Home > Uncategorized > More words that matter: capital and labor – Part one

More words that matter: capital and labor – Part one

from Peter Radford

I was having a conversation this morning in which I argued the word “capitalism” has no meaning.  Or, perhaps, it has too many meanings.  It is a fraught one as well.  People get vexed in its presence.  I ought also have said the same thing about the word “labor”. Both words are relics of the early years of industrialization when they meant more to those throwing them around back then.  In our contemporary economy they mean rather less.  To me they reference things quite different from what they are in typical economic thinking, they are place-holder words for a power relationship that exists in a modern economy between employer and employee.  That relationship is better described in a corporate context, in which case the notorious “capitalist” slides from view to be replaced by the sort of managers agency theory is purported to talk about, while the power lurks in the background.

That power relationship was massively asymmetrical in the decades before the emergence of modern democracy, but has been made more benign subsequently.  Note that I am not arguing all is well.  It has been made more benign, not perfect.  Far from it.  Democracy is the counterweight to the excesses erstwhile capitalists unleash on us all.  It is why plutocrats, as I prefer to call them, are constantly trying to pervert democracy.  It’s a power struggle that never ends.  So we ought expect the latest batch of plutocrats to seek to do evil to democracy: it dilutes their power and thus threatens their wealth.  There is nothing new in this power struggle, most societies have had a self-serving elite trying its damnedest to pillage the underclass.  Our modern economy is no different.

The slipperiness of both words, capital and labor, has done quite a bit of damage to economics.  They were inserted early on into that strange animal we call the production function.  They were regarded as inputs into the machinery of the economy and a great deal of time and effort has gone onto understanding their relationship.  It was only noticed later that their domination of the production function threw a chilling light on the lack of understanding economists had on a central issue of concern to them: growth.  Which, it turned out, was more caused by something called total factor productivity than it was by either capital or labor.  Clearly something was amiss.  Maybe capital and labor were far less important than we thought, or, maybe, they were the wrong things to be talking about in the first place.

And it wasn’t as if the problem was a small one that could be tucked under the rug.  For instance, when Abromovitz first checked his numbers, what he referred to as the residual in his equations accounted for approximately 80%-90% of growth.  Capital and labor were, indeed, of little importance.  Solow confirmed this a little later, although his version of the residual was a bit smaller, weighing in at around 60%-70%.  Clearly economics need a major revision.

Hear is Abromovitz’s description of what he took away from this conundrum:

So the Residual was really a grab-bag.

For this, there were several big reasons. One was that the measure of factor inputs was incomplete. The whole intangible side of total capital accumulation-education, on-the-job training, and research and development (R&D)-was neglected. And so were other categories of expenditure and forgone earnings by business, households, and govern- ment (for example, the costs of improving health) that have the effect, and often the purpose, of increasing future income. So also were the productivity gains attributable to better allocation of resources and to economies of scale. And all these missing elements were unmeasured and difficult to measure but still embedded in the Residual. It was clearly not a measure of the advance of applied knowledge alone.

With all that in mind, I called that big Residual “some sort of measure of ignorance”

A measure of ignorance is a mighty healthy way to describe the finding.  It is a valuable discovery to learn that your hitherto assumption, in this case that the key inputs are capital and labor, is incorrect.  Economics should be applauded for this discovery.

What it should be criticized for is its consequent continued inclusion of capital and labor as inputs, and for its adoption of total factor productivity as something to be studied rather than eliminated by further discovery of what, exactly, are the proper or more influential inputs.

This does not mean that economists ignore the problem.  We are constantly hearing from them that modern workers need to sharpen their skills if they are to remain relevant in our high technology economy.  There’s a clue in there somewhere: perhaps skills are an input?

As an employer I purchase access to those skills when I hire an employee.  As a worker I sell those skills to the highest bidder.  Or I try to.  In the context of our highly inter-connected economies skills are a key ingredient to getting stuff done.  If so, they ought to be an input.  Or some proxy ought to be.

But now we have another problem: we have disaggregated labor.  We have identified one part of it as being a skill.  What else is there?  Might I suggest energy?  As we all know work requires energy.  We transform our natural environment by applying energy to previously useless, or disordered, stuff and thus turn it into useful, or ordered stuff.  Our subsequent consumption of this ordered stuff then disorders it, but that’s a different discussion for later.  So energy seems to be important.  It needs to be an input.   This would be helpful in our conversations about the environment.  If energy was an explicit input in our production functions we would expose it to more analytical critique and, dare I suggest, make it easier to discuss ways to source it more efficiently.

So labor might better be viewed as a combination of skill and energy.  The word labor could then be banished to the realm of politics, or I would prefer to political economy, where it belongs.  People do work.  People apply their skills and their energy to a material or informational substrate to create order which they then consume to extract the energy, as in food, or other use, as in an iPhone.

What about capital?

