NEW! THE PHYSICS OF CAPITALISM by Erald Kolasi (EXCERPTS)

The Physics of Capitalism: How a New Political Ecology Can Change the World
by Erald Kolasi
384 pages / 978-1-68590-090-8 / $32

Our collective humanity very much depends on the natural world, for joy, for comfort, and for sheer survival. Nature is full of complex and dynamic systems that are constantly interacting with our societies. The natural world is not simply active in some abstract sense; its collective physical interactions guide and forge many fundamental features of human societies and civilizations. Humanity does not exist on a magical pedestal above the rest of reality; we are just one slice in a grand continuum of physical systems that interact, combine, and transform over time. We too belong to the natural world, and we too experience its interactions and conditions, just like everything else. The wonders of the world are waltzing to the rhythm of restless atoms and oscillating fields.

….Energy is embedded in all human actions. But it’s not something that’s just lying around, ready to be used. All conceivable economic transactions, from the exchange of money to the production of commodities, require energetic conversions from various sources. Oil is first extracted from the ground, then converted to gasoline at a refinery, and finally the gasoline is burned by your car’s engine, which converts the chemical energy of the gasoline into the mechanical work of the tires. And while you’re busy browsing the Internet, the solar panels are taking the light energy from the Sun and converting it into electricity, which is then sent to your home so you can stay online. The conversion of energy into different forms is what makes civilization possible. It’s what allows us to do things like drive to the grocery store, surf the web, play video games, watch television shows, and read romance novels at the beach. In this fundamental sense, all economic activities depend on energy flows, and none of those activities can exist separately from the laws of physics.

Excerpted from Chapter 1: Growth and Scale in Economics

…The most dangerous recurring theme of human history is civilizational collapse and dysfunction caused by widespread ecological disruption. We are now entering an age of profound and unprecedented ecological crisis, a bionomic disruption that threatens not just the viability of our economic systems, but large portions of the planet’s biological fabric. Although global warming is a major long-term challenge, it’s just one of many fundamental problems that have been caused by the capitalist acceleration of the past two centuries. For just one notable example, recent studies have suggested that roughly 8 to 10 million people die every year from air pollution, and the dominant cause of that pollution is the combustion of fossil fuels. In addition to global warming, humanity has adversely affected the planetary ecosphere by polluting the world’s oceans and atmosphere, starting the sixth mass extinction event in our planet’s history, causing massive disruptions to the nitrogen and phosphorus cycles that sustain all plant growth, boosting the incidence of global pandemics through agricultural expansion, and expediting the shortage of critical natural resources, including drinking water for much of the world’s population.

To the extent that human civilization will buckle and bend over the next few centuries, it will be from the cumulative pressure of all these factors, not from any single factor by itself. But since our problems are largely framed in the context of climate change, the corresponding solutions are narrow and technical, amounting to little more than hoping for rapid technological change to replace fossil fuels with renewables like wind and solar. For this school of thought, the goal is to simply decarbonize the global economy and continue as if nothing else matters. This approach is misguided precisely because our ecological problems don’t boil down to one simple thing. Substituting renewables for fossil fuels is an important and admirable objective, but not if it’s done without thinking about the broader context of our ecological challenges.

The dominant narrative in this entire debate is the idea that humanity can overcome the ecological problems of late-stage capitalism through technological innovation.This book will make a very different argument. Technological innovation has produced more energy-intensive societies with destructive ecological consequences. Improving energy efficiency tends to lead to more energy use over time, not less. Having a good understanding of the physics of capitalism will provide a better foundation for radically changing the politics of capitalism. Instead of advocating for technological change, we should advocate for social and political transformation. We should change how power is wielded in society, how decisions are made, how labor is organized, how wealth is distributed. Revolutionary transformation is what we need to secure our future.

…How should we understand the concept of economic growth? These questions are not just some silly academic exercises. If we’re going to figure out how to make our economies compatible with the wider planetary biosphere, then we need to impose constraints and specify parameters for acceptable levels of growth and scale. And if we’re going to talk about growth and scale, then we need to have a good sense of what’s actually growing and how big it’s getting, which means we need to address this question: how should we measure the size of an economy? This deceptively simple question is actually quite tough to answer. In an economic context, size and scale can mean lots of different things. For example, we can measure the size of a country’s population and see how it changes over time. We can measure the total mass or volume of everything produced by a particular society. We can measure a society’s total energy consumption. What we should measure and call the “size of an economy” really depends on what we’re trying to study. If we’re looking at crop productivity in agriculture, for example, we might measure the caloric content produced per unit area. The specific demands of the problem should guide the parameters of the definition.

2. The Neoclassical World

Before explaining the specific details of the ecodynamic synthesis, we first need to understand a few things about the dominant school of economics that it’s meant to replace. The prevailing paradigm of explanation among economists who are supportive of capitalism is known as neoclassical theory. Because it’s the dominant school, it has great institutional force among governments and corporations, and thus strongly affects how people in power behave in their response to common social problems. Only by dispelling its myths and perversions can we set the stage for another, more comprehensive perspective on how to organize human society in the face of our impending ecological challenges. For much of the nineteenth century, economic debates in Europe unfolded in the context of what’s now commonly called classical economics, which tried to understand the nature of production by analyzing the role of different productive factors, such as labor and manufactured capital. Classical economists were especially interested in the production process and how it influenced prices and other economic variables. From Adam Smith to Karl Marx, they also emphasized the strong connections between political, institutional, and economic systems. But things began to change in the late nineteenth century, when European economists like William Stanley Jevons, Carl Menger, and Léon Walras established the basis for neoclassical economics by shifting the focus of economic thinking from the analysis of production to an analysis of individual preferences as expressed through exchange markets. This shift made it far easier to obscure the power relations and dynamics involved in creating exchange markets in the first place.

Neoclassical thinkers argued that economic value is subjective and that commodities have no inherent worth, a position known as the subjective theory of value. What we are willing to buy in the market, according to them, ultimately comes down to our individual values, to what we find useful and important to us now or in the future. Those values, in turn, are only constrained by the relative scarcities of the goods and services in question. We value things that are scarce and disregard things that are abundant. The neoclassical thinkers claimed that people and businesses want to maximize utility, a vague concept that means something like desire. In practice, utility can stand for anything from consumer satisfaction to financial profits, as the situation warrants. According to the theory, economic agents maximize their utility by making decisions at the margins, hence why supporters of the theory are also known as “marginalists.” In other words, when they decide what they want, people do not think about broad categories of goods like “chairs” or “books.” They desire a specific chair or a specific book, and then they look at the net costs and benefits that come with consuming that extra commodity. Subject to various constraints, they will keep consuming until they have maximized their utility function, which is another way of saying “until they have fully satisfied their desires.” As part of this intellectual program, people were assumed to be rational agents who could make free and independent choices.

