In the 17th century, France was a dominant power, considered the leading force of a new world order. But then things started going wrong. France was losing a war against the much smaller and less wealthy England. How was that possible? What was France doing wrong? To answer such questions, a group of professionals (mainly physicians) gathered together and started a new science – the science of economics. They became known as the physiocrats. They were heavily influenced by the new ‘dawn of humankind’ (what we now call the Age of Enlightenment) and the scientific revolution ignited by Isaac Newton, and wanted to put the economy onto the foundations of ‘natural philosophy’ or science. Although in favour of ‘freeing’ trade, the physiocrats were not in favour of capitalism and called bankers the sterile class and parasites (as they were not producing something). Above all, they believed that agriculture was the basis of all economy and therefore the most important activity. The physiocrats had some initial success and influenced Adam Smith. However, the Western world was going through radical change and steadily moving in a different direction from the one they espoused. The pieces of printed paper that we discussed above became more important than the goods themselves, and the ‘sterile class’ became more powerful than the food producers. Welcome to capitalism! Capitalism stood up on these two legs: one being the business of investment, understanding the potential of money to generate wealth rather than just being a convenient means for the exchange of goods; and the other being consumerism, based on mass production and mass consumption. Let’s start with the former.

Impersonal investment

There is no doubt that investment is a defining feature of capitalism. After all, capitalism’s very name comes from capital, another term for investment. However, this is a bit more complicated: when a hunter, millennia ago, gave a fur or two in exchange for a bronze spear tip, he invested in his business, but he was hardly a capitalist. Capitalism is defined by special types of investment, hence the addition of impersonal in the title. Getting to that point was a long and gradual process. To make it clearer, investment too is categorised by ‘degrees of separation’ (in this case, from production or the invested).

The zero degree of separation is when you invest in your own affairs. You put aside some money you have earned, and when you save enough you invest in starting or expanding your business. This is commendable, morally and otherwise. Even in the case of inherited money, as a rule of thumb, it is better for society as a whole that beneficiaries invest that money in a business rather than spending it on hedonistic pleasures (e.g. buying valuable pieces of art that only they, rather than the general public, can enjoy). Such an investment, of course, existed in other social systems. It is not a defining feature of capitalism and, even more importantly, could not by itself sustain capitalism. Linking this kind of investment to capitalism may have a romantic appeal, but capitalism could not survive by relying on it.

 The first degree of separation is when people who know you – your friends or family members (including extended families) – invest in your business. Usually, those who ‘made it’ would help others from their close-knit community to start their business. This is still common in some cultures and societies, but is also not a defining feature of capitalism. Many pre-capitalist societies operated with such a system and, indeed, it can still be a primary source of investment, although only in societies in which capitalism is not yet in full swing.

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The second degree of separation is more typical for capitalism. It involves professional investors who don’t know or care about you but think that they can make money out of your business. This is how impersonal investment started, leading to stocks and shares. It was an incredibly useful invention. Imagine this: you have a great idea for making money, but you are poor – you don’t have the capital to put this great idea into practice. As not many poor people have rich friends or relatives, professional investors are there to fill in the gap. Collaboration between an entrepreneurial individual or an inventor and those with money allows for the creation of something new or something needed, from which not only the inventor and the investors benefit, but also those who buy the product. It seems to be a win-win situation, without which many good ideas would never have had a chance (we would have to rely on those who were both rich and inventive, but the rich are less motivated to invent something, and the pool of potential inventors would be much smaller). This system also offers the poor an opportunity to rise on the basis of their own merits. Persuade the investors that your business idea is sound, and you get money to make it happen. It seems only fair that investors and bankers get a handsome return for their investment, as they are taking a risk – nobody can ever be completely sure that a particular business or idea will work.

So far, so good. But things get more complicated. If investors put money into your business, how do they know that you will honour the deal? They can ask for a written guarantee that you will pay them back with some interest (to cover the risk). But, what sort of interest? Well, this is difficult to set in advance – your idea and the resulting business can make a little money, a lot of money, or fail completely. The way to get around this conundrum is to become a shareholder – the investors own a part of your business, so if it makes little money, they get little return, if it makes a lot of money, they get a lot in return. Such a deal works well for a businessperson and for the investor, and it is not surprising that it quickly caught on. Furthermore, this type of investment also reduces nepotism and corruption. Relying only on friends and family for running a business may result in too much looking inward, which is not conducive for society as a whole.

