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Who Exploits Whom?

Mises Daily: Wednesday, December 15, 2004 by


The avowed claim of the various socialist schools ranging from the die-hard Marxists to the welfare-state Social Democrats is to bring justice into the economic affairs of society. In their view, justice means protecting the interests of the workers against the capitalist bloodsuckers who allegedly produce nothing but nevertheless are able to reap handsome profits.

The Social Democrats are willing to betray their principles on grounds that a bloody civil war along with a centrally planned economy could be even worse than ongoing worker exploitation. Still, they are under the impression that it is the workers who are the ultimate owners of the products because it is they who toil and sweat, i.e., who are directly involved in the physical production of goods.

Austrian economist Eugen von Böhm-Bawerk, as explained in the recent article by Robert Murphy, defended the existence of very high profits because of the necessary function capitalists perform. Even Böhm-Bawerk, however, explicitly acknowledges the basic right of the workers to the whole value of the goods they produce. But his positive analysis tries to convince the reader that capitalists' existence is important and of a high value even to the workers. The function of the capitalist, according to Böhm-Bawerk, is to provide workers with the means to buy present (consumers') goods.

Workers require capitalists because they are either unable or unwilling to wait until the products of their labor ripen to the full value of consumers' goods. Seen in this light, the basic function of a capitalist appears to be merely that of a good salesman who trades present goods against unfinished future consumers' goods. Thus, workers get only a discounted value, which is still allegedly equal to the value of their marginal product, of what will eventually become present goods of the full market value and capitalists get the difference — interest income. We may say, using a popular expression among economists, that capitalists perform a "waiting" function.

The argument of workers' unwillingness to wait until the products of their labor eventually ripen to their full value, to be sure, may appear to be somewhat insensible. Waiting several years to be paid off in full would mean for many workers and their families simple starvation. So, the workers may appear in the circumstances where they are simply physically unable to wait for an extended period of time to live under the state of permanent duress. And why in such cases does the rate of interest depend on the time preference of the capitalists and not of the workers?

These concerns and questions are valid only if we assume that workers in fact are the rightful owners of the goods produced. To claim that workers do get only a fraction of what they produce means essentially that profits are deductions from wages.

Here I follow George Reisman[*]to argue that in the very nature of the things workers do not have any claim of ownership to the products of their labor, but, to the contrary, businessmen and capitalists do. In addition, wages constitute deduction from profits.

The Issue of Which was First

The proposition that wages are deductions from profits will most certainly appear to be simply incredible, if not even manifestly wrong. For who works in the factories and is engaged in the immediate creation of goods and services? However, the fact that workers are engaged in the process of physical production is virtually of no relevance whatsoever if we want to dig deeper and try to understand the economic interdependencies in a division of labor (capitalist) economic system.

The first thing we have to realize is that not everyone who is engaged in physical production receives wages. To see this, imagine a self-employed sheep raiser somewhere in the steppes of Kazakhstan a hundred years ago. Assume that our sheep raiser is not self-sufficient and that he needs clothes, bread, and a variety of other things which he can buy in a nearby town market. Assume further that the economy of Kazakhstan is developed enough and uses gold coins as its money.

The next time he needs all the stuff, our sheep raiser goes to the market and sells some of his sheep for, say, ten gold coins. Here comes the crucial question. Are we entitled to call the ten gold coins he receives from the sale of his products wages? No, we aren't. Regardless of the fact that our sheep owner is a poor fellow who rises up very early and works very long hours under unpleasant working conditions, the ten gold coins cannot be termed his wage, because to receive wage one must be first employed by someone else. By definition, a wage earner or, equivalently, a proletarian is someone who owns no means of production besides his own body, and whatever exceptional physical strength and skills he might possess.

Our sheep owner, by way of contrast, is his own boss and can decide what to do with his property — the sheep herd. The money the sheep owner receives after he has sold some of them is his product sales revenue. Now we come closer to the nature of the exact relationship between wages, product sales revenue and profit. In a few moments we shall see that in order for wages to come into existence there must first be profits.

In order to see this we must realize the fact that in the market economy people engage in productive activities for the sole purpose of earning money. Earning of money is of literally vital importance because, usually, the only way to acquire the goods one consumes is through expenditure of money one possesses. Earning of money becomes the decisive focal point of all productive activities in the economy. Individuals and business enterprises are able to earn money only if they offer things that somebody is willing to exchange his money for.

Furthermore, in the market economy, earning more money or even a definite minimum amount of money does not come easily because one's potential customers

have always the free choice to spend their limited incomes elsewhere. Only through continuing quality improvements or through continually offering goods for lower prices or through a combination of the two is it possible to outcompete one's competitors permanently, thus ensuring a steady flow of income for oneself.