The apparent purpose of this neoclassical shift was to make economics a formal science, a seemingly objective field of study that yielded categorical laws and principles about the behavior of human societies. Historians, especially Philip Mirowski, have thoroughly documented how neoclassical theory developed out of flawed analogies and misguided parallels with classical physics. Marginalists reasoned that just like particles are constrained by attractive and repulsive forces, prices and utilities are apparently constrained by the underlying forces that determine supply and demand. In the traditional picture from classical physics, particles respond to the forces they experience in their local environment, like a ball being thrown up in the air and then coming back down under the force of gravity. Forces constrain the dynamical behavior of the particles, and these constraints are described through differential equations with initial conditions. In the same vein, the marginalists believed that prices and wages respond to various forces coming from the real domain. Changes in supply and demand cause changes in prices and wages, almost like a mechanical device with levers, cogs, and wheels. The real domain is analogous to the lever, and the cogs rotate in response to the lever getting pushed and pulled in certain directions.
In his 1892 book, Mathematical Investigations in the Theory of Value and Prices, the American economist Irving Fisher described the equilibrium conditions on the marginal utility of an individual and claimed that these conditions correspond “to the mechanical equilibrium of a particle the condition of which is that the component forces along all perpendicular axes should be equal and opposite.” He then produced an infamous table in which he made a series of direct and ludicrous analogies between physics and human society. For example, the table seriously suggests that a particle is analogous to an individual person and that energy is analogous to the concept of utility. Whereas energy was subject to minimization conditions, utility would be subject to maximization conditions instead. But here is one critical difference between physics and economics. Astronomers can tell us precisely when Halley’s Comet will return near the Earth’s orbit. They can tell us exactly where Mars will be in 56 years. By contrast, economists cannot predict the motion of prices in the same way that astronomers can predict the motion of planets and comets. No one can say with any certainty what the price of red apples sold at the local Whole Foods will be 27 years from now. Prices and wages are not like planets and comets. Because the world of money is a social creation mediated by social relations and institutional hierarchies, it has a tangled web of causation far more complex than anything described by the simple differential equations of classical physics.

Many early neoclassical thinkers used mathematics quite recklessly, making fanciful assumptions simply to obtain a desired result without understanding the full implications of what they were doing. That’s the charitable interpretation. The more realistic interpretation is that they simply didn’t care about the consequences. These new theorists hoped that economics could be understood as an objective science divorced from politics and the rest of society; that way it could serve as an easy crutch to defend the status quo. The “dismal science” had finally arrived. Once Marxism exploded onto the scene at the turn of the twentieth century, neoclassical theory became the primary intellectual weapon used to defend the class hierarchies and power structures of capitalism, and it retains that role to this very day. However, neoclassical thinkers were gullible to look to physics for their salvation, as if coming up with ill-conceived mathematical equations immediately made their claims more plausible. They should have turned to philosophy instead. Then they would have learned about something called emergence, a concept that represents one of the major themes of this entire work. They would have learned that friction and dissipation are important features of our macroscopic world, but they do not exist at the level of a few quantum systems. More to the point: individual cells do not have personalities, but 40 trillion of them interacting the right way constitute human beings who can think, feel, plan, laugh, and cry. People are not particles. The idea that slaves can maximize their utility by improving their marginal position through independent choices is exactly as laughable as it sounds.

Perhaps the central flaw of neoclassical theory is the assumption that our preferences are independent from the rest of society, apart from our interactions in an exchange market. In reality, personal choices are neither subjective nor even that personal; they are causally subsumed in highly complex social networks involving families, friends, coworkers, bosses, political leaders, and numerous other people. Economics is not separable from society and politics. Our preferences and desires do not magically flow from within us; they are shaped and constrained by other people, sometimes in subtle ways that are not immediately perceptible. The implication is that commodity prices and labor wages cannot be understood as microscopic, individual-level phenomena. That expensive shoe is not expensive just because you really want it, and your low salary is not the result of you being lazy or dumb. These economic variables are all products of complex social factors converging together across time and space. The people who wield the greatest political, institutional, and economic power are critically important in determining the broad constraints that apply to the prices of certain commodities and the wages of different individuals. The ecodynamic synthesis presented in this work remains sensitive to these crucial facts. Neoclassical economics, on the other hand, is built upon flawed ideas, which even the fanciest mathematical models cannot remedy.

Utility and Prices

The central concepts of neoclassical theory, utility and marginality, both contain a severe defect: they are not empirical quantities that can be measured. Instead of being measured directly, the way someone might measure masses or heights, their values are inferred indirectly from wages and prices, which neoclassical theory assumes provide a window into some hidden world of value. But prices and wages can never fulfill this goal. Commodity prices can change, and often do change, even when the commodities produced are exactly the same. Perhaps these prices are changing because they are measuring some underlying shift in utility, but they could also be changing because of a million other reasons. There is no way to tell because utility is not something we actually see or measure. In the twentieth century, the economist Paul Samuelson shifted the focus from utility to “revealed preferences,” but this concept turned out to be just a more sophisticated phrase that was equivalent to utility. Just like utility, preferences are not measured directly. We are supposed to infer them from observed behaviors. The theory of consumer preferences suffers from other problems too, not least of which is the fact that observed choices do not necessarily result from a constructed set of personal preferences. Sometimes you buy that container of ice cream because it was in your “bundle” of preferred goods, but sometimes you buy another container because your wife told you to go to the grocery store for her favorite ice cream instead. The mere fact that you made an economic decision does not necessarily reveal a personal preference. Our choices are embedded in complex social interactions, an important point to remember as we develop our comprehensive critique of the subjective theory of value. Despite its numerous problems, utility is still widely taught in college classes and remains a major background component of economic thought among the marginalists.

In fact, utility hovers over economics like a metaphysical shadow, a Platonic Form that cannot be detected but somehow underlies everything. The major consequence from this philosophical adventurism is that much of neoclassical theory has become ideological, tautological, and nebulous to the point of being incoherent. Even though we can easily point to real-world examples that prove its assumptions wrong, the assumptions are fluid enough that the theory can be made to say just about anything. Consider the assumption that economic agents are “rational” actors that aim to maximize utility. One can quickly dispatch this silly assumption by pointing to philanthropy, among a million other economic activities. If individuals and corporations always wanted to maximize income and profits, respectively, then they would not be giving away large sums of money to charities, even after accounting for sizeable tax deductions or even illegal forms of tax evasion. Neoclassical theorists can always claim, and many do, that people and firms are still pursuing their utility, just in a different way. The inclusion of altruism into mathematical models of utility has become all the rage in certain corners. But these models are largely useless because they exclusively measure altruism through financial transactions. They have no conception of utility and altruism independently of monetary exchange. They have already assumed the truth of what they are trying to show. Notice also that these altruistic models still consider utility to be an individual phenomenon. In other words, when a person makes a donation to a charity, that donation is seen as increasing the individual’s utility function. But people can make a donation purely because of social pressure, like when someone tells her spouse to make a donation to her favorite organization. In these cases, which are quite common, the satisfaction does not come from the act of donation, but rather comes from the knowledge of having brought joy to someone whom you really care about. Humans either maximize utility exclusively through self-interested participation in an exchange market or they maximize utility more broadly through various types of social interactions. However, the latter situation requires that we must sometimes decrease the utility we gain from an exchange market, which happens quite often in life but also completely trashes the mathematical formalism of neoclassical economics. The theory is absurd either way, but one can quickly spot how it loves to play chameleon.