I think Abromovitz gives us the answer, or he hints at it.  It is the accumulated consequence of prior advances in knowledge.  It is manifested in technology, not narrowly defined as machinery, but is more broadly defined as embedded knowledge within any process that allows skills and energy to be more efficiently deployed.  Which means that capital includes all sorts of things we typically disregard: it includes our ability to manage a process, our ability to discover new knowledge, and our ability to fund these along with the application of prior advances in knowledge.  Capital is, in short, an enabler that has a huge social component which is why it has always had a fraught aspect.  Who owns it also owns the enablement, even though skills and energy are more fundamental or basic.

More sophisticated capital, by which we mean simply that we have learned a lot along the way, means we can expand our ability to imprint our skills on a wider array or forms of substrate by coupling it with energy.  All to create order.  All, subsequently, to consume and destroy that order.

I realize that this is very crude, for which I apologize.  It began this morning in my rejection of the word capitalism, which is a distraction from our understanding of the creative process we apply to our environment to make the stuff we both like and need.  But I do see the economy as a cycle of creativity wherein our skills are enabled by what we learned in the past and the harnessing of energy, to fashion a substrate into an order we value in its destruction.

More on all this later.

  1. Ahmed Fares
    June 4, 2020 at 5:33 pm

    Thank you Mr. Radford for a fascinating article. A lot to think about here.

    I’ve been thinking a lot lately about how capital is just stored labor, and how skills are human capital. It blurs the line between capital and labor. I like this quote from Adam Smith on human capital:

    “Fourthly, of the acquired and useful abilities of all the inhabitants or members of the society. The acquisition of such talents, by the maintenance of the acquirer during his education, study, or apprenticeship, always costs a real expense, which is a capital fixed and realized, as it were, in his person. Those talents, as they make a part of his fortune, so do they likewise that of the society to which he belongs. The improved dexterity of a workman may be considered in the same light as a machine or instrument of trade which facilitates and abridges labor, and which, though it costs a certain expense, repays that expense with a profit.”

  2. June 5, 2020 at 5:23 am

    Steve Keen lately has made both capital and labor functions of energy, with substantial results.

    I concur on ‘capital’. As neophyte in the strange world of economics, I concluded it was so ill-defined as to be meaningless. Likewise ‘capitalism’. Money, a factory, knowledge (mostly a common inheritance), those make sense. Capital is what a capitalist owns? Not helpful.

  3. ghholtham
    June 5, 2020 at 3:09 pm

    The central role of energy first became obvious when the oil embargo of 1974 quadrupled world oil pieces, triggering a global recession and stagflation. Economic models of the time, with capital and labour as the only productive inputs (with a state of technology scale factor) were unable to deal with the issues that arose. It is a legitimate criticism that despite that lesson little progress has been made in factoring energy into the economic theory of production subsequently. (People have tried to include skill levels with proxies like years of education etc).
    I suppose that is because oil reserves in the ground or under the sea do not produce anything. They have to be extracted and refined. Their “value” is then represented by the labour and capital costs expended in that process. If we count the refined oil in as well as the capital and labour we double-count. Still the conventional formulation is unsatisfactory for many questions we need to address, most importantly the ecological ones. In general it worries people that we have separated off the production of economic value as measured in dollars from the underlying physical processes.
    Capital has been defined by the way it has been measured. The backward-looking measure just adds up all past investment expenditures and rolls it into a capital stock. The forward-looking value of that stock is equal to the present value of the profits or rents that will accrue to the owners of the capital in future. In general the two are not equal (they will be only in some fantasy land of continuous equilibrium). A company’s stock market value, for example, does not equal the book value at cost of its assets.
    Moreover, there is no reason why in aggregate the backward looking measure should have any stable relationship to the value of aggregate output. People were trying to capture and represent the common observation that countries with more infrastructure and general kit tended to produce more and be richer than countries with less. But in truth, we haven’t got any further and thrown no further light on that observation. One lesson to be drawn is that no formulation will answer all questions. Decide what question you are addressing before trying to model a situation or process.

    • June 6, 2020 at 10:37 am

      Taking the first and the last statements here, have economists been asking the right questions since 1974? In any case, here is E F Schumacher talking to the National Coal Board Headquarters staff in 1950:

      “In the past, the improvement in fuel efficiency was driven forward by a steady and remorseless rise in the real price of fuel. But in the last few years – contrary to what most people think – the real price of coal,has fallen. In terms of other commodities, believe it or not, coal is now cheaper than it was in 1938. Is this a good thing when there is a shortage of coal, a shortage which makes it more than ever necessary that coal should be most efficiently and sparingly used?”

      By 1958 Schumacher was suggesting Jevons had been asking the right question way back in the nineteenth century: “Are we wise in allowing the commerce of this country to rise beyond the point at which it can be long maintained”?

      “Instead of forecasting what we ‘need’, some people at least might attempt to work out what it would be wise and prudent to need. … Modern man seems to be singularly unwilling to face the future. … Yet, as the late Sir Francis Simon said [in 1954], ‘the twilight of the fuel gods will be upon us in the not very distant future’. It is precisely here that economists and statisticians could make a really vital contribution. Instead of compiling long term forecasts of requirements, they might make long-term studies of availabilities; they might help to open people’s eyes to the fact that the problem of resources is in no way solved and that the way we are carrying on exposes our own children to totally insoluble problems. They might, furthermore,devote themselves to the study of alternative patterns of living – because unquestionably patterns exist which permit genuine increases in living standards without an increase in the squandering of irreplaceable resources”.

