housing, machinery, whatever), none of these are 'capital' in the sense which De Soto is describing.

The essential point is that for any of these assets to become capital, they must be 'fixed' by a legal process of property rights, and it is this legal process which is the heart of capitalism. It is this legal process which is the equivalent of the dam on the lake, which allows for the potential energy locked up in that body of water to be accessed and deployed in various creative ways. So, whatever assets there may be, unless there is a conversion process, it is not possible to speak of 'capital', nor is it possible to speak of capitalism.

Now the key step in the argument, and the natural link in with the MoQ, comes when De Soto is describing 'the codes of conduct that govern the use and transfer of assets', in other words, the formal property systems that have developed in the West. He writes, "Formal property records and titles thus represent our shared concept of what is economically meaningful about any asset. They capture and organise all the relevant information required to conceptualize the potential value of an asset and so allow us to control it. Property is the realm where we identify and explore assets, combine them and link them to other assets. The formal property system is capital's
hydroelectric plant. This is the place where capital is born."

De Soto goes on to identify six ways in which this legal process enables capitalism to function:
1. The economic potential of any asset is 'fixed' by the abstraction involved (as described above);
2. Various elements of dispersed information are integrated into a single, formal, representational system;
3. It makes individual people accountable to an impersonal process of adjudication, rather than local and customary relationships;
4. Crucially, the abstractions are fungible, that is, "unlike physical assets, representations are easily combined, divided, mobilised and used to stimulate business deals". The process of abstraction allows all sorts of creativity to apply;
5. It enabled a network of individual actors to relate within a reliable and transparent framework, which "radically improved the flow of communications about assets and their potential [and] enhanced the status of their owners, who became economic agents able to transform assets within a broader network";
6. Finally, and crucially, it gave a strong and clear protection to the transactions carried out within the system, thereby enabling trust and the proliferation of business.

We can discuss the above in more detail over time, but what I want to emphasise is the way in which De Soto's characterisation of capitalism parallels Pirsig's description of different levels. That is, what De Soto is describing is an intellectual level phenomenon, i.e. the abstraction (symbolic representation) of physical, biological or social assets, and the way in which they have 'gone off on purposes of their own', generating vast new static patterns of Quality. (Note that this analysis disagrees with Pirsig's own account of capitalism.)

De Soto's main point, in fact, is that the problem in Third World countries is not the presence of capitalism, but the absence, in other words, that those countries are still operating at the social level, and it is the absence of the intellectual level phenomenon of capitalism (i.e. the abstract representations of economic assets) which is hindering their economic development. De Soto's book is an extended argument as to how and why this is the case.

Now, the foregoing is the conceptual analysis of 'capitalism', and to summarise, it is my view that capitalism is the intellectual level representation and organisation of economic assets in such a way that new forms of Quality can come into existence. The question might then be - is this the best or the only intellectual level organisation of economic assets?

Leaving aside the question of open-ness to DQ, and associated questions of human rights and liberty etc, (on which Pirsig is reasonably clear IMHO) it seems to be the case that the existence of capitalism has benefited the residents of those nations depending upon it, and it can also be shown to have benefited the population of the world as a whole. The following thoughts (from Lomborg) seem pertinent:
- global GDP per capita, from a base of approximately $400 in pre-history to 1800 is presently around $6000;
- global poverty has diminished: "In the past 50 years poverty has fallen more than in the previous 500" (UN report of 1997) - still much to do, but the situation in developing countries is much better than it was;
- inequality "peaked in the 1960's [due to historical factors], has been decreasing since then, and is likely to continue to decrease dramatically for the coming century";
- the proportion of people starving in the world has fallen from 35 percent in 1970 to 18 percent today, and is expected to fall to 12 percent by 2010.

Lomborg's conclusion is that 'Things are not everywhere good [he's mainly concerned with Africa] but they are better than they used to be". As he puts it, "All in all, pretty incredible progress."

I've wanted, with the above, to provide more of a conceptual background for our discussion, rather than dive immediately into comparative statistics and moral debates about globalisation etc. I'm sure we can come on to those in our forthcoming posts. But I'll give the last word here to De Soto again, because I agree with it completely:

"I am not a diehard capitalist. I do not view capitalism as a credo. Much more important to me are freedom, compassion for the poor, respect for the social contract and equal opportunity. But for the moment, to achieve those goals, capitalism is the only game in town. It is the only system we know that provides us with the tools required to create massive surplus value. When capital is a success story not only in the West but everywhere, we can move beyond the limits of the physical world and use our minds to soar into the future."

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