Research from the field of behavioral economics has also revealed that people frequently do not act in ways that standard neoclassical theory predicts. People make impulsive financial decisions and succumb to herd mentality. Sometimes they cheat and lie. Sometimes they ignore good evidence and advice, ending up with terrible investments that destroy their hard-won earnings. They are anything but the rational agents that the marginalists need them to be in their useless mathematical contraptions. The marginalists have an answer for this. They will respond by saying that, on average, people do behave rationally over the long run, even if they might do some pretty dumb things on certain occasions. But they have no way of knowing if that’s actually true, for the simple reason that things like “rationality” and utility are never measured directly. They are inferred from the same economic variables that they are supposed to explain. Neoclassical theory has no way of showing that people are actually rational; it simply makes that assumption, takes it for granted, and then hopes for the best. Even if you could get past this problem, there would still be an issue with the arbitrary notion of rationality used in economics. One can easily imagine forms of rationality that do not require optimal outcomes in the utility that we derive through exchange markets. For example, we could instead think of rationality as a balance between competing utility functions, some of which describe the pleasure that we derive from buying commodities while others describe the pleasure that we get from spending time with friends, pursuing our favorite hobbies, and playing games with our children, among other social activities. Sure, this definition is arbitrary, but no less arbitrary than the useless metaphysical abstraction historically adopted by neoclassical economists.

Many of these issues were famously explored by the economist Joan Robinson, who correctly argued that utility is a circular idea. She asserted that “utility is the quality in commodities that makes individuals want to buy them, and the fact that individuals want to buy commodities shows that they have utility.” One cannot infer utility from prices and then shamelessly proceed to infer prices from utility. The implication is, once again, that prices cannot offer us an exclusive window into individual values. Commodity prices can change because of many reasons, from political elections to violent wars and revolutions. Trying to isolate the influence of individual “values” among all of these factors is an absolutely hopeless task because so many of these factors are integrated together. People could like an article of clothing for its color, fabric, artistic value, and a million other reasons. For example, a t-shirt can become instantly popular one day because a celebrity was seen wearing it and then got photographed by the paparazzi. Some commodities, or types of commodities, can gain visibility in the public eye through highly chaotic and unpredictable ways. Product endorsements are also common nowadays, especially with social media personalities who sometimes create their own product lines, be it for cosmetics, clothes, food, and many other things. Economists do not consider the importance of social influence at all when trying to understand price dynamics. That omission makes sense for their institutional role within the capitalist system; they have settled for the usual propaganda that prices represent objective and reflexive signals from the “real” domain of physical production. Saying that society might play a role in setting prices sounds too subjective and irrational for those in charge, who need people to believe that the economic realm is a perfect reflection of fundamental scientific laws, instead of an elaborate construction that benefits those who have wealth and power.

Supply and Demand

It’s certainly true that supply and demand provide important constraints on economic activity and the dynamics of the nominal domain. If 95 percent of the world’s apples suddenly disappear tomorrow, it’s a safe bet that global apple prices will rise dramatically. In the critique that follows, I am not rejecting supply and demand as useful categories of economic analysis; I am specifically rejecting the way that these two concepts have been abused and manipulated within neoclassical theory itself. I myself will happily employ supply and demand as explanatory concepts later in the book, but only by placing them within broader causal and historical contexts. It’s absolutely misleading to believe the naïve Newtonian picture in which supply and demand function like mechanical forces that pull and push prices in different directions. Too often in both academic and public discourse, it’s this silly picture that’s blindly repeated, and virtually all changes in prices, wages, and profits are automatically attributed to “supply and demand” like a Pavlovian reflex. This was especially the rationale du jour during the height of the recent global pandemic, when much of the media and many academic economists kept spitting out the phrase “supply and demand” for any unusual patterns in consumer goods prices, labor markets, real estate markets, or any other strange activity in the global economy, making hardly any further attempts at deeper explanations. We’ve arrived at a point where “supply and demand” has become a popular catchphrase, repeated just because everyone else seems to be saying it, but without any actual awareness of its meaning or implications. In reality, the nominal domain of prices, profits, and wages is heavily filtered and structured by intermediary social relations and various economic and political struggles over the distribution of economic resources. Prices don’t just move in tandem with changes in the biophysical world; their actual trajectories are heavily influenced by intervening social dynamics.

Let’s try to better understand why this seductive catchphrase is profoundly misguided. The traditional neoclassical story tells us that prices are determined by supply and demand. The law of demand states that, all else being equal, prices are inversely related to the quantities demanded. If something becomes more expensive, people will want to purchase less of it. And the law of supply says almost the opposite: all else being equal, prices are directly related to the quantities supplied. If prices rise for a particular commodity, then producers will want to supply more of it, so they can make more money. The dynamic competition between these two economic levers is supposed to yield the “equilibrium” price. That’s the neoclassical story in a nutshell: scarce things are expensive and plentiful things are cheap. But this insight is largely vacuous for many reasons.

First, let’s consider the problem of causation. If changes in prices are caused by changes in supply and demand, then what’s causing changes in supply and demand? One cannot fall back on tropes about how there’s a feedback loop here, because real feedback looks are always causally embedded in a larger environment; they’re never isolated. For example, a major theme of this book is the energetic feedback loops between human society and the natural world. But these feedback loops can only function in the context of a causal arena featuring light energy from the Sun, gravity from the Earth, and many other necessary biophysical factors. It’s therefore not convincing to rely on circular reasoning and to claim that prices and supply and demand mutually cause each other. The basic truth is that supply and demand are incidental causes, at best. Price dynamics are fundamentally caused by social and political struggles over the distribution of economic resources. Supply and demand cycles are usually engineered by powerful individuals, corporations, and governments, as a strategy to yield the prices and profits they ultimately desire. Gas prices in the Western world skyrocketed in 1974 because the OPEC cartel temporarily suspended oil shipments to Western countries as a way to punish them for supporting Israel in the October War; the price of gas didn’t just rise because a shortage magically and spontaneously appeared out of nowhere. It increased because of geopolitical dynamics, which caused the shortage in the first place. For another example, the De Beers cartel deliberately restricted the supply of diamonds in global markets throughout the twentieth century, leading to grotesque price inflation along the way. A typical neoclassical economist would look at the situation and blame a supply shortage for the high price of diamonds, just like they’d reflexively blame a supply shortage for the high price of anything. But there was only a supply shortage because De Beers artificially created one to cement its stranglehold over the diamond industry. To think of supply and demand as omnipresent forces that somehow control prices behind the scenes is to ignore the active agency of powerful individuals and corporations in establishing the critical parameters of the nominal domain, from prices and wages to profits and interest rates. Imagine a child hitting a baseball that accidentally smashes the neighbor’s window and then has the nerve to tell his neighbor, “Well I didn’t break the window. The ball did.” In a silly and pedantic way, it’s of course true that the ball physically penetrating the window caused it to be smashed into pieces. But then again, it was the child who swung the bat and gave the ball its unfortunate trajectory, and this is the cause we ultimately care about. Neoclassical economists recycle ritualistic propaganda about supply and demand and the “invisible hand” of the market as a way of obscuring and marginalizing the critical factors, like social power and class domination, that collectively have a far more profound impact on the dynamics of the nominal domain.