The third degree of separation: the second degree of separation was so successful that, unlike in other cases, the third degree followed almost straight away: people quickly discovered that it was possible and lucrative to trade in the papers that shareholders receive, which created another economic layer. Stocks and shares were traded even if the traders had nothing to do with the products or goods associated with them. You buy and sell product futures or company shares without ever seeing or having any contact with the product or company. Why would you do that? Because you believe that the value of those futures or shares (not the value of the product or company) will either grow or fall. Welcome to the stock market! In a nutshell, as the financial term futures hints, it is all about trading in the future. A new psychological component, belief in the future, entered the fray – in other words, speculation, an attempt to make something out of nothing (as the future doesn’t exist yet): investing money to make more money, without producing anything or providing any substantial services. This degree of separation, unique to capitalism, is based on an ingenious idea: profit can be made without relating in any way to the real product or the service behind it. Consequently, the investment ceases to have a real connection with the production. You buy something not because you need it, or like it, or even know much about it, but simply because you believe that its value will increase in the future. One consequence of this is that the pivot of the system is no longer in physical reality or in society, but in the psychology of the individual.

Now, imagine your neighbour hears that the shares you have invested in have grown in value and they want some too. If you need money, you may put a price on your shares and sell them to them. Your neighbour’s neighbour wants a piece of that pie too. So, your neighbour thinks “why not make some quick money by selling the shares to them for a higher price than I paid for them?’ This expands and soon the whole village, region and country is in a frenzy. The vast majority of the people buying and selling know nothing about the business behind it all, or those who run it. They only know that they can make money by buying and selling the piece of paper. However, this cannot, of course, go on forever. At a certain point, people start realising that the value of the shares is greater than what the business behind it can ever actually make and they now want to get rid of their shares as soon as possible. So, the aim of the game is to sell the piece of paper when the peak is reached (and it has to be reached because of the shifting ratio between supply and demand). Everybody wants to get as close as possible to that peak point – holding on to the shares while the price is rising and selling them just before they start falling. Whoever buys the shares from those who got it right is going to be a loser. This sort of trading is always a gamble and, as in any gamble, some (those who buy after the peak is reached) must lose. The win-win game becomes a win-lose game, and those who desperately tried to buy, now equally desperately try to sell. This is the story of all economic bubbles or booms and busts. They are not aberrations, but inherent to capitalism. Indeed, this cycle made an appearance in the very early days of the first stock exchanges. As mentioned, the Netherlands was the leading country in developing the banking system and creating the financial market. It was also where, shortly afterwards, the first boom and bust – the infamous tulip mania of 1636-37 – took place.

Even if this degree of separation is socially not very useful and creates regular financial crises, its allure has proved irresistible and the separation between investment and production has continued to an exponential degree. We will return to this a little bit later. For now, let’s consider consumerism – the other leg of capitalism.

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Nowadays, consumerism gets, by and large, a bad press and rightly so. But to begin with, consumerism was a positive development. New things and things that had previously been available only to the privileged few, suddenly became available to the majority. Everybody wants to have a washing machine, right? So, let’s go back in history for a moment to understand how consumerism started and how something good turned into something bad when pushed too far. Consumerism here refers to mass consumption, as well as mass production, without which mass consumption would not be possible. Of course, production (if used as a generic term for various kinds of provisions) and consumption have always existed. What is unique to capitalism is the ‘mass’ element. To get there, production and consumption have also gone through the increasing degrees of separation.

The zero degree of separation between production and needs is when one fends for oneself (and perhaps one’s immediate family). Throughout a large part of human history, and even nowadays in some places, there was no separation between the ‘producer’ and the ‘consumer’. By and large, people would make their own clothes, build their own shelters, and consume what they grow, find or catch.

The first degree of separation occurred with the advent of agriculture, trade and the division of social roles. The producer was no longer necessarily the consumer of the products. However, at this degree of separation, the demand always preceded the supply. There are still occurrences of this. For example, you go to a tailor to get a new suit. The tailor will take your measurements and ask you what you want; only then will they start making your suit. This was common in pre-capitalist societies, but is inefficient for mass production and mass consumption.

The second degree of separation is unique to capitalism, as it enabled mass production and consumption. We are so used to it, that it is easy to overlook how ingenious it is. In the second degree of separation, supply precedes demand. In other words, you produce for anticipated customers. This is what we are all familiar with: you go to a shop and choose from garments that already exist. Developers usually build houses not because somebody asks them to, but because they anticipate that there will be a demand for these houses. In previous eras, if you wanted a house, you built it yourself or found somebody to build it for you. The capitalist innovation was that the houses were built not to order, but in an anticipation of potential buyers[1]. So, the suppliers speculate that there will be a need for their product. But this can be risky, so why do they do it? The answer, quite simply, is because even very small profit can, if the item is mass produced, generate enormous wealth (in comparison with a big profit on a very small number of items). This, however, requires new means of production. While the Dutch were busy developing the banking system and financial market, something out of the ordinary was happening on an island nearby: the rise of machines. There are a number of reasons why the Industrial Revolution (starting in earnest in the second half of the 18th century) took place in Britain:

  • Economic: Britain at that time had more waged labour than any other country in Europe or any other part of the world. England’s population (prior to the union with Scotland in 1707) had been decimated by plague in the 16th century and civil war in the 17th century, reducing the availability of labour and therefore making it more expensive. At the start of the 18th century, labour costs still remained relatively high. This had several consequences:
    • It paid to invent and make machines, as they could be cheaper than employing the waged workforce. In countries where labour was cheap, there was no incentive to make and use machinery as it would be more expensive.
    • A relatively large number of people had disposable income. Therefore, it was possible and worthwhile to mass-produce as well as develop the science and technology that would enable this.
    • Some people invested their extra money in the education of their children, who could then operate the machinery.
  • Geographical and environmental: Britain had huge reserves of easily accessible coal, and developed a network of canals that enabled fairly fast transport. Moreover, being an island, Britain already had a formidable navy and was in a very good position to use it as the major trade routes shifted from the Mediterranean and Middle East to the Americas, India and the Far East.
  • Intellectual: since the time of Newton in the late 16th century, Britain had become a centre of the scientific revolution that underpinned the industrial one.
  • Political: the parliamentary system was less centralised and consequently less bureaucratic than, for example, the political system in France. This allowed for much faster implementation of technological innovations.
  • Socio-political: urbanisation and the rise of the middle class were conducive not only to the Industrial Revolution, but also to mass consumption and production.
  • Religious: cultural influences embedded in religion (the so-called protestant work ethic) were also conducive to the rise of capitalism and the Industrial Revolution as its engine. Making money was no longer considered at odds with spirituality.

All these factors contributed to this monumental shift, but rather than seeing them as multiple causes, the Industrial Revolution should be viewed as arising from their dynamic interdependent relationships (as complexity theory would have it). A form of proto-capitalism called mercantilism, to which Adam Smith was vehemently opposed, already existed, but the Industrial Revolution gave capitalism a real push and brought it to maturity. For example, in 1500, China was the world’s biggest manufacturer. And yet within a century or so, much smaller Britain had taken the mantle. In fact, China’s decline was partly due to the Industrial Revolution taking place on the other side of the globe. In 1750, 33% of the world’s manufacturing took place in China and 25% in India; by 1913, the UK, the USA and Europe accounted for 75% of the total, while Chinese and Indian shares of world manufacturing dropped to just 4% and 1% respectively (Allen, 2011). Of course, colonial powers having an upper hand played a part in this shift, but the faster and cheaper manufacture mattered too – and, in fact, gave a further push to colonialism.

The Industrial Revolution enabled mass production, but a market in which to sell the new products was also needed. Mass production necessitates mass consumption. Capitalism requires that the majority of the population are not capitalists, but consumers. This means that a large segment of the population needs to spend money rather than save or invest it – if everybody was a capitalist, capitalism would cease to exist! When the internal market is not big enough, the seller must look abroad. The products need to be sold, and if this requires elbowing or arm twisting, so be it. Britain, France, the Netherlands and other European countries were fighting for colonies and spheres of influence not only because of the resources they provided, but also because of the markets they badly needed (hence the Opium War with China, for example). Send boats that will bring back silk, spices, raw materials, etc. with something to sell first, and you will make more profit than if you send them empty. The developing capitalist countries at that time (now considered developed countries) kept their tariffs and carefully guarded their economic borders, while forcefully trying to sell abroad. As a side note, it is ironic that the neo-liberals try to impose openness to the free market on today’s developing countries, when none of the already-developed countries had open borders when they were developing. However, rising inequality, coupled with competition, soon saturated the market. The world was not endless after all. So, other ways of increasing consumption needed to be found – leading to further degrees of separation, to which we will turn shortly.

To summarise, capitalism rose on these two legs (investment and consumerism) and it still depends on them. Other things such as (limited) mass education and (limited) democracy followed. We can see that there was a whole web of dynamic, interdependent relationships between a number of factors that led to the ascent of capitalism in Western Europe. This web does not need to be replicated in order to have industrialisation and capitalism, but the two legs we’ve identified are necessary anywhere, not just where they originated. That said, there were two remaining features that helped capitalism flex its muscle: quantification and competition.

[1] Food markets had seemingly operated in a similar way long before capitalism. However, the farmers in the past produced what they could (depending on the environment) mostly for themselves and the ruling class, and offered the surplus at a market. They did not produce something because they anticipated the need, but hoped that at least some people in the market would want what they had.

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