But the quality improvements and lower prices are usually achievable only with the help of more tools and materials as well as more and more intelligent labor. At this point we have to introduce the species of entrepreneurs/businessmen who actually make the relevant business decisions concerning the investments in tools, materials and labor.

Our sheep owner acquires the status of an entrepreneur/businessman if he regards his productive activity, here raising sheep, as being for the purpose of earning sales revenue. From the perspective of our sheep owner the product sales revenue he receives qualifies as a potential means of his survival or, alternatively, his income.

If he decides to invest a part of it, say, into employing a worker and paying him a definite amount of money, say, on a monthly basis, then he incurs business costs. His investment in the form of monthly wage payments regularly diminishes the fraction of the sales proceeds which, following common practice, is to be regarded as profit, i.e., the difference between product sales revenue and costs.

Observe that where our sheep owner does not incur any costs in the form of monthly wage payments, the entire amount of his product sales revenue must qualify as profit! The abstract analysis given above confirms the proposition that profits, not wages, are the original form of income.

To understand the matter more clearly, we extend our original example and assume that our sheep owner hires his propertyless neighbor Murat to help him out watching the sheep and guard them against hungry wolves. They agree that Murat receives one gold coin per month for his services. Now, the picture becomes an entirely different one. Here we have one wage earner and one entrepreneur/capitalist.

Are we entitled in this case to say that Murat is entitled to own all the sheep just because he manages to save them from the wolves by watching them carefully? No, he isn't! It is certainly true that the marginal productivity of the sheep herd has gone up since Murat has been hired, but this fact alone does not mean that Murat is entitled to claim the marginal product (sheep saved from the wolves) for himself just because he has been hired.

What he receives as his wages is not the marginal product of his watching services but just the one gold coin. Observe the crucial role played by the sheep owner here.

Murat's wage — one gold coin that he receives — comes into existence solely because the sheep owner is wise and prudent enough to save the one gold coin from his sales revenue and to use it to pay Murat.

By employing Murat the sheep owner hopes, naturally, to earn more gold coins than he expends paying Murat. But still, Murat is able to earn the one coin and to contribute to a greater overall physical marginal productivity, and thus ultimately to his real wage, because of the savings and wise business decision of the sheep owner! Had the sheep owner consumed the one coin, say, by buying his wife delicious fruits, Murat would have remained unemployed and there would have been fewer sheep for humans to consume.

We can generalize the case. The existence of wage earners as a distinct economic class comes into existence, and remains in existence, only because and as long as there are entrepreneurs/capitalists who are willing to pay wages out of their saved funds.

We can go even further and see more clearly the crucial role played by the system of monetary exchange.

As Ludwig von Mises pointed out, without money and economic calculation stated in monetary terms, no capitalistic/roundabout method of production is possible.[†]The capitalistic/roundabout methods of production, in turn, are carried out with the means of capital funds saved, i.e. not consumed, by businessmen and capitalists.

The capital funds saved and expended in the production process can be termed productive expenditures because they are made for the purpose of producing goods and services that will be subsequently sold for usually a greater amount of money than the sum originally expended for buying the factors of production.[‡]

Productive expenditures of businessmen and capitalists in the form of wage payments and purchases of capital goods not only create a distinct class of wage earners, but also at the same time bring into existence the necessary conditions for a greater physical productivity of a given number of people willing to work for wages, thereby raising their real wages.[§]

The institutions of capitalism such as the monetary economic system and the system of private property enable those individuals in a human society who are more intelligent, productive and prudent than others to apply their own labor, and that of others, for the task of production, thereby bettering their own lives and also, and to an enormously greater extent, the lives of others who less capable.

I would like to conclude with a question: who indeed "exploits" whom? Do businessmen and capitalists exploit the workers, or do workers basically live from the intelligence, productivity, and prudence of entrepreneurs and capitalists?


[*] See the enormously valuable book by Professor Reisman(1996) Capitalism: A Treatise on Economics, Jameson Books, Ottawa, Illinois. Also available on the internet, URL: http://www.capitalism.net/. The issues I deal with in this article Professor Reisman discusses in a much greater detail along with a host of important applications and extensions in chapters 2, 4–7, 11, 13 of his book.

[†]See, Ludwig von Mises (1922): Economic Calculation in the Socialist Commonwealth

[‡]On the concept of productive expenditure and its role within the division of economic labor, see in particular Capitalism, pp. 441–62.

[§]For a full analysis of the determinants of productivity of labor and real wages, see Professor Reisman's own and truly pathbreaking Productivity Theory of Wages, ch. 14, pp. 603–72 of Capitalism.