And then there’s the problem of demarcation. It’s not easy to know how to define or measure supply and demand in specific circumstances. Take oil as an example. What is the global supply of oil? Is it all the oil on planet Earth? Is it all the oil in proven reserves? All the oil in commercial or strategic inventories? How about the finished oil products stored in refineries or marine terminals? Take housing as another example. What’s the supply of housing? Is it the stock of existing homes for sale? The stock of new homes for sale? Both combined? What about non-rental vacant properties? What about new finished homes held back for inventory? The fundamental reason why this issue matters is because we might find results that are consistent or inconsistent with the laws of supply and demand depending on how we define these terms and what we actually measure. If the global oil supply is all the untapped reserves on planet Earth, then oil extraction over time depletes that finite stock, implying that prices should get consistently and continuously higher, if the law of supply is right. But that’s not what we see; oil prices actually exhibit huge swings and variations over time. Given these problems, economists typically understand the term supply to mean whatever is available for sale in a market. Business economists often differentiate between the stock, which is what the seller holds in reserve, versus the supply, which is the amount offered for sale in the market. This distinction is relevant because market supply is often poorly defined, and the available supply will depend on what we decide to include as part of the market in question. But more importantly, supply is often artificially constructed by those who have the power to do so. Capitalists routinely create artificial scarcity by controlling how many products show up in their markets in the first place. As mentioned above, De Beers used to keep diamonds off the market so it could inflate diamond prices, and OPEC does the same thing with its production quotas on oil. Ticketmaster often sequesters a large percentage of tickets for major events to justify higher prices on the remaining tickets that it does offer for sale to consumers. Real estate developers keep many of their finished homes from getting on the market, precisely to justify higher prices on the homes that are available for sale. Pharmaceutical companies in the United States use a variety of legal and political methods to limit available drug supplies, thus pumping up prices for millions of people. Restricting supply is a time-honored capitalist tradition designed to make goods and services seem like they’re special and exclusive. For that reason, defining supply as just the stuff that’s available for sale in the market is often an ideological cover for the corrupt and self-interested decisions of elite capitalists.

Demand is even more notoriously difficult to define than supply. Here’s how the economist Susan Feigenbaum puts it: “The quantity of a good a person is willing and able to purchase at any given price during a specified time period…all other factors held constant.” Two other economists used a bit of a mathematical caricature to define the concept: “Demand = Desire to acquire + Willingness to Pay + Ability to Pay.” These definitions all sound great and intuitive, but it doesn’t take much thought to realize that they’re pseudoscientific pablum. How does an economist exactly measure someone’s desire or willingness to purchase something? The short answer is that they can’t; all they can do is measure what products were purchased, in what quantities, and the corresponding prices. Desire and willingness are neurobiological phenomena that cannot be accurately and consistently measured with our current technological systems. Speaking in these silly terms is part of the lazy neoclassical effort at explanations based on methodological individualism, the notion that economic behaviors and decisions are derived from the autonomous preferences that exist within individuals. But the reality is that people take plenty of economic actions that have absolutely nothing to do with their internal desires and personal preferences, simply because we’re social creatures whose actions are often influenced, and sometimes even forced or manipulated, by others.

As if these issues aren’t bad enough, there’s also the problem of time. It’s possible to get conflicting conclusions about the laws of supply and demand depending on the time intervals under analysis. This issue points to a general problem in economics: a cherished empirical relation might hold for five years or so, then break down completely once we get out to 20 or 30 years. Alternatively, the relation in question might hold up pretty well over long periods of time, but could easily break down over short time intervals, such as weeks or months. Another issue is the problem of stability and equilibrium. For any given price point, there exist an infinite number of supply and demand curves that could generate that price. Because it’s practically impossible to measure supply and demand, at least as they’re typically defined, it’s also practically impossible to identify which curves are responsible for generating any given feature of the nominal domain, from individual salaries to commodity prices. This is an especially important point, because even if we grant the neoclassicals all their wildest fantasies about supply and demand determining everything, the practical consequences of that admission are virtually irrelevant as there’s no way to empirically nail down the supply and demand curves to which specific markets are supposedly responding. And if we can’t do that, it becomes hard to make policy recommendations based on supply and demand considerations, since we wouldn’t know which supply and demand curves apply to households and businesses, both at a microeconomic level and at an aggregate level.

In the 1970s, the economists Hugo Sonnennschein, Rolf Mantel, and Gérard Debreu published a series of papers concerning the uniqueness and stability of general equilibrium in neoclassical economics. General equilibrium is a hypothetical macroeconomic state where aggregate supply is supposed to equal aggregate demand. Their work came in the context of earlier results from Debreu and the American economist Kenneth Arrow showing that general equilibrium could exist, but only under highly idealized assumptions which apply absolutely nowhere in the real world. The results of Sonnennschein, Mantel, and Debreu collectively became known as the “SMD theorem” after their last names. The SMD theorem states that general equilibrium, even if it exists, is neither stable nor unique. If an economy reaches a state of general equilibrium, it won’t be able to stay there. And what’s worse, there are multiple paths towards general equilibrium, opening up the problem of which path we should pursue. In short, the SMD theorem is a highly negative and deflationary result for neoclassical theory because it shows that even if you know the equilibrium prices that prevail in general equilibrium, that information cannot tell you anything about the underlying economy that actually produced those prices. In effect, there are many “microscopic configurations” that can produce the same state of general equilibrium. Later results from Alan Kirman, Donald Saari, Ivar Ekeland, Donald Brown, and Chris Shannon have only strengthened and expanded the original conclusion.