      Did the economic hacks advising Prime Ministers and Presidents listen? Did they heck!

  4. ghholtham
    June 8, 2020 at 12:35 pm

    It turns out that accumulating waste outputs, notably CO2 but also microplastics, are a bigger problem than depletion of inputs. People have been warning of the latter since Malthus and Sir Francis Simon was of course entirely wrong – proven reserves of hydrocarbon fuels are bigger now than they were when he wrote. The problem is that it would be madness to use them since we cannot sequester CO2 emissions and there is already enough in the atmosphere to raise global temperatures by over 3 degrees. Indeed we need to develop technologies to suck CO2 out of the atmosphere if we are to avoid destructive climate change.
    No doubt Diogenes and Epicurus were both right about the good life. Somehow, though, elected politicians have to persuade the public.

  5. Shivz
    June 9, 2020 at 11:13 am

    I will contribute two quotations:
    1. “The intention of the fixed capital is to enable the same number of labourers to perform a much greater quantity of work” (Smith).
    2. “The economy of the world is not based on the simple interplay of capital and labour. Sure, these are involved. But they are secondary characteristics, not fundamental ones… while it’s all well and good to measure the flow of capital and the markets for labour, don’t mistake this data for the forces that really drive growth, which are inventions (or, if you prefer, ideas) and the ways that they are made real”( Myhrvold).
    A whole world can be drawn therefrom.

  6. Ken Zimmerman
    June 27, 2020 at 11:10 am

    Peter, you describe your analysis as crude. From where I stand, the entire field of economics is more than a little crude, and simplistic on top of it. But I digress. Work and organizational psychologists and management theorists/researchers are always looking for the next gimmick to “convince” workers to be more efficient and more creative in ways that benefit the company that employs them. The latest “term of art” for achieving that goal is “worker engagement.”

    Psychologists are still debating a definition for the term. Kahn (1990), one of the first to theorize about work- related engagement, describes engaged employees as being fully physically, cognitively and emotionally connected with their work roles. More recently, Macey et al. (2009) defines employee engagement as “an individual’s sense of purpose and focused energy, evident to others in the display of personal initiative, adaptability, effort, and persistence directed toward organizational goals” (p. 7). Perhaps the most widely cited definition of engagement is that from Schaufeli et al. (2002, p. 74), who defines engagement as “a positive, fulfilling, work-related state of mind that is characterized by vigor, dedication, and absorption”. Schaufeli et al. (2006) emphasizes the diffuse and state-like (versus trait-like or momentary emotion-like) nature of engagement, arguing that engagement is a “more persistent and pervasive affective–cognitive state that is not focused on any identified object, event, individual, or behavior.” (p. 702)

    As a new proposed measure of why and how workers contribute to company productivity and success, one major question concerns the dilemma: is engagement just old wine in a new bottle? For example, how does engagement differ from other related organizational constructs such as job involvement, job satisfaction, commitment, discretionary effort, and turnover intention. Which shows the long history of theorizing and research on worker roles in the firm and worker contributions to firm success and productivity. Which I believe demonstrate amply that economic reward is never likely to be the only or even the major factor in worker contributions to the firm.

    Although it seems unlikely there will ever be universal agreement about a single definition and measure of engagement, it is important that measures of engagement reflect what is conceptually at the core of the construct. Definitions of employee engagement might usefully recognize it as a positive work-related psychological state characterized by a genuine willingness to contribute to organizational success. This may not only reduce definitional noise but help provide opportunities for more interpretable and robust meta-analyses which will help us understand, with greater confidence, the strength and the direction of the relationships that engagement has with its properly conceptualized antecedents and outcomes.

    Definitions of engagement, however cast, might therefore usefully reflect these two essential qualities: (i) a positive and energized work-related motivational state, and (ii) a genuine willingness to contribute to work role and organizational success.

    The theory, still only partially tested is that some combination of high worker engagement combined with high job involvement, high job satisfaction, high job commitment, a yet to be determined level of discretionary effort, and low turnover intention leads to firms that are both more (utmost?) creative and productive. Research thus far also seems to show that monetary rewards, while important are less important than the above factors for firm success and high productivity.

    Kahn, W.A. (1990), “Psychological conditions of personal engagement and disengagement at work,” Academy of Management Journal, 33(4), 692–724.

    Macey, W.H., Schneider, B., Barbera, K.M. & Young, S.A. (2009), Employee Engagement: Tools for Analysis, Practice, and Competitive Advantage, Malden, MA: Wiley.

    Schaufeli, W.B., Bakker, A.B. & Salanova, M. (2006), “The measurement of work engagement with a short questionnaire: a cross- national study,” Educational and Psychological Measurement, 66(4), 701–16.

    Schaufeli, W.B., Salanova, M., González- Romá, V. & Bakker, A.B. (2002), “The measurement of engagement and burnout: a two sample confirmatory factor analytic approach,” Journal of Happiness Studies, 3, 71–92.

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