Finally, there’s the problem of interdependence. Neoclassical economists often think that supply and demand are autonomous and independent forces that jointly determine economic outcomes. That’s the fantasy. In the real world, however, supply and demand are not actually independent functions that magically settle on some equilibrium price. The two are fundamentally synergistic and interdependent, precisely because governments and corporations usually try to control both levers when they plan for the future. Large corporations actively intervene to shape and influence the demand patterns of consumers through a bewildering array of strategies. They spend hundreds of billions every year on advertising to persuade people to buy junk they don’t need. They also spend vast sums of money to lobby politicians, to make campaign contributions, and in some cases to outright bribe lawmakers to get their desired legislative result. They exploit their monopoly power to knock out potential competitors and to erect barriers to market entry, thereby substantially narrowing and limiting the available market options for consumers. This speaks to a broader truth about capitalism: markets never bring about order by themselves, they are always constructed from pre-existing orders and social structures. Dominant corporations don’t just sit around waiting until consumers “like” their products; they ruthlessly manipulate the law and the political system to shape and corner the market as they wish. The notion that economic outcomes are the product of decentralized and distributed networks is a lazy and vapid fairy tale designed to excuse the failures of the status quo.

All social and economic orders are constructed from the dynamic interplay of pre-existing class and power relations. But elites and capitalists are largely missing from neoclassical theories. In this fantasy world, it’s only consumers and regular people who make choices, like what house to purchase, where to go to college, or what business to start. The rich and the powerful apparently have no agency whatsoever. It’s not capitalists who set wages and prices; it’s the market, through spontaneous orders, invisible hands, and ghosts in the machine. In the neoclassical paradigm, the market has the same function as God did for elites in the Middle Ages: it’s a convenient deus ex machina for justifying and eternalizing the current structure of the world. In the neoclassical vision, the consequential decisions of powerful elites are reimagined and abstracted as mysterious market forces, both to legitimize the social impacts of those decisions and to obscure their true origins, making the resulting social order seem completely normal and natural instead of imposed and constructed.
In practice, it’s also quite difficult to empirically test most claims about supply and demand. Take demand as an example. Sure, it may be easy enough to notice simple correlations between rising prices and lower sales. But the “law” of demand has another part, its infamous ceteris paribus condition, “all else being equal.” This condition implies that quantities can change for many other reasons besides price fluctuations, and vice versa. The empirical problem for the economist is to show that any change along the demand curve was specifically caused by variations in prices, as opposed to the thousands of other factors that could have driven the exact same observation. But how exactly is one supposed to do that? How do you keep “all else” equal in any real-world situation? How does one account for all possible confounding factors and variables? There are numerous statistical methods in econometrics to deal with these kinds of issues, but absolutely none of them are foolproof, and neoclassical economists are infamous for creating juvenile models that explain nothing useful about the world. Unlike laws in the natural sciences, most of the claimed “laws” in economics are pseudoscientific gimmicks meant to rationalize the existing order.

The ultimate constraints on supply always come from nature, but society can and does intervene in numerous ways to adjust the levels of supply and demand that are actually available. This intervention can occur through concerted government action, through strategic economic decisions from dominant groups, through various kinds of class struggles, or through some dynamic combination of all these things. The conservative British Prime Minister Margaret Thatcher once seriously suggested, in an effort to deprioritize the role of government in solving social problems, that “there is no such thing as society. There are individual men and women, and there are families.” This is a bit like saying, “there is no such thing as a human being; there are only atoms and molecules.” And if you want to explain and understand human behavior, you must do so at the level of atomic and molecular interactions. Of course, even atoms and molecules are not the most basic constituents of nature. We can just keep the reduction going all the way through to strings and branes, if we care about consistency, and assuming that those things exist. In parroting this nonsense, Thatcher failed to grasp that what constitutes a “thing” is not just its components, but also the interactions that underlie the components, which is why the “thing” is capable of changing in the first place. Individuals do not exist in a vacuum, sunbathing on their private islands away from everyone else. Society represents the mental abstractions and organized interactions that allow people to communicate and work together. It does exist, it does affect the distribution of goods and services to individuals, and it does provide an extra lever of constraint on supply and demand. A glib statement like “prices are determined by supply and demand” means nothing unless it considers the role that various social forces played in establishing and reinforcing those cycles. In the words of economist Mariana Mazzucato, “prices and wages are often set by the powerful and paid by the weak.” Neoclassical economists largely ignore these hard realities, pretending that individual preferences somehow come out of thin air, divorced from the causal webs and structures of society and nature.

Production and Distribution

Although the concept of marginality permeates every feature of neoclassical theory, it plays an especially important role in the context of productivity and the neoclassical theory of distribution. The original goal of this theory was largely political: to defend the power of capital by telling workers that they lived in a fair and just economic system. The marginalists argued that economic agents obtain returns that are equal to their marginal products, assuming certain economic conditions. The marginal product of an input is the net gain in productive output that comes from the addition of an extra unit of that input to the productive process. This definition implies that workers earn salaries corresponding to their company’s net increase in productivity. Be more productive and you get a higher salary. Similarly, businesses earn profits that equal the net value of output they produce for society. In his influential 1899 book, Distribution of Wealth, the neoclassical economist John Bates Clark wrote: “It is the purpose of this work to show that the distribution of the income of society is controlled by a natural law, and that this law, if it worked without friction, would give to every agent of production the amount of wealth which that agent creates.” Clark continued by plainly revealing the ideological purpose of his work: “The welfare of the laboring classes depends on whether they get much or little; but their attitude toward other classes…depends chiefly on the question, whether the amount they get…is what they produce…If it were to appear that they produce an ample amount and get only a part of it, many of them would become revolutionists, and all would have the right to do so.” Translation: let’s try to justify the income that flows to capitalists by making them appear to be productive.

An immediate problem with this fairy tale was that Clark and the marginalists had no objective way of measuring marginal productivity. What is “productive output” exactly? Economists had absolutely no clue, and they still don’t. They simply assumed that a company’s sales are equivalent to its productivity, when in reality sales are just a company’s income, which can be caused by many different and complex factors. The problem with the glib notion that sales are the same thing as productive output is that it eliminates the possibility of explaining those sales through some independent measure of production, because the neoclassicals artificially defined sales to be productivity. They fell into a circular trap: the marginalists had no idea how to think of productivity independently of things like profits and wages. Instead of using productivity to explain sales, all neoclassical theory does is simply define productivity in terms of sales, then turns around and calls that an explanation. But if productivity is defined in terms of the nominal domain, then it cannot be used as a causal explanation for observations in that very same nominal domain. If X is the explanatory variable for Y, then we cannot use Y to explain X, because we’re saying nothing more than Y explains itself, which is absurd. Neoclassical economists might argue that productive outputs are explained by productive inputs like capital and labor. But this rebuttal gets them nowhere, for how are these inputs actually measured by economists? Once again, they’re practically measured in financial terms, the very same financial values that an independent notion of productivity is supposed to explain in the first place. In blindly equating productivity to monetary values, the neoclassicals lost the ability to use the concept of productivity as a way of explaining the dynamics of those monetary values. An easy analogy here is to medicine. When someone gets a fever, we all understand that the fever is a symptom of some underlying disease; it’s not the cause of anything by itself. The cause is the virus inside the body and the fever is a biological manifestation of the body fighting off the virus. In medicine, there’s an obvious difference between the cause and the symptom, and they can both be measured separately. One can measure body temperature and notice that it’s high, indicating a fever. One can also take a lab test and confirm the presence of the underlying virus. Everything in this example is conceptually simple and straightforward. But in neoclassical economics, that critical distinction between cause and effect is absolutely destroyed, to the point where the cause, productivity, and the symptom, the nominal domain of financial sales and incomes, are practically and artificially defined to be the same thing, leading to a vacuous theory devoid of any meaning.

There are also several empirical and observational issues that strongly refute the neoclassical story. From standardized test scores to observational studies in applied psychology, an overwhelming amount of empirical evidence indicates that human ability and productivity are normally distributed. They follow the familiar “bell curve” distribution common to so many other random variables, such as height and weight. However, the same thing is not true for income and wealth. It turns out that these generally follow a power law distribution. These distributions are characterized by a minority of extreme values, the “long tails” that stretch far beyond the normal range of data. The details of these statistical distributions are not important for our purposes. Here’s the only thing that matters: variations in wealth and income are far greater than variations in ability and productivity. We are forced to conclude that productivity alone cannot successfully explain the distribution of wealth and income. If salary differences reflected productivity differences, then salaries would be more or less normally distributed as well. Some very important details are obviously missing from the neoclassical theory of distribution.

Another major problem is that productivity is not simply an individual trait. It’s a social effort. In actual work environments, people have to interact and communicate with other people. Workers are not isolated towers; they are embedded in certain social and productive relations in the workplace. This interconnectivity makes it almost impossible, in practice, to disentangle the productivity of one worker from another, regardless of how we decide to measure productivity. Numerous research studies in applied psychology have revealed the fundamental importance of social familiarity and coordination on team performance and productivity. Finally, consider the aggregation problem, that recurring nightmare for neoclassical theory. In the real world, people do many different kinds of jobs. Some people work as machine operators and retail clerks, others work as insurance agents and senior marketing directors. There is no obvious unit of measurement that would apply equally well to the productivity of all these people. How do you compare the physical output of a farmer to that of a lawyer? Remember that we cannot use profits and wages because those are the very things we want to explain. The fundamental point here is that neoclassical theory has absolutely no clue how to even define productivity, separately from monetary exchanges.

Neoclassical theory has a strong fixation on justifying the profits that flow to capitalists. One of the primary ways it does so is by arguing that capital is productive, hence the owners of things like factories and machines deserve to benefit from their productivity. An immediate objection, as Marxists would point out, is that factories and machines are themselves built by human labor, so they’re only productive in a secondary and derivative sense. It’s for this reason that Marx called capital factors “dead labor.” Beyond this critique, there are also severe methodological flaws in how neoclassical economists measure and understand the concept of capital. In macroeconomics, we can supposedly measure “real” output through mathematical constructs known as aggregate production functions. An aggregate production function takes aggregated inputs, like labor and capital, and gives out the maximum possible output that those inputs can generate. There is no problem with this procedure as a general abstraction. The problems arrive specifically when the inputs and the outputs are measured in monetary terms, using dollars or some other currency. These are exactly the kinds of games that economists play in practice, despite the futility of trying to aggregate using commodity prices and distributions that diverge in highly chaotic ways. Virtually all financial aggregates that appear in macroeconomics are simply mathematical artifacts that have no concrete meaning. Let’s consider the problem of aggregating capital through monetary units. In an economy with different kinds of commodities, it does not seem obvious what units we should pick to add up things like apples, computers, and chairs. One could pick stable and reliable units, like kilograms for mass or joules for energy, but that would be too rational and scientific. Economists instead wax poetic about the “capital stock,” even though no one really knows what that means.

Textbooks pretend that the capital stock is a collection of productive factors, such as tools, equipment, and machinery. This definition is wrapped up in the ideological desire to see capital factors as productive, thereby justifying the profit rates obtained by the capitalists. But here’s the basic reason why this approach leads to absolutely nowhere. How does one compare the productivity of an office computer to that of a robotic arm operating in a factory? Capital goods are used for very different purposes; they perform different actions and produce different things. They’re “heterogenous,” to use the official term among academics. We’re faced with the problem of coming up with a common unit of measurement for heterogenous capital stocks, and most economists have no better answer than resorting to the nominal domain, using things like prices, profits, and sales as proxies for productivity. Economists ignore natural units when measuring the productivity of capital goods; they pretend to measure productivity using monetary values instead. This brings up an immediate problem. How do we measure monetary values for capital without invoking the rate of profit, which is what the valuation of capital is supposed to explain in the first place? If capital is productive and helps to explain why firms score profits, then profits cannot be used as a proxy for productivity, otherwise they would be self-caused. The value of the capital stock depends on profit rates, but profit rates themselves depend on the value of the capital stock. We are stuck in a circular loop, as many economists have recognized over the years, including the likes of Knut Wicksell, Joan Robinson, and Piero Sraffa.

To get a concrete sense of this problem, consider an oil company that wants to figure out the total financial value of its oil tankers. It assigns an average price per tanker and then multiplies the total number of tankers in its inventory by that average price. Easy right? Not so fast: oil prices fluctuate up and down, sometimes dramatically so. The company’s profit rate, along with its market value, may decline if oil prices fall sharply. And the profit rate of the company affects the sale price of the tankers. When oil is expensive, the tankers are worth more because they’re transporting an expensive commodity around. They have precious cargo on board. But when oil becomes very cheap, the tankers are generally worth less than before. Let’s be clear about the fundamental problem here. The monetary valuation of the tankers allegedly serves as a proxy for their productivity; this monetary metric of productivity is supposed to explain the profit rate of the company. However, it looks like the profit rate of the company is actually explaining the valuation of the tankers! In reality, it’s even more complicated than that because the company’s profit rate also depends on the financial valuation of its tanker fleet; it’s a two-way street. An oil company that can charge more money when it sells a tanker will obtain higher revenues, and potentially higher profits. But there’s also a flipside to this story. If the tankers are valued more “on the books,” their insurance costs might be higher, potentially hurting the profitability of the company. The central point is that the “value” of a firm’s capital stock is integrated with the company’s profit rate in highly complex ways, and the profit rate itself depends on the valuation of the capital stock.

This inescapable reality makes it extremely difficult, if not impossible, to measure the physical and “productive value” of capital in monetary terms, if we’re using the term “productive value” as a reference for the source of the profit rate. The price of capital factors is highly variable and unstable, reflecting the chaotic conditions of economic activity. When it comes to capital as an economic unit of analysis, most economists suffer from severe schizophrenia. They have defined capital as everything from a physical factor of production, like factories and vehicles, to the amount of money that a business or an individual has available for investment. Other uses and definitions are also found in the literature, suggesting that the concept is far too cryptic and ambiguous, to the point where it means virtually nothing. In refusing to specify a scientific unit for measuring capital, economists have deliberately left the concept as a vague black hole that can satisfy every wish list. Sometimes it can be physical stuff that we use in production cycles. Sometimes it can be profit. Sometimes it can be net worth. Capital is only limited by our imaginations.

Time and Money

If harping about capitalists being productive doesn’t quite explain their profits, the marginalists made sure to have another trick up their sleeve. The beauty of having an ill-defined and ambiguous theory is that the potential for rubbish is virtually endless. Because the marginalists had absolutely no idea what determines the rate of profit, they made sure to offer several potential answers. That way at least one column would remain standing if the others ever collapsed. One of those answers, the theory of time preference, originated with the Austrian economist Carl Menger and received further refinements from his compatriot Eugen von Böhm-Bawerk and the American Irving Fisher. The theory goes roughly like this. People value the consumption of goods and services in the present more than they value the consumption of the same goods and services in the future, hence the “time preference.” In order to delay the instant gratification that comes with consumption, people must either pay a price or earn a reward. The price that we pay for our time preference is interest, and the more we value consumption in the present, the more likely we are to pay a higher rate of interest when borrowing a loan. From the perspective of the lender, the situation is reversed. The lender already has lots of money. He could spend that money right now on things like consumer goods and vacations. But he could also invest it. Investing the money now means that the lender is delaying his gratification in hopes of earning a bigger reward down the road.

The reward for that delayed gratification is the interest rate that the lender demands for his investment. Different people can have different time preferences. Some might really want lots of money to spend right now, perhaps to buy a big house or something. They will usually pay high interest rates for that preference. Others might really want to invest lots of money in the present, perhaps by buying lots of stocks. They will typically expect high returns for doing so. But the basic point is this: interest rates are the costs associated with the passage of time. In this view, interest rates reflect our time preferences, not the productivity of capital. Piero Sraffa may have axed off the idea of capital as an independent factor of production, but neoclassical theory still had other ways of explaining profit rates. In the 1884 work History and Critique of Interest Theories, Böhm-Bawerk criticized socialists for ignoring the role of time in the production process. He reasoned as follows. If all commodities are produced instantly, then capitalists could never score any profits because there would be no risks and uncertainties involved. But production is distributed across time. Certain goods are produced in the short-term, then those goods are used to produce other goods in the medium-term, and then those combined goods produce other final goods in the long run. Profit is the necessary price for this “roundabout” process.

Böhm-Bawerk claimed to agree with socialists that workers should be paid the full value of their labor, but he wanted to clarify what that means by distinguishing between present value and future value. He maintained that workers can either by paid the present value of their labor right now or that they can be paid the future value of their labor in the future. But they should never be paid the future value of their work right now, which is what the socialists were suggesting, according to him. This line of thinking requires money to have a certain time value: a dollar today is worth more than a dollar a year from now because the current dollar can be invested and can start accruing some interest. Here is where Böhm-Bawerk made his critical point: because it takes time to produce commodities, the workers receive their wages before the final products that they made are sold in the market. What this implies is that a time difference exists between the compensation of the workers and the sale of the commodities. This time difference is the reason why capitalists score a profit, according to Böhm-Bawerk. Capitalists make more money from the sale of commodities to consumers than the amount they are paying to their workers because the workers are paid before the commodities are sold. In effect, the salaries of the workers are discounted to their present value from some expected future output. The workers cannot be paid the full value of what they have not yet completed, and so the capitalist takes home the difference between the full value of the product and the value of what the workers have done until now. In this view, profit is a natural part of production, not a consequence of greedy confiscation from capitalists.

Böhm-Bawerk pads his argument further with an example. He considers a worker making a steam engine. If the engine requires five years of work to manufacture and has a final price of $5,500, then the worker who produced the engine should receive $5,500, assuming he worked all five years on the engine. But suppose the worker left the job after only a year. Böhm-Bawerk asks us to think again about what wage he deserves now. One response might be that he should get $1,100, which is one-fifth of $5,500. However, Böhm-Bawerk argues that this position is wrong because $1,100 is one-fifth the price of a fully completed steam engine, which is not what the worker has produced. Instead, the worker has produced some unfinished component of what could become a steam engine four years from now. Because present goods are worth more than future goods, one-fifth of a fully finished steam engine right now should have a higher value than one-fifth of a steam engine that won’t exist for another four years. The worker should thus be paid less than $1,100, if he wants the money after one year and not after five years, when the completed steam engine can be sold. But how much less? Now we enter the realm of subjectivity; the amount of the worker’s salary depends on the discount rate that we pick. If we discount the market value of one-fifth of a steam engine at a rate of 2 percent over 5 years, then the worker would be paid about $1,000. If we pick a discount rate of 7 percent instead, then the worker would get about $800, which is obviously much less money.

But here’s a simple question that could tarnish the immaculate fantasies of the Austrians: who decides the discount rate? Who decides how much to discount the expected future value of the commodities produced by the workers? The capitalist does, of course. In effect, the capitalist establishes both the interest rate and the discount rate in one fell swoop, and he can pick whatever he wants. Nothing in this argument constrains his choice, apart from the condition that the worker’s wage should be higher than $0, otherwise the worker would be little more than a slave. The Austrians could claim that the interest rate would constrain the discount rate because the two are the same thing. But nobody knows what the interest rates will be for commodities that are sold five years from now. The capitalist knows the numbers for prior interest rates and may try to infer the future ones from those, but there is no guarantee that this hopeful extrapolation will actually materialize. The Austrians might retreat to time preference: the desire for profits now is what sets the interest rate, and the discount rate by extension. Now we have a circular quagmire. Time preference fixes the profit rate and then the profit rate establishes the time preference. The capitalist basically decides his own profit rate. This classic argument by Böhm-Bawerk, truly a masterpiece in flawed reasoning and grandiose twaddle par excellence, has made the rounds quite often in the history of neoclassical thought. But it does not invalidate the idea that capitalists exploit their workers. It simply provides new constraints on the space in which that exploitation can happen, assuming that its premises are correct. Of course, its fundamental premises are not correct, and now we can finally proceed to tear them apart.

Böhm-Bawerk picked a very convenient example for himself: a situation with a large time difference between the worker’s compensation and the sale of the commodity. But suppose we have a case with a much smaller time difference, which is certainly the case for most products that are not as complicated as a steam engine. Even with a marginal time difference, capitalists routinely score huge profit rates. This is true even once you take into account the roundabout nature of production, the fact that several stages of labor and goods are involved in the delivery of a final commodity for exchange. Production cycles with quick turnarounds are not only capable of delivering huge profits, they are the fundamental basis of those profits. As we’re going to see, a major economic goal of technological development is to speed up dynamical cycles by delivering more services and commodities in a given unit of time. Faster dynamical cycles coupled to a liquid monetary environment generate larger networks of circulation and distribution. The general rate of profit then represents a changing order parameter that tracks how much influence dominant capitalists have over the dynamical and distributional cycles in the economy. Contra Böhm-Bawerk, capitalists do not derive their value from the passage of time. They derive value and power from differential accumulation, from the fact that they strive to control and accumulate more stuff than other peer competitors. It follows that time difference cannot be an important factor in the determination of interest rates. Money has absolutely no inherent time value. The idea that long-term profit rates should be positive is simply a transitory and historically contingent phenomenon of modern capitalism, incessantly parroted by the rich and ingrained in society more broadly as a pervasive cultural expectation.

Nor does his argument translate very neatly into our contemporary age of financial capitalism, where the time differences involved could be a few minutes, much less months or years. Consider a stock broker who must convince clients to keep buying stocks. For every successful transaction, the broker earns a commission fee. But she does not keep the entire commission; she must split it with the brokerage firm. However, the present value of her labor is the full commission, which is being delivered right now, not five years later. If she deserves the present value of her work, she should get the entire commission, according to a straightforward reading of Böhm-Bawerk. His argument also has nothing useful to say about arbitrage, the buying and selling of assets for the purpose of exploiting a price difference between two markets. A high frequency trader that buys an asset at one price and then sells it in a different market for a slightly higher price, all in the fraction of a second, can make a huge profit while incurring virtually no risk at all during the transaction. High frequency trading is now a major component of the modern financial system, making up to a quarter of all trading volumes according to some studies, if not more. The neoclassical fantasy genre claims that arbitrage opportunities should not exist, or should disappear very quickly. But not only do they exist, they proliferate widely in currency markets across the world and deliver consistent returns spanning decades, so clearly some capitalists are making huge profits without batting an eyelash about risks and time preferences.
Finally, consider some major structural features of modern financial systems in the Western world and how they combine to reduce or eliminate risks. All members banks of the Federal Reserve System used to obtain a virtually guaranteed six percent annual dividend on their invested assets in the Federal Reserve, the central bank of the United States. Smaller financial institutions are still receiving the dividend to this day. I say “virtually” guaranteed because the Federal Reserve must score a profit to hand out those dividends, but “earning” this profit is a mere formality since the Federal Reserve controls the money supply for the entire country. This brings up an even more fundamental point: the biggest banks and lenders in the Western financial system, from JP Morgan to BNP Paribas, can practically do whatever they want without incurring any systemic risks because of their strategic alliances with the state. If some shocking event happens and threatens their very existence, the government has and will always intervene to save them from collapsing, given their importance to the wider economy. Citigroup has been bailed out by the United States government no less than three times in the past century. Risk and time preference have nothing to do with the handsome profits of the major private banks; these profits largely derive from their fortunate strategic position in the wider class and political architecture of modern capitalism.

At this point, the marginalists may decide that other factors besides time are involved in setting interest rates. But whatever reductionist approach they choose will also explain very little in the end, because the core problem is not with their arguments, but with the assumptions behind their arguments. When the marginalists weaved together a simple tale about returns and productivity, people like Robinson and Sraffa could at least refute their bedtime stories on the basis of mathematical reasoning. But when it comes to time preference, the issues involved are far more nuanced and philosophical. As an offshoot of the subjective theory of value, time preference suffers from the same problems. The marginalists claim that multiple interest rates can exist for the same economic process because people have different time preferences. That leaves open the problem of explaining why people have different time preferences. The subjective theory of value turned out to provide no useful basis for understanding economic behavior, even as an emergent explanation of the world, and the concept of time preference does not fare any better. Consider the most basic claim of the theory: that we value consumption in the present more than consumption in the future. This claim implicitly assumes that we have complete information about the future, otherwise we could never know how much we value future consumption. But no one has complete information about the future, and thus no one really knows how much they would value future consumption. They can certainly estimate and anticipate future levels of investment and consumption, but this assertion is an entirely different one than the claim about what people actually value at different points in time. We simply have no idea how much value we would attach to consuming a slice of pizza next year versus having one right now. Maybe some unique life event intervenes next year and makes you value the consumption of pizza even more. But you would never know anything about that right now.

The Austrians could respond by saying that people value the certainty of the present over the uncertainty of the future. You may not even live to see next year, so it’s better to have that pizza now instead of counting on it later. This claim is certainly true for many people, but it still does not explain the degree to which we value certainty over risk and uncertainty. It does not explain the vast divergences in the way that people order their time preferences, in the way that they consider, tolerate, and understand the nature of risk. The marginalists fail to grasp that our time preferences are coupled to our social expectations and economic realities. Consider how the United States government prevented the collapse of so many major companies during the Great Recession, including heavyweights like AIG and General Motors. During the coronavirus pandemic in 2020, the federal government essentially bailed out entire industries, such as airlines and hotels, by pumping them with cash and extending generous loans. A capitalist who has managed to secure generous government subsidies for his business will have a very different perception of risk than many of his counterparts, who may not have been that lucky. But it would then be the height of folly to attribute the profit rates of this capitalist exclusively to his time preference for investment, which depended heavily on external factors all along. Again, these examples are not some silly abstractions; they happen quite frequently in capitalist economies and have a huge impact on the bottom line. Private capital in the West seems to be on the verge of collapse about once every decade, and direct intervention from the state is the only thing that saves it.

Böhm-Bawerk said that capitalists deserve their profits now because the production process takes place over time. But there are other complex dimensions to the production process besides time. Production certainly unfolds in time, but it also unfolds in space and becomes embedded in the particular social and economic relations that prevail within that space. A capitalist who wants to shutter a plant in the United States and open up a new factory in a place like India or Vietnam, where labor costs are lower and the governments crush workplace dissent, immediately knows that a wide array of complex social and political factors are about to boost his profit rate. The foreign government trying to entice the capitalist to move his business could even offer numerous kinds of financial bribes and sweeteners to seal the deal. The overall effect for the capitalist is that his investments now face a much lower risk profile. In other words, the idea that capitalists deserve whatever profits they get because they are taking huge risks with their money is an absurdity, precisely because dominant capitalists, through their power and wealth, are able to find many social, political, and economic methods to either eliminate or severely curtail their exposure to risk.
Capitalists work really hard at minimizing and socializing the risks involved with their business adventures. When things inevitably go wrong, they are usually shielded from the consequences. Here we see another example of the profound limits with the methodological individualism championed by the marginalists. Viewing people as a bunch of disconnected units with random tastes and preferences is the epitome of missing the forest for the trees. Human beings are very much aware and alert to the most important fact about our social existence: that we have to share the world with other people and that those people have a huge influence on what we do in life, whether we like